January 7, 2010
After the terrorist attacks of September 11, 2001, Congress passed Public Law 107-306, establishing The National Commission on Terrorist Attacks Upon the United States (also known as the 9-11 Commission). The Commission was chartered to create a full and complete account of the circumstances surrounding the September 11, 2001 terrorist attacks, including preparedness for and the immediate response to the attacks. The Commission was also mandated to provide recommendations designed to guard against future attacks. The Commission eventually published a report with those recommendations. The failure to implement and adhere to those recommendations is now being discussed as a crucial factor in the nearly-successful attempt by The Undiebomber to crash a jetliner headed to Detroit on Christmas Day.
On January 3, 2010, Federal Reserve Chairman Ben Bernanke gave a speech at the Annual Meeting of the American Economic Association in Atlanta, entitled: “Monetary Policy and the Housing Bubble”. The speech was a transparent attempt to absolve the Federal Reserve from culpability for causing the financial crisis, due to its policy of maintaining low interest rates during Bernanke’s tenure as Fed chair as well as during the regime of his predecessor, Alan Greenspan. Bernanke chose instead, to focus on a lack of regulation of the mortgage industry as being the primary reason for the crisis.
Critical reaction to Bernanke’s speech was swift and widespread. Scott Lanman of Bloomberg News discussed the reaction of an economist who was unimpressed:
“It sounds a little bit like a mea culpa,” said Randall Wray, an economics professor at the University of Missouri in Kansas City, who was in Atlanta and didn’t attend Bernanke’s speech. “The Fed played a role by promoting the most dangerous financial innovations used by institutions to fuel the housing bubble.”
Nomi Prins attended the speech and had this to say about it for The Daily Beast:
But having watched his entire 10-slide presentation (think: Economics 101 with a political twist), I had a different reaction: fear.
My concern is straightforward: Bernanke doesn’t seem to have learned the lessons of the very recent past. The flip side of Bernanke’s conclusion — we need stronger regulation to avoid future crises — is that the Fed’s monetary, or interest-rate, policy was just fine. That the crisis that brewed for most of the decade was merely a mistake of refereeing, versus the systemic issue of mega-bank holding companies engaged in reckless practices, many under the Fed’s jurisdiction.
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Meanwhile, justifying past monetary policy rather than acknowledging the real-world link between Wall Street practices and general economic troubles suggests that Bernanke will power the Fed down the path of the same old mistakes. Focusing on lending problems is important, but leaving goliath, complex banks to their worst practices (albeit with some regulatory tweaks) is to miss the world as it is.
As the Senate takes on the task of further neutering the badly compromised financial reform bill passed by the House (HR 4173) — supposedly drafted to prevent another financial crisis — the need for a better remedy is becoming obvious. Instead of authorizing nearly $4 trillion for the next round of bailouts which will be necessitated as a result of the continued risky speculation by those “too big to fail” financial institutions, Congress should take a different approach. What we really need is another 9/11-type of commission, to clarify the causes of the financial catastrophe of September 2008 (which manifested itself as a credit crisis) and to make recommendations for preventing another such event.
David Leonhardt of The New York Times explained that Greenspan and Bernanke failed to realize that they were inflating a housing bubble because they had become “trapped in an echo chamber of conventional wisdom” that home prices would never drop. Leonhardt expressed concern that allowing the Fed chair to remain in such an echo chamber for the next bubble could result in another crisis:
What’s missing from the debate over financial re-regulation is a serious discussion of how to reduce the odds that the Fed — however much authority it has — will listen to the echo chamber when the next bubble comes along. A simple first step would be for Mr. Bernanke to discuss the Fed’s recent failures, in detail. If he doesn’t volunteer such an accounting, Congress could request one.
In the future, a review process like this could become a standard response to a financial crisis. Andrew Lo, an M.I.T. economist, has proposed a financial version of the National Transportation Safety Board — an independent body to issue a fact-finding report after a crash or a bust. If such a board had existed after the savings and loan crisis, notes Paul Romer, the Stanford economist and expert on economic growth, it might have done some good.
Barry Ritholtz, author of Bailout Nation, argued that Bernanke’s failure to understand what really caused the credit crisis is just another reason for a proper investigation addressing the genesis of that event:
Unfortunately, it appears to me that the Fed Chief is defending his institution and the judgment of his immediate predecessor, rather than making an honest appraisal of what went wrong.
