Thursday, June 11, 2009

One Economic Narrative

Wall Street Journal columnist Holman Jenkins Jr. tries to trace the cause of the credit crunch in the June-July Hoover Institution Policy Review:
[I]t isn’t true that Wall Street made these mortgage securities just to dump them on them the proverbial greater fool, or that the disaster was wrought by Wall Street firms irresponsibly selling investment products they knew or should have known were destined to blow up. On the contrary, Merrill Lynch retained a great portion of the subprime mortgage securities for its own portfolio (it ended up selling some to a hedge fund for 22 cents on the dollar). Citigroup retained vast holdings in its so-called structured investment vehicles. Holdings of these securities, in funds in which their own employees personally participated, brought down Bear Stearns and Lehman Brothers. AIG, once one of the world’s most admired corporations, made perhaps the biggest bet of all, writing insurance contracts against the potential default of these products.

So Wall Street can hardly be accused of failing to eat its own dog food. It did not peddle to others an investment product that it was unwilling to consume in vast quantities itself.

Nor is it true that Wall Street executives and CEOs had insufficient "skin in the game," so that "perverse" compensation incentives created the mess. That story also does not pan out. Individuals, it’s true, were paid sizable bonuses in the years in which the securities were created and sold. But most also had considerable wealth in the form of stock and stock options in their firms, which bet their own capital on these securities. Many also appear to have invested directly in funds to hold the subprime securities.

They had skin in the game. Personal losses to top executives in banks that failed or whose share prices collapsed were in the millions, hundreds of millions, and in some cases billions of dollars. . .

It isn’t true, either, that Wall Street manufactured these securities as a purblind bet that home prices only go up. The securitizations had been explicitly designed with the prospect of large numbers of defaults in mind — hence the engineering of subordinate tranches designed to protect the senior tranches from those defaults that occurred. . .

Nor is it plausible that all concerned were simply mesmerized by, or cynically exploitative of, the willingness of rating agencies to stamp Triple-A on these securities. Wall Street firms knew what the underlying dog food consisted of, regardless of what rating was stamped on it. As noted, they willingly bet their firm’s money on it, and their own personal money on it, in addition to selling it to outsiders. . .

Up has gone a cry in the aftermath for some kind of "systemic regulator" to prevent a reoccurrence and spare the political class from having to vote for bailouts in the future -- though, in an evasion of reality, this ├╝ber-regulator is supposed to spot bubbles and unwise risk-taking before they blow up, sounding a whistle just when investors are at the most enthusiastic lest investors inflict more losses on themselves than Congress will decide in retrospect should have been permitted.

In reality, we already have a systemic regulator -- the Federal Reserve, whose traditional mission, in the colloquial description, is to "take away the punch bowl just when the party is getting started." The Fed has been imperfect in this task in the past and will be so in the future.

What Congress doesn’t want to admit is that it wants not a systemic regulator, but a systemic savior — an institution that can step forward and stop panic in its tracks. But we have one of those too — the Fed again. For all the arguments heard on Capitol Hill last fall that only a $700 billion appropriation stood between us and financial Armageddon, that $700 billion sum has proved a pittance compared to the resources the Fed, under Ben Bernanke, has deployed out of its hip pocket. The Fed has bought unwanted assets and issued guarantees to the tune of more than $1 trillion. It has created untold billions in excess bank liquidity through monetary policy. If we’re honest, the Fed’s ability to print money stands behind the FDIC, which insures the nation’s bank deposits. It stands behind Fannie and Freddie, which are increasingly in the business of losing money on purpose to help the housing market. Even the U.S. Treasury has been edging sideways toward relying on the Federal Reserve to finance the exploding national debt.

We have a systemic savior -- the Federal Reserve. And all that remains to be seen is how much its efforts this time will ultimately cost in the erosion of the purchasing power of the U.S. dollar.
I'm not sure I concur with all of Jenkins's analysis, but read the whole thing. And see Arnold Kling.

(via The Corner)

6 comments:

bobn said...

Well, this guy plasters toegether a lot of stuff in a sentence. Let's take out the filler to get to the point:

[I]t isn’t true that ... the disaster was wrought by Wall Street firms irresponsibly selling investment products they knew or should have known were destined to blow up.

This is exactly what is true. The fact that they kept some of the sludge does not relieve them of responsibility for its creation - wheter taxpayers pay directly by owning the crud, or indirectly by bailing the banks and/or enduring the credit crunch, changes nothing.

On the contrary, Merrill Lynch retained a great portion ... Citigroup retained vast holdings ... AIG, ... made perhaps the biggest bet of all, ...

All of whom have received and continue to receive handsome bailouts, which you and I are or will be paying for.

Nor is it true that Wall Street executives and CEOs had insufficient "skin in the game," so that "perverse" compensation incentives created the mess.


From Wikipedia entries for each of the following:

Chuck Prince: On November 4, 2007 he retired from both his CEO and chairman duties due to unexpectedly poor 3rd quarter performance, mainly due to CDO and MBS related losses, while still receiving a $38m pay package. Prince left with vested stock holdings valued at USD$94 million and the roughly $53.1 million salary he received over the four years in the position. He also received a pension of $1.74 million and another one million stock options. He is still a consultant with Citigroup.




Hank Paulson: His compensation package, according to reports, was US $37 million in 2005, and US $16.4 million projected for 2006. His net worth has been estimated at over US $700 million.

Stanley O'Neal: O'Neal earned US$ 48 million in 2006 and 46 million in 2007 and O'Neal walked away with a golden parachute compensation package that included Merrill stock and options valued at $161.5 million at the time.

Right, Carl. No problems there!

It isn’t true, either, that Wall Street manufactured these securities as a purblind bet that home prices only go up. The securitizations had been explicitly designed with the prospect of large numbers of defaults in mind — hence the engineering of subordinate tranches designed to protect the senior tranches from those defaults that occurred

Ummm, NO! The senior tranches have been destroyed, along with everything else. Whoever this clown is, he's just lying. And you are so far out of your element that you don't realize it.

Carl, you need to get some help with this blog. The stuff you're linking to and quoting lately is just frigging crap!


And for God's sake, don't call what these Wall Street swindlers did some form of "engineering". I'm a real engineer, BSEE, and I know better. All these people "made" was massive fraud, obfuscated by bad math.

OBloodyHell said...

No time to respond to the whole thing, bob, but it's rather interesting that you chose to ignore Frank Raines and Jamey Gorelick.

bobn said...
This comment has been removed by the author.
bobn said...

OBH: GSEs were legally to be regulated by the executive branch. It's the executive branch's failure to do this that let the GSEs get in over their heads. But that happened under your beloved Bush, so you'll never admit that. That fact is not subject to debate ans is *never* gonna change. That's why you also refuse to admit that the bulk of the crap happened between 2004 and 2007, right after your beloved Bush's SEC completely opened the barndoor on the I-Banks.


Also, While the government-sponsored enterprises (GSEs) own 56% of the nation’s single-family mortgages, the mortgages they own represent 20% of all serious delinquencies.

In contrast, private label [Wall Street] securities own 15% of the nation’s mortgages but 51% of the serious delinquencies
.

OBloodyHell said...

> It's the executive branch's failure to do this that let the GSEs get in over their heads.

THEY DID NOT FAIL TO DO SO YOU STUPID LYING ASS.

I have made this point to you OVER AND OVER, and I'm damned sick of your ignoring it like some incompetent halfwit who cannot stop parroting a stupid mantra they've learned.

Get your head OUT of your rectal cavity.

I've pointed you to VIDEO FOOTAGE FROM C-SPAN of a SENATE FINANCE COMMITTEE MEETING which openly SHOWS an executive branch official attempting to call attention to the BLATANT accounting errors made by the GSEs.

That's not someone's "editorial interpretation" of what happened, it's the Dems in their OWN WORDS AND DEEDS interfering with fixing the problem

The OFHEO representative -- not anyone from the GSEs -- was OPENLY AND PUBLICLY excoriated by the Dems in charge of said committee, notably including Barney Frank. Frank's "best" line was that "he wanted to roll the dice some more with the GSEs", while the other Dems stated that the GSEs had behaved "honorably and effectively"

This in 2004, BEFORE the s*** hit the fan. If things had been dealt with THEN they might have gotten under control before going tits up.

Raines and Gorelick BOTH later were forced to return their bonuses for the time periods in question, making it clear that, despite what the SBC said, they were GUILTY on ALL COUNTS of falsifying the earning reports of the GSE they were in charge of.

Given that I have pointed this out to you TIME AND AGAIN, yet you continue to parrot the same idiot line, it is clear that you are either a complete and total imbecile incapable of learning new facts or a lying PoS charlatan with no moral scruples at all.

==================================================
Which are you, bob, an imbecile or a lying PoS?
==================================================

Even SNL managed to figure it out, bob, and they hardly qualify as bastions of conservative thought.

bobn said...

Point 1: The GSEs did not do this - Wall Street did. Until you respond to that, all else is meaningless.

Point 2: CongressCritters say lots of stupid stuff. It's what they do best. You know what it means? Nothing - not until they encapsulate their stupidity into a law, which is then signed by the president, does it matter. This is because the GSEs were regulated by the OFHEO, part of the executive branch. From OFHEOs FAQ:

"The financial safety and soundness regulation is vested in the Office of Federal Housing Enterprise Oversight (OFHEO). OFHEO implements, monitors and enforces capital standards for Freddie Mac and Fannie Mae."

So until you show an actual law instructing OFHEO to be stupid and corrupt, (as opposed to the natural tendency of all Bush "regulators" to do so), all the C-SPAN vids you can muster are meaningless.

These are the reasons why I keep ignoring your rants about GSEs and Congress. I will continue to do so.