Links on Financial Fiascos

A series of links from the last week or so

Charleis Gasparino's work on the crash
Book Review: "The Sellout" - WSJ.com

This goes way back:

"So what made 2008 so much worse? For one thing, the market was in the throes of a housing mania so intense that a leading lender, New Century Financial, touted its ability to generate a mortgage offer in as little as 12 seconds. For another, the government had made a series of horrendous policy decisions that, as Mr. Gasparino shows, encouraged financial firms to go long on housing in ways that would have once been unimaginable.

In 1995, Henry Cisneros, the secretary of housing and urban development, directed Fannie Mae and Freddie Mac—two "government-sponsored enterprises" in housing finance—to buy and guarantee mortgages of low- and moderate-income borrowers amounting to 42% of their annual business volume. His successor, Andrew Cuomo, moved the number up to 50% and directed Fannie and Freddie to buy the mortgages of borrowers with "very low income." The effect was a flood of government-subsidized lending."

Can't afford a mortgage - That's OK, you have a "right" to a home

Note that I applaud the goal of home ownership, as owners tend to be more responsible citizens, but there have to be sensible guidelines.

More from Charlie:
RealClearMarkets - An Interview with Charlie Gasparino:
"But what you will also find in my book, which I guarantee is absent from most of the others, is the root cause of the risk taking, which I believe begins and ends with the policy makers. The various heads of HUD, like Henry Cisneros, Andrew Cuomo and those in the Bush Administration who believed owning a home was a right, rather than something that should be earned, led to the disaster at Fannie Mae and Freddie Mac, which spread its guarantees to subprime loans, a place it traditionally stayed away from.

You also can't excuse Alan Greenspan for handing out free money to Wall Street every time the big firms screwed up over the past thirty years. It gave them incentive to double down on their risky bets until of course they double-downed so much the system blew up."

More on GSE's:
Barney Frank, Predatory Lender - WSJ.com

"Since the early 1990s, the government has been attempting to expand home ownership in full disregard of the prudent lending principles that had previously governed the U.S. mortgage market. Now the motives of the GSEs fall into place. Fannie and Freddie were subject to "affordable housing" regulations, issued by the Department of Housing and Urban Development (HUD), which required them to buy mortgages made to home buyers who were at or below the median income. This quota began at 30% of all purchases in the early 1990s, and was gradually ratcheted up until it called for 55% of all mortgage purchases to be "affordable" in 2007, including 25% that had to be made to low-income home buyers.

It was not easy to find candidates for traditional mortgages—loans to people with good credit records or the resources for a substantial downpayment—among home buyers who qualified under HUD's guidelines. To meet their affordable housing requirements, therefore, Fannie and Freddie reduced their lending standards and reached into the FHA's turf. The FHA, although it lost market share, continued to guarantee what it could, adding to the demand that the unregulated mortgage brokers filled. If they were engaged in predatory lending, it was ultimately driven by the government's own requirements. The mortgages that resulted are now problem loans for the GSEs, the FHA and the big banks that were required to make them in order to burnish their CRA credentials."

Then Charlie wrote an OpEd piece:
Charles Gasparino: Three Decades of Subsidized Risk - WSJ.com:

"The greed merchants needed a co-conspirator, Mr. Forstmann argues, and that co-conspirator is and was the United States government.

'They're always there waiting to hand out free money,' he said. 'They just throw money at the problem every time Wall Street gets in trouble. It starts out when they have a cold and it builds until the risk-taking leads to cancer.'

Mr. Forstmann's point shouldn't be taken lightly. Not by the press, nor by policy makers in Washington. But so far it has been, and the easy money is flowing like never before. Interest rates are close to zero; in effect the Federal Reserve is subsidizing the risk-taking and bond trading that has allowed Goldman Sachs to produce billions in profits and that infamous $16 billion bonus pool (analysts say it could grow to as high as $20 billion). The Treasury has lent banks money, guaranteed Wall Street's debt and declared every firm to be a commercial bank, from Citigroup with close to $1 trillion in U.S. deposits, to Morgan Stanley with close to zero. They are all 'too big to fail' and so free to trade as they please—on the taxpayer dime."

From across the pond - similar need for re-regulation in the Anglo world of finance
Banks are too big, and the model needs to change

Of note - the policy to allow mega-banks was to allow American and British banks to compete with the perceived mega-banks of Europe and Japan.
In both systems, banks are a much large portion of the finance system, as opposed to the equity and debt markets in New York and London.

The Agenda for a Finance Revamp - WSJ.com:

"The repair of the global financial-regulatory system is too important to future prosperity to be left to technocrats and bankers. But the substance is so arcane and complicated that few politicians or informed citizens can grasp the issues, let alone choose solutions."

But there not all is well between London and the US
Andrew Sorkin's Too Big to Fail

Wall Street's crisis: Book of revelations | The Economist:

"...as Lehman Brothers tottered, there was briefly hope that Barclays Bank would ride in with an 11th-hour bid. But the British government, fearful of contracting the American cancer, took fright and blocked it, helping to seal the investment bank’s fate. As American officials absorbed the news, an exhausted and exasperated Hank Paulson, the then treasury secretary, muttered that the British had “grin-fucked us.”

Andrew Ross Sorkin’s fly-on-the-wall account of the great panic of 2008 is littered with such colourful anecdotes. It is meticulously researched, drawing on interviews with more than 200 of those who participated directly in the events it covers, including their handwritten notes and tape-recordings of critical meetings. The result is a compelling reconstruction of the drama surrounding the government seizure of Fannie Mae and Freddie Mac, Lehman’s collapse, the rescue of American International Group (AIG), the subsequent market pandemonium and the shoring-up of big banks’ capital with public funds."

I happen to agree with past Fed Chair, Paul Volker:
Volcker: Bernanke Didn't Go Far Enough | Newsweek Politics | Newsweek.com:

"But Bernanke didn't go nearly as far as Volcker says we should. Volcker wants to keep major commercial banks that enjoy federal-deposit guarantees away from big-time speculative trading. 'They shouldn't be doing risky capital-market stuff,' Volcker told NEWSWEEK before the Fed announcement. But, he adds, the president 'obviously decided not to accept'"

Which leads to the following - on bank's capital structure(s):

"The peculiarity of the banks is not some arcane matter. Regulators are furiously trying to find ways to prevent taxpayers picking up the tab for banking crises. The latest bill passing through Congress aims to hit the industry for the cost of bail-outs, for example. Their main weapon, however, is forcing banks to have bigger equity buffers. Bankers complain that equity is too expensive and will have a knock-on effect on the price of credit, damaging the economy. But this contradicts a cornerstone of corporate finance, set out by Franco Modigliani and Merton Miller in 1958, that a firm’s value is unaffected by its capital structure (at least in a perfectly efficient, tax-free world)."

Much more here:
Economics focus: Buffer warren | The Economist