As I have argued in this space for nearly 2 years, one cannot fix what’s broken until there is a full understanding of what went wrong and how. In the case of systemic failure, a proper diagnosis requires a full understanding of more than what a healthy system should look like. It also requires recognition of all of the causative factors — what is significant, what is incidental, the elements that enabled other factors, the “but fors” that the crisis could not have occurred without.
Ritholtz contended that an honest assessment of the events leading up to the credit crisis would likely reveal a sequence resembling the following time line:
1. Ultra low interest rates led to a scramble for yield by fund managers;
2. Not coincidentally, there was a massive push into subprime lending by unregulated NONBANKS who existed solely to sell these mortgages to securitizers;
3. Since they were writing mortgages for resale (and held them only briefly) these non-bank lenders collapsed their lending standards; this allowed them to write many more mortgages;
4. These poorly underwritten loans — essentially junk paper — was sold to Wall Street for securitization in huge numbers.
5. Massive ratings fraud of these securities by Fitch, Moody’s and S&P led to a rating of this junk as Triple AAA.
6. That investment grade rating of junk paper allowed those scrambling bond managers (see #1) to purchase higher yield paper that they would not otherwise have been able to.
7. Increased leverage of investment houses allowed a huge securitization manufacturing process; Some iBanks also purchased this paper in enormous numbers;
8. More leverage took place in the shadow derivatives market. That allowed firms like AIG to write $3 trillion in derivative exposure, much of it in mortgage and credit related areas.
9. Compensation packages in the financial sector were asymmetrical, where employees had huge upside but shareholders (and eventually taxpayers) had huge downside. This (logically) led to increasingly aggressive and risky activity.
10. Once home prices began to fall, all of the above fell apart.
As long as the Federal Reserve chairman keeps his head buried in the sand, in a state of denial or delusion about the true cause of the financial crisis, while Congress continues to facilitate a system of socialized risk for privatized gain, we face the dreadful possibility that history will repeat itself.
The Outrage Continues
February 1, 2010
The news reports of the past few days have brought us enough fuel to keep us outraged for the next decade. Let’s just hope that some of this lasts long enough for the November elections. I will touch on just three of the latest stories that should get the pitchfork-wielding mobs off their asses and into the streets. Nevertheless, we have to be realistic about these things. With the Super Bowl coming up, it’s going to be tough to pry those butts off the couches.
The first effrontery should not come as too much of a surprise. The Times of London has reported that Goldman Sachs CEO, Lloyd Blankfein (a/k/a Lloyd Bankfiend) is expecting to receive a $100 million bonus this year:
Blankfein is also thumbing his nose at the American taxpayers. Despite widespread media insistence that Goldman Sachs “paid back the government” there is a bit of unfinished business arising from something called Maiden Lane III — for which Goldman should owe us billions.
That matter brings us to our second item: the recently-released Quarterly Report from SIGTARP (the Special Investigator General for TARP — Neil Barofsky). The report is 224 pages long, so I’ll refer you to the handy summary prepared by Michael Shedlock (“Mish”). Mish’s headline drove home the point that there are currently 77 ongoing investigations of fraud, money laundering and insider trading as a result of the TARP bank bailout program. Here are a few more of his points, used as introductions to numerous quoted passages from the SIGTARP report:
My favorite comment from Mish appears near the conclusion of his summary:
Mish’s last remark (and his link to an earlier posting) brings us to the third disgrace to be covered in this piece: The AIG bailout cover-up. On January 29, David Reilly wrote an article for Bloomberg News (and Business Week) concerning last Wednesday’s hearing before the House Committee on Oversight and Government Reform. After quoting from Reilly’s article, Mish made this observation:
David Reilly began the Bloomberg/Business Week piece this way:
That “secretive group” is The Federal Reserve of New York, whose president at the time of the AIG bailout was “Turbo” Tim Geithner. David Reilly’s disgust at the hearing’s revelations became apparent from the tone of his article:
The “cover-up” aspect to this caper involved intervention by the New York Fed that included editing AIG’s communications to investors and pressuring the Securities and Exchange Commission to keep secret the details of the bailouts of AIG’s counterparties (Maiden Lane III). The Fed’s opposition to disclosure of such documentation to Congress was the subject of a New York Times opinion piece in December. The recent SIGTARP report emphasized the disingenuous nature of the Fed’s explanation for keeping this information hidden:
The SIGTARP investigation has revealed some activity that most people would never have imagined possible given the enormous amounts of money involved in these bailouts and the degree of oversight (that should have been) in place. The bigger question becomes: Will any criminal charges be brought against those officials who breached the public trust by facilitating this monumental theft of taxpayer dollars?