Dear Readers: A new essay from Professor Athena, a highly placed executive in a major financial institution.
What Next? Nell Fenwick Tied to a Railroad Track?!
In the course of this recent financial crisis, the press and Congress who panders to public opinion (votes) has searched endlessly for the villain. After the meltdown that occurred in 3Q 2008, the play is nearing the final act and the villain is at last revealed. It is Goldman Sachs.
As has been widely reported, Goldman was paid out in full on their CDS contracts with AIG courtesy of the taxpayers. They reported record earnings in successive quarters. They seemed among Wall Street firms to have skated through as Dudley Do-Right the fair-haired hero, while players like Lehman and Merrill Lynch fell by the wayside. They had Warren Buffett as a key investor and friends among the current administration in power. But wait. They played both sides of the same transaction involving subprime mortgages? Never mind that’s the very definition of broker/dealer. Never mind that it was totally legal. On thin evidence of fraud but ample evidence of malicious greed, they are faced with a hanging mob led by the likes of Sen. Carl Levin and those who blog on Slate.com. All of this should strike some as the height of irony if not completely politically convenient. A friend who works for a large and extremely well-capitalized foreign bank pointed out to me just this morning that Goldman may be accepting the role of villain so as to fire a few people, pay big fines, and an off-stage whisper is faintly heard that “if you are patient you can get rich, because cap-and-trade is just around the corner and all the carbon credits you can dream of”. This is truly a diabolical plot twist. If we were looking at a cartoon of Snidely Whiplash, he would have dollar signs for eyes at this point. Holy smokes, Rocky and Bullwinkle!
The truth of the proposed financial reform bill (a mere 1400 pages) is that it does not do three important things. It does not eliminate the “too big to fail” problem. It does nothing to address FNMA and FHLMC, the biggest contributors by far to the explosion of product in the subprime lending markets. It does nothing for the consumer and small business, despite creating another layer of bureaucracy disguised as a financial consumer protection watchdog. It will instead make a bad situation worse. Republicans were right to oppose its passage as it is and to demand a better bill.
If Congress truly cared about addressing what caused the current financial meltdown so as to prevent a potential reoccurrence of it, they could do two things that would change the risk landscape for everyone:
- 1. They could pass legislation to make it illegal going forward to lend more than 80% of appraised value on a residential home mortgage inclusive of all existing debt (applying also to second mortgages). Anything over 80% of valuation using three MAI appraisals averaged would required PMI (private mortgage insurance). If these standards seem at first blush too strict, they are what was used since the 1950’s up until the 1990’s, and we had no housing meltdown and corresponding financial system meltdown over 40+ years of home ownership. Lending more is indeed irresponsible and usurous, in that it sets the borrower up to lose their home if prices decline slightly. It also sets someone up with a precarious and risky asset. It should be eliminated, and when it is the CDS markets won’t have a place to go with whole loan bets. End of the party and back to boring assets that generate a dependable cash flow stream. End of problems in the future for FNMA and FHLMC, since they go back to how their portfolios were structured (with high-quality, conforming loans) prior to 1990.
- They could pass in the same legislation oversight of CDS markets ONLY (not cocoa futures, not rice and soybeans and oil) to require a central clearinghouse and to require insurance underwriters and other contraparties to set aside physical collateralization of CDS contracts, complete with inherent margin calls. No more repeats of a situation where a company has only 400 million in total capital and 3.5 billion outstanding in CDS. A standard futures trading market with margin calls will solve this other backroom poker party. As Wall Street would say, “Stick a fork in it, it’s done”. This would allow true hedgers (who own the underlying stock in case of equity hedging, or who own the underlying commodity in the case of physical commodities) to go about their performances in accordance with business as usual. The spec-er’s will have to deal with collateralized positions and margin calls. They had a free ride on the unregulated financial products merry-go-round much too long.
As a business person with over 30 years experience in fixed income institutional investing, but especially where financial regulatory reform is concerned, I am a pragmatist. It matters much less to me who is responsible for the problems, because there is plenty of blame to go around. It matters to me that the problem be fixed on a permanent basis as best we can, in order to eliminate risk going forward for everyone involved. I think one thing we have learned from the financial crisis is that what happens on Wall Street impacts the average American much more than previously imagined. Financial liquidity freezes mean loans are not made and businesses fail. A credit crisis is not a good thing. Having unsold homes is not a good thing. Losing your job is not a good thing. Losing confidence that you are being told the total situation about a financial product is not a good thing. And especially ballooning our federal deficit to bail out selected companies at the expense of hard-working American taxpayers is not a good thing.
The hard thing is to admit what we did wrong, and to fix it by making lending policy changes going forward that solidify our economy with respect to the housing markets. The easy thing is to vilify Goldman Sachs. This administration is booing and hissing all the way to the finale. They are doing far less to fix the real problems.
In a related post, Bizzyblog details something all we Tea Party Patriots understand: ‘Financial Reform’ Is a Massive Power Grab
Yes, today, there is even more Obama Kabuki Theater to enjoy!