This post first appeared on April 10, 2008
Floyd Norris of the New York Times, in an otherwise fine piece, “It’s a Crisis, And Ideas Are Scarce” has a paragraph that set my teeth on edge. But let’s deal with the parts that have merit first, and hold the rant in abeyance.
Norris uses the Paul Volcker’s speech at the Economic Club of New York this week as a point of departure, covering it in more detail than other commentators:
Paul Volcker, the former Federal Reserve chairman whose legacy has not crumbled since he left office, was right this week when he said the financial engineers had created “a demonstrably fragile financial system that has produced unimaginable wealth for some, while repeatedly risking a cascading breakdown of the system as a whole.”….
“Any return to heavily regulated, bank-dominated, nationally insulated markets is pure nostalgia, not possible in this world of sophisticated financial techniques made possible by the wonders of electronic technology,” he said.
In any case, the banks are not all that healthy anyway, thanks to their losses from the strange securities created under the new system…..
Regulation needs to be strengthened, particularly for investment banks. Providing a safety net brings, in Mr. Volcker’s words, “a direct responsibility for oversight and regulation.” He forecast that “investment banks are going to end up with a leverage ratio imposed upon them.” And one lesson of this disaster is that having parallel financial institutions — one regulated and one not — simply drives activity to the unregulated area, at least until something blows up….
It is also clear that the efforts being made to cut back American regulation, in the name of making our markets more competitive, are attempts to deal with the wrong issue. To quote Mr. Volcker again, “For financial regulation in general, competition in regulatory laxity cannot be a tolerable approach.”….
Mr. Volcker, who knows how inflation can get out of hand, said the current situation reminds him of the early 1970’s, when inflation began to accelerate. The Fed’s moves to slash short-term interest rates and bail out Wall Street, however necessary they may be, could easily raise inflation and cause more damage to the weak dollar.
Volcker puts his finger on the central problem, the the securitization model, aka “originate and distribute,” has broken down. New issuance volumes are off dramatically in all product areas. But what is more troubling is that many types of securitized products depended on credit enhancement, and that does not appear to be coming back anytime soon, if ever (at least in anywhere near the same volumes). Note how many “rescue the housing market” plans rely on federal guarantees (Fannie, Freddie, FHA), an indirect acknowledgment of the problem.
Yet the consensus view, which increasingly appears to be wishful thinking, is securitization will come back once the credit crisis is past the acute phase. Yet look at the elements that appear irretrievably damaged: monolines, key providers of credit touch-ups, have renounced the structured finance business. Credit default swaps, another important source of credit improvement, are suffering from a shortage of protection-writers (among them the bond guarantors) and other former sources of credit enhancement (hedge funds and investment banks) are now correctly regarded as less secure. That leaves overcollateralization as the only readily available means for creating the desirable AAA tranches out of pools of less than stellar assets. It isn’t yet clear what that means for the structured credit business going forward,
In addition, with rating agency reputations in tatters and many investors burned by buying pseudo AAA paper, it may be a very long time before investor confidence is restored. It may not occur in the absence of reforms that have teeth.
Yet even the astute Volcker does not appear to have considered the possibility that the securitization process will remain largely non-operative until root-and-branch re-regulation is in place to entice investors back into the pool (no pun intended). That implies that in the meantime, on-balance-sheet credit intermediation will assume a large role. But that requires far more financial firm capital (the resulting bigger balance sheets dictate larger equity bases) precisely at a time when losses are shrinking bank capital and new equity is costly and hard to procure.
Now to the offending part. From Norris:
At the same time, there is a limit to the usefulness of finger-pointing. Most of the critics — myself included — did not anticipate the severity of the credit collapse, and we should not act as if the executives and regulators who failed to prevent it were blind or stupid. Rather than go into self-defensive crouches, those people need to use hindsight to ameliorate the mess.
I can’t fathom where Norris’ concern about an excess of “finger pointing” (except perhaps at Greenspan) comes from. If anything, there has been too little, rather than too much, investigation of how we got where we are.
Consider the contrast. In 1987, after the stock market crash, the so-called Brady Commission (formally, the Presidential Task Force on Market Mechanisms) was established a bit more than two weeks after the crisis. Admittedly, the stock market meltdown was a discrete event, while our credit crisis has been an slow-moving train wreck. Nevertheless, the Brady Commission working oars were not part of the regulatory apparatus; its executive director was a Harvard Business School finance professor, Robert Glauber; the staffers came heavily from the private sector. This gave them the freedom to look at deficient practices without incurring the ill will of people in their field.
By contrast, consider Bernanke’s in a speech yesterday, “Addressing Weaknesses in the Global Financial Markets,” of the measures taken to understand the roots of our current financial mess:
In the United States, policymakers’ efforts to identify the sources of the financial turmoil and the appropriate public- and private-sector responses have been coordinated through the President’s Working Group on Financial Markets (PWG), chaired by the Secretary of the Treasury. The group’s other principals include the heads of the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission, and the Board of Governors of the Federal Reserve System. With the support of the staff of the respective agencies, the PWG began to address these issues last fall, as the severity of the financial turmoil became increasingly apparent; in mid-March, we issued a brief statement outlining our tentative conclusions and policy recommendations.1 At the international level, the Financial Stability Forum (FSF), whose membership consists of central bankers, regulators, and finance ministers from many countries, including the United States, will also soon release a report on the causes of and potential responses to the turmoil.
There has been no independent investigation by people who had access to the key actors and relevant documents. No matter how well intended the regulators and government officials looking into the credit crunch might be, it simply isn’t human nature to point fingers at oneself.
Similarly, I don’t place much stock in Norris’ “I didn’t think it would get this bad, therefore no one should be held accountable for missing it.” With all due respect, Norris may be well connected, but that is not the same as being an insider (see Daniel Ellsberg’s book Secrets for long-form treatment of this topic). And there were few Cassandras with far less access than Norris who did see this coming. We shouldn’t shy away from understanding why those who should have known better chose instead the convenient path of wishful thinking and willful denial.
I like his logic that “Because I didn’t see it coming, therefore it’s not a matter of stupidity and criminality, so let’s not point fingers.”
I don’t think that follows, Einstein. That just means you were an idiot and/or derelict as well. At the very best it means you’re incompetent and should be fired, since we need and deserve much, much better media watchdogs, if that’s at all what you claim to be.
Of course Norris and the rest of the media hacks led the propaganda charge telling the people “You just go about your business, Wall Street has everything well in hand.” So anyone outside the elite has a right to point strict liability fingers at anyone within the elite who wasn’t sounding the alarm.
(I actually think Norris has been relatively one of the better ones. If Morgenson’s the only NYT columnist I’d say has been any good, Norris was the next least bad. But that’s in part because I did’t recall seeing this kind of exculpatory lie coming from him.)
I love the “reruns,” but I’d love to see some side-by-side hindsight commentary, too. You wrote a whole book about the crisis that was “unforseeable,” and it would be fun to see some current “Yves, here” comments interspersed in bold-italics with your original thoughts talking about how things have proven out. I’m sure your selection is based on your view of the validity of your stated predictions of the time, but a lot of people will start from right now, not the time of your original post. It would be good to provide some guideposts.
Of course the NYT doesn’t want anyone to look at the role of the CRA or the madness of the “subprime” philosophy at Fannie and Freddie.
For someone (other than Peter Schiff) who saw clearly that the train was going to go off the tracks (as a result of an asset bubble), see “The Dollar Crisis” by Richard Duncan.
Thank you. Elected officials have done an incredible job of deflecting blame for any of this, and the media is complicit. With all the talk of bailing out “Wall Street” and the banks, the biggest bailout of all is the govt bailing itself out (FN/FH), to the tune of $200 billion (but expected to quadruple). So, let’s all give them some more money, they’re so good with it…
Because the CRA and FNM/FRE had absolutely nothing to do with unregulated Wall St firms imploding. Lehman, Merrill, and Bear dealt in non-conforming mortgages for the most part and they did so willingly – they were not “forced” to like AM radio idiots endlessly repeat as a lie.
These people live in their own bubble. But when it fails, it pops us, not them.
I was recently down in Virginia doing landscape photography in the Manassas Battlefield National Park. The Virginia landscapes are beautiful — soft, undulating, rhythmically punctuated by stately trees standing alone in rolling grassy fields, with distant hills and powder blue sky behind.
There is a churchlike sense of quiet there, which is befitting the place. The only sound is the wind.
It’s strange to consider the violence that raged there, as I suppose it is on any former arena of war. But the thought has crossed my mind more than once, that if the nation were divided militarily — with the banksters and their political hack supporters on one side — and us and our looted honor and looted treasure on the other, and if there were the equivalent of a Fort Sumpter. Then the shooting would have started already by now.
And for anyone to say — after years of NINJA loans, liar loans, one TV commercial after another offering unbelievable credit terms, the hyperbolic surge in housing prices vs. rents vs. income, repeated warnings by many sober financial commentators, etc. etc. — that who could have see this coming, then they are so lost in the self-enriching bubble of their own fantasy world that they are implicitly disqualified to opine intelligently on anything related to money, banking or economics.
They should leave the public stage as a matter of honor and dignity and for the good of society. Unless, that is, they are willing to own up to their errors and to make a public service of themselves as icons of corrupted power and redemption through confession, honesty and a redoubled effort to forge an economic system that promotes social and financial justice.
I don’t take any pride in saying this, but several people (myself included) did call this way back in 1995, when the Rubin-Greenspan-Graham trio began their push to repeal Glass-Steagall. Problem was (is) nobody paid any attention because the vested interests in “making our financial markets competitive for the future” trumped all else. Well now were paying the price. And that price will be a fundamental crisis of capitalism. This isn’t a double dip. This isn’t the second great depression. This will become a crisis of the survival of capitalism, because the brand of capitalism that has taken root is pernicious and destructive to the fundamental principles of democracy and capitalism that once took hold in the US. Our system is broken beyond repair. Nothing, short of a massive revolution. And that’s not going to happen because our slow insidious march toward our own societal unraveling is happening right under our noses and it’ll be too late before we know what happened.
Actually, several political groups and one individual called this back in 1978. If you go back and read the newspapers published that year you should come across some of those political groups.
The one person who called it, correctly called three other global events (simply from extrapolating from the known data back then, including the exact year of the dissolution of the Soviet Union).
His prediction for capitalism: its death by the end of 2012.
When I was a teen in the 60’s and asked my father what the Vietnam war was about, he replied that “All wars are about economics.” As an O.S.S. interrogator of the German High Command, he had been amazed at the sheepish demeanor of the “Invincibles”. Considerering our great relations with both Japan and Germany today, the waste seems such a tradegy. But we are entering a similar economic scene, hopefully we can hold those accountable before we destroy all else.
“Yet the consensus view, which increasingly appears to be wishful thinking,is securitization will come back once the credit crisis is past the acute phase.”
Besides, rating agencies regaining their credibility, the values of the assets being securitized will have to find their natural (not Gov supported) levels. Else it matters not what rating the agencies are giving the paper, the once bitten twice shy investor doesn’t want to touch a sandcastle.
As they say in IT, that’s not a bug, that’s a feature.