Against Monopoly

defending the right to innovate

Financial Crisis

Monopoly corrupts. Absolute monopoly corrupts absolutely.

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Laugh or cry

Commit to a retirement facility carefully

The victims of the Great Recession keep emerging from the carnage wrought by the big financial players. This one comes from the "retirement communities" link here. People buy into them thinking that all is well for their old age. It may not be, as a number of the companies had big plans to provide services they can no longer finance or have made guarantees on deposits that are now controlled by the contingencies in the fine print of their contracts. What seemed certain when the buyer signed up may no longer be so. The prospect is they will not recover until the economy, particularly employment, has recovered and new tenants can afford to buy into them.

Is this time really the same?

The News Hour Monday had an interview with Ken Rogoff and Carmine Reinhart, authors of This Time Is Different and you can still see the video or download the transcript here. Its conclusions are sobering:

Our current crisis is like all the others studied over an 800 year span. They all result from ignorance (of the past) and from the mistaken belief that this time is different. The crises are made up of ballooning housing and equity prices, staggering borrowing from abroad, slowing economic growth, deregulation, and a mountain of short term debt.

These were the common features of financial crises of Asia in the 90s, of Latin America in the 80s, on Wall Street in 1907, in Germany in 1873, in the Mississippi bubble of 1720, and the 1340 Florence collapse. The current decline on Wall Street from peak to bottom was average, 35%, as was that in housing prices. The recovery so far has been typical of the past, when on average, stocks went back to their peak in two to three years while unemployment took two years to reach a bottom and five more to reach the pre-crisis level. Governments double their debt in three years, historically followed by defaults too numerous to mention.

If we examine the US response to the current crisis, we are not doing very well in either our diagnosis or our repairs to break the mold.

Citigroup (and the regulators) learn nothing from experience

Much the most interesting piece on the financial debacle that I have read recently concerns Citigroup and its predecessors link here. It turns out to have been a source of rot in the financial system since the 1920s before the Great Depression. Somehow it always escapes reform, has to be rescued, and comes back to rip us off again.

"During the 1920s, the institution then known as National City Bank opened stores around the country to encourage the burgeoning middle class to invest in stocks and bonds. With little money down 10 percent of the cost of a trade was all an investor needed to buy shares investors poured into the stock market."

"Before the crash, industry practice allowed National City not only to underwrite securities but also to employ a sales army to peddle them to depositors." One response was passage of "the Glass-Steagall Act, separating activities of commercial banks (which offered plain old savings accounts and loans) from those of investment firms." "Although thousands of smaller banks failed, government policies to prop up the banking sector helped National City and other major banks weather the Depression."

During the 90's bank crisis from lending to Latin America, the company (then known as Citigroup) was saved by weakened capital and accounting rules and by low interest rates created by the FED.

It and other banks then used their clout to get Glass Steagall repealed. "By liberating our financial companies from an antiquated regulatory structure, this legislation will unleash the creativity of our industry and insure our global competitiveness," Mr. Sanford I. Weill and Mr. John S. Reed, Citigroup's co-chairmen and co-chief executives, said in a statement after repeal. "As a result, all Americans investors, savers, insureds will be better served."

We all know what happened then. The bank's health remains precarious and largely dependent on the government guarantee. But it is still resisting reform and opposing moves to split up the too-big-to-fail banks.

Two case studies in our still-ill financial system

Two news stories this week inform us just how fragile the financial system still is. The longest appeared in two parts in the Seattle Times and traces the demise of WaMu, a major mortgage lender that went broke last year link here and here. The other story concerns the re-emergence of Maurice Greenberg, the "financier" who built AIG, lost it in a bid for control several years ago, still owns a lot of its stock, and is now fashioning a competitor, C V Starr, which apparently replicates AIG in its activities, in its style and its complex organization designed to obscure what is happening, and is now acquiring many former AIG employees link here.

The WaMu story shows how it went from profitable but healthy mortgage lending to increasingly risky subprime high interest paper that was sold by agents and approved with increasingly lax WaMu reviews. Recognizing that the profits depended on ever-rising real estate prices, WaMu moved to dump its own holdings of these mortgages through securitization but got caught with billions in mortgages it couldn't unload in 2007 when that market froze up in recognition of how poor these securities were.

The worrisome aspect of both these stories is that the financial regulators were oblivious of what was happening and that nothing has yet been done to prevent it from happening again. Read these stories and beware.


More details on the financial mess

The most important decision on financial reform seems to have been made by the Administration: to reject Volcker's lead on financial reform to reinstall the wall between commercial and investment banks and repeal the implicit government guarantee to the investment bank lenders link here. Rather Obama chose to follow that of Summers-Geithner-Bernanke (christened the "Summersists", as opposed to the "Volckerists"), to leave the banks big but try to regulate their behavior. This might be the right choice, in order to get it through Congress, but the banks seem happy, apparently in the belief that they can get what they want. Why do I feel that they are right?

Felix Salmon raises questions about write downs in banks' valuation of mortgage servicing rights which give banks a steady income and which they have capitalized on their balance sheets link here. Presumeably, they bought these from mortgage lenders and mortgage derivative creators, but there is no current market price for them so holders can play games with the carrying value on their books. Their value will vary if mortgages are paid off early, ending the service income but also with interest rates on alternative investments. This is another aspect of the enigma that is investment banking. Why should the government guarantee lenders to banks which hold this kind of investment?

Another aspect of the financial crisis was the bailout of Chrysler and GM. Steven Rattner, the car czar or chairman of the President's Automobile Task Force is on the record with a report, an article in Fortune, and a persuasive interview on PBS link here. An aspect of this is that top executive salaries are being imposed by the salary czar on seven companies, two of which are the financings arms of the car companies--so the executive salaries of just three banks are being limited, though taxpayers have bailed out the whole industry. Big deal.

Felix Salmon has another heads up, this one on the hedge fund activities of John W Merriweather, a founder of bankrupted Long Term Capital Management and now of JWM Partners link here. Salmon notes that partner fees end when the fund no longer beats its previous high. Time to close the fund and start a new one with a lower payoff marker. Interesting incentives Wall Street sets for itself.

You can read another chapter of ANDREW ROSS SORKIN's book, Too Big to Fail, this time on The Race to Save Lehman Brothers link here. Bottom line: it was chaos and bankers and officials were talking to each other in terms that would normally have gotten them in trouble with the feds.

A useful fact on which to end: A study found that securitized mortgages were five times as likely to be delinquent as mortgages that were not resold to securitizers link here.


the idea that "too big to fail" is just too big is gaining traction, with recent comments from Alan Greenspan, Paul Volker, and Mervyn King. Simon Johnson over at The Baseline Scenario has a good summary.

Revelations--But wait, more to come

The media are really covering the financial crisis as each day brings more revelations. Start today with Louis Uchitelle on Obama advisor Paul Volcker who wants to redivide commercial and investment banking with the latter no longer enjoying a government guarantee but who has been kept out of the decision making link here. Then go link here to watch how the Commodity Futures Trading Commission [CFTC] was on to the "dark" market in derivatives as a bomb waiting to blow but was blocked in its attempts to gather information on what was happening.

Finally, Felix Salmon directs us link here to Andrew Ross Sorkin's new book, Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System---and Themselves, which breaks some pretty stunning news, dating from the end of June, 2008. At that point, it was still months before the now-famous but then-secret waiver, issued in mid-September, which allowed Treasury Secretary Hank Paulson to talk to Goldman Sachs; he'd promised not to do that when he moved from Goldman to Treasury but he did it anyway.

A major feature of all these is the cast of characters, starting with Alan Greenspan, hired by Reagan and kept on by Bush 1, Clinton, and Bush 2, and self-described as a "strong" libertarian and free market ideologue of the Ayn Rand school. Then there is Robert Rubin as Treasury secretary, and his minions, Tim Geithner and Larry Summers, most recently joined by FED chairman Bernanke. They and Wall Street are still running things.

Most people are libertarian in some aspects of their political beliefs, but the belief that government is always bad and that markets will take care of, for example, our foreign policy challenges is stretching and has brought us to where we are now.

"How Moody's sold its ratings -- and sold out investors"

There hasn't been much on the rating agencies role in the financial disaster last year, but there is now link here. Details on the failures of Moody's, S&P, and with a little about Fitch are now available via Kevin G. Hall from McClatchy Newspapers.

I won't repeat it all because the article is long and full of persuasive detail. Despite protestations that all has been corrected, anyone who trusts their ratings would be a fool in the absence of a showing of major reform.

Several commentators have said the raters were culpable, but did not have major responsibility for the massive financial fraud that took place. That conclusion is very hard to accept. Without their active collaboration, the bubble could not have occurred.

Have we seen anything yet to suggest that this will now change?

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