Opinion

The Great Debate

Banking spins destruction myth: Hoocoodanode?

By J Saft
December 5, 2008

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

Just as every society has a creation myth, banking is now busily writing a destruction myth that seeks to explain and soothe in a world torn to its foundations.

The myth, as expounded by regulators, bankers and their various service providers, is that we were hit by a perfect storm, a 1,000-year flood so unpredictable that we can’t possibly be held accountable for it. An act of god, rather than the folly of man.

Or as the excellent financial blog Calculated Risk puts it: “Hoocoodanode?”

The implication of course is that now banks know these sorts of things can happen, banks will behave sensibly because it is their best interests to do so. It’s just that the data we put into the models only covered the boom years. Now that we are getting good data on a downturn, well, problem solved. No need for overly heavy-handed regulation, that will only stifle growth and recovery.

No need for intrusive compensation controls; this will simply drive risk takers out of banking and into less regulated areas, or will prompt a brain drain in which the best minds might go into, god forbid, industry.

There is a pronounced unwillingness to take responsibility and to recognize that many of the factors that went into creating and sustaining the bubble weren’t so much unknowable but more likely, for those in a position to do something about it at the time, either unprofitable, unpleasant or politically inconvenient to know.

Take, for example, Robert Rubin, former U.S. Treasury Secretary and current board member at Citigroup.

“Nobody was prepared for this,” Rubin told the Wall Street Journal. He has been paid $115 million, excluding stock options, since 1999 and was advising Citigroup when it decided to mimic its peers and take on more risk.

“… What came together was not only a cyclical undervaluing of risk (but also) a housing bubble, and triple-A ratings were misguided,” said Rubin, who believes he along with Alan Greenspan has taken an unwarranted knock to his reputation. “There was virtually nobody who saw that low-probability event as a possibility.”

There is simply no doubt that a number of people were raising red flags about risk, about the use of ratings, about issues around securitization, and most certainly about an emerging real estate bubble. But it proved impossible for those risks to get a proper hearing within a system that was throwing off so much life-changing money.

WHOSE MONEY, WHOSE RISK?

Rubin, when queried on his pay, answered that he could have make more elsewhere. True enough, no doubt.

But while everyone is free to take money that is on offer, that is different from saying that you have earned it, or that, in a system in which pensioners and taxpayers are the ultimate bag-holders, it is appropriate and should not be subject to regulation.

There is a similar argument on pay making the rounds: that since so many senior managers lost so much of their fortunes in the failure of companies such as Lehman Brothers and Bear Stearns, this demonstrates that there was not a misalignment of risks between employees, shareholders and the governments that ultimately must pick up the pieces when things go wrong.

It is very sad that so many people lost so much, but this is not even close to being an argument for continued light touch regulation. The issue is not so much that people in banking and finance have skin in the game, but that they are far from alone in having it, and that their ultimate cost of capital is in part a function of the fact that it is and has been understood that the state will step in if things
come to grief.

That argues, in my view, for stricter regulation of bank capital and of bank compensation so as to decrease the risks. That means tying compensation more closely to risks, including the risk that things that look good today go bad in three years’ time. The UBS scheme, under which bankers can “lose” money they “earn” based on various performance factors in subsequent years, is not a bad start.

Those who argue against more stringent regulation have one thing right: it is going to cost, and requiring banks to hold more capital will impose a ceiling on the speed at which the economy can easily grow. Of course, we are always regulating the last war out of existence.

One idea worth consideration is proposed by Paul Miller of FBR Capital Markets and would involve regulating assets and how they are funded, rather than just the institutions.

That would help to guard against the next shadow banking system and another highly levered and ultimately government-insured bout of speculation.

–  At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click here. –

Comments
76 comments so far | RSS Comments RSS

Obviously the bankers and financiers will ride the storm head held high and they’ll come out on top with more of our savings AND tax follars in their pockets. We had this coming and everyone in the finance sector knew this would occur, every single one as even a child can do the sums. There are no excuses other than greed and blackmailing bankers are holding us to ransom right now.

Posted by Trev | Report as abusive
 

An article in the New York Times in 1999 said, in regard to “liars loans” and zero-down payment home loans, and a higher level of mortgage owners defaulting, that this could be sustained as long as the market was growing, but if mortgage holders began to default, then it would result in a financial crisis at least as large as the 1930s depression. They knew, they certainly knew. GW Bush even allowed the investment banks to widen their reserve requirements from 10-to-1 to 30-to-1. The bond rating organizations (Moody, Standard & Poor) also stamped out high ratings on bonds despite evidence they were losing value and not adequately backed. This sounds like no accident. If not by chance, then what is their hidden agenda?

 

To think that this is not an orchestrated event is laughable. We now see the consolidation of power within a handful of banks. Institutions are allowed to fail while others are assisted. Changes in policy and tax code are adjusted after the give away of Bear Stearns and Wachovia to J.P. Morgan. Wells Fargo sees the adjusted tax codes and fights J.P. for the spoils of Wachovia. