From: Laura Rowley
Earlier this week I interviewed a veteran banker at a major Wall Street investment firm, seeking an insider's view on what caused the current economic crisis, what life is like for people on Wall Street, and what's ahead for the economy.
On condition of anonymity, the banker provided a blunt assessment of the risks taken, mistakes made, and the toll of the financial destruction. Here are the highlights:
Q: What's the cause of the economic crisis from your perspective?
A: There is an awful lot of blame to go around on Wall Street, in Washington, and in the irresponsible behavior of individuals. But stepping back, the critical error was that everyone [thought] there would not be a substantial, nationwide decrease in real estate prices. The whole subprime debacle was predicated on the fact that people said, "Well, this borrower is not really credit worthy and can't afford the house, but in four years it will be up 20 percent or more."
It was widely believed that if you had bad mortgages from different geographic areas that all those [real estate markets] weren't going to go down together. You had a pool of 100 bad mortgages from borrowers with low income or bad credit, that were each a piece of [expletive]. The idea was you put them together and now it's not a piece of [expletive]. People believed that through geographic diversification you can diversify risk. That was what undergirded the entire breakdown, and this was not a 3-year phenomenon, it was building for 10 years. Fannie Mae and Freddie Mac were absurdities; those firms were recklessly and incompetently run.
Q: What role did the rating agencies play?
A: The rating agencies facilitated this by giving investment-grade ratings to the securities. In the stretch for yield, you could [buy] AA-rated corporate bonds and earn 50 basis points over Treasuries, but if you bought AA-rated mortgage-backed securities you'd get 150 basis points. From the buy side, there was a real breakdown in their fiduciary obligation, because they overly relied on ratings agencies and didn't do their own research.
Rating agencies are incredibly powerful; you can't do debt financing without them. You have to play by their rules. They hold themselves out as these objective providers of ratings advice, but they are human beings, and [rating structured finance deals] was a higher-margin profit [center] for them. But I think [the bad ratings] were more due to sheer incompetence than being bribed.
Q: But weren't these the so-called "smartest guys in the room"?
A: These are not the smartest guys in the room. The ratings agencies don't pay as well, so people working there are using it as platform to get on the Street, or they work there because they're tired after a career on the Street, or they couldn't get hired on the Street.
Q: But wasn't leverage the real problem? Lehman was leveraged about 30 to 1 when it collapsed.
A: The investment banks were imprudently leveraged, but what killed Lehman and Bear was they had bad assets. You can survive a painful downturn -- and believe me, de-leveraging has been painful for everyone, but you can survive. Wachovia was only levered ten times, but had terrible exposure [to bad mortgages] and therefore couldn't raise capital. In hindsight Lehman shouldn't have been leveraged 30 times, but in a bull market having [a leverage ratio] of 25 times is not necessarily crazy. The real issue is asset quality.
Q: What's your view of the government's $700 billion-plus bailout?
A: I think Paulson was well intentioned around the notion of moral hazard, but he was wrong. I think if he could redo it, he would have saved Lehman. The devastation of Lehman failing -- the implication of their failure is hard to predict. I think you're seeing it play out in the stock market and the credit markets; I think you're going to see some hedge funds go out of business. Some of it has already been made public and some will come soon, but there are a lot of implications of Lehman reflected in the capital markets.
Q: What about the move to backstop the commercial-paper market and guarantee money market funds?
A: I think it's unfortunate, but it's one of the situations where the government has to step in. You've got to have confidence in the basic functioning of the banking system. The risk borne by the government is quite small, and the benefits are incredibly high. Unlike industrial companies, where bankruptcy works well, it does not work well at all in the financial system and Lehman is a poster child in that regard. If you're one of the big car companies and you go bankrupt, you can keep making cars; it's an ongoing business. With financial institutions, so much of what you do is predicated on confidence -- business literally evaporates overnight.
Q: What do you say to the taxpayers who didn't participate in the borrowing frenzy of the last few years, who saved diligently and are now paying the price with their tax dollars? And who may have to pay it again when the baby boomers retire and the government raises taxes to bail out people who haven't saved?
A: I also lived very conservatively and did not borrow, and I think we're all going to get hosed. But the reality is it's in our interest that the economy doesn't melt down. I'm a right-wing free market [supporter], and the last person to ask for government intervention, but if we allow a breakdown in the financial system you're going to have a depression. It's like the military -- incredibly expensive, but the cost of not doing it is far worse.
Q: What about the characterization that the greedy Wall Street bankers made their millions in the boom and left others holding the bag?
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Saturday, October 18, 2008
10 Things That Are Going Right
From: Kiplinger Washington Editors, Inc.
Never in modern memory have Americans been so gloomy about their future. A record 90% of registered voters say the country is seriously off on the wrong track, according to the most recent ABC News poll. Whispers of a recession at the beginning of 2008 have turned into a full-blown financial panic, despite unprecedented intervention from Washington and other capitals around the world. A long economic slump lasting well into 2009 looks quite likely.
But take heart. The editors of Kiplinger's Personal Finance and Kiplinger's forecasting put their heads together and came up with ten things going right these days. See if you agree:
1.Oil Loses Its Swagger: With the U.S. and global economy hurting, oil prices have dropped 50% in just three months, from $147 a barrel in July to the $75 range. Remember $80-$100 fill-ups at the pump? The national average for a gallon of gasoline is down to $3.10, from $4.11 in March, and should stay in the $3.00-$3.50 range through next year. Prices for home heating oil and natural gas are also headed lower this winter than last.
2. A Tipping Point for the Auto Industry: After years of talk and false starts, finally, all the major carmakers are furiously developing hybrid and alternative-fuel vehicles that could lessen our dependence on foreign oil. Meanwhile, desperate dealers are offering unheard-of deals on new, gas-fired models. For example, Toyota is offering $1,000 cash back and 0% financing on the 2009 Camry, the most popular car in America. Don't drive much? If you've always wanted an SUV or truck, the discounting on some models is extraordinary.
3. Interest Rates Are Low and Headed Lower: The prime rate is at 4.5%, which is driving down interest rates on home-equity lines of credit and some consumer loans. The interest rate on a traditional 30-year fixed-rate mortgage is averaging 6.5%, the highest it's been since the summer of '07, but still not too far from the historic low of 5.8% reached in 2003-05 and 1963-65. And although credit-card companies are cutting personal spending limits, rates are dropping, too. The average rate on credit-card purchases fell to 11.89% in the first week of October, down from 12.13% in September, according to LowCards.com, which tracks 1,260 credit cards.
4. Homes Are More Affordable: Real estate, which was overpriced during the housing bubble, has returned to earth. That's especially good news for first-time home buyers who were priced out of the market. While scare stories persist of credit drying up, the reality is more a return to traditional lending standards that had been thrown overboard-recklessly in many cases-by lenders. That means to qualify you usually need a 20% down payment, sufficient annual income, good credit and a tolerable load of debt.
5. Your Bank Savings Have Never Been Safer: The $700-billion federal rescue plan more than doubles the amount of federal deposit insurance on individual bank accounts, to $250,000 from $100,000. Uncle Sam sweetened the pot further on October 14 by providing unlimited FDIC insurance on non-interest-bearing accounts. That will provide more coverage for the nation's small businesses, which use these accounts. Plus, a new temporary federal insurance program covers the full value if your money-market-fund shares fall below a net asset value of $1.00 (called "breaking the buck"). The program provides coverage for shareholders for the amount they owned on September 19, 2008.
Read Full Story
Never in modern memory have Americans been so gloomy about their future. A record 90% of registered voters say the country is seriously off on the wrong track, according to the most recent ABC News poll. Whispers of a recession at the beginning of 2008 have turned into a full-blown financial panic, despite unprecedented intervention from Washington and other capitals around the world. A long economic slump lasting well into 2009 looks quite likely.
But take heart. The editors of Kiplinger's Personal Finance and Kiplinger's forecasting put their heads together and came up with ten things going right these days. See if you agree:
1.Oil Loses Its Swagger: With the U.S. and global economy hurting, oil prices have dropped 50% in just three months, from $147 a barrel in July to the $75 range. Remember $80-$100 fill-ups at the pump? The national average for a gallon of gasoline is down to $3.10, from $4.11 in March, and should stay in the $3.00-$3.50 range through next year. Prices for home heating oil and natural gas are also headed lower this winter than last.
2. A Tipping Point for the Auto Industry: After years of talk and false starts, finally, all the major carmakers are furiously developing hybrid and alternative-fuel vehicles that could lessen our dependence on foreign oil. Meanwhile, desperate dealers are offering unheard-of deals on new, gas-fired models. For example, Toyota is offering $1,000 cash back and 0% financing on the 2009 Camry, the most popular car in America. Don't drive much? If you've always wanted an SUV or truck, the discounting on some models is extraordinary.
3. Interest Rates Are Low and Headed Lower: The prime rate is at 4.5%, which is driving down interest rates on home-equity lines of credit and some consumer loans. The interest rate on a traditional 30-year fixed-rate mortgage is averaging 6.5%, the highest it's been since the summer of '07, but still not too far from the historic low of 5.8% reached in 2003-05 and 1963-65. And although credit-card companies are cutting personal spending limits, rates are dropping, too. The average rate on credit-card purchases fell to 11.89% in the first week of October, down from 12.13% in September, according to LowCards.com, which tracks 1,260 credit cards.
4. Homes Are More Affordable: Real estate, which was overpriced during the housing bubble, has returned to earth. That's especially good news for first-time home buyers who were priced out of the market. While scare stories persist of credit drying up, the reality is more a return to traditional lending standards that had been thrown overboard-recklessly in many cases-by lenders. That means to qualify you usually need a 20% down payment, sufficient annual income, good credit and a tolerable load of debt.
5. Your Bank Savings Have Never Been Safer: The $700-billion federal rescue plan more than doubles the amount of federal deposit insurance on individual bank accounts, to $250,000 from $100,000. Uncle Sam sweetened the pot further on October 14 by providing unlimited FDIC insurance on non-interest-bearing accounts. That will provide more coverage for the nation's small businesses, which use these accounts. Plus, a new temporary federal insurance program covers the full value if your money-market-fund shares fall below a net asset value of $1.00 (called "breaking the buck"). The program provides coverage for shareholders for the amount they owned on September 19, 2008.
Read Full Story
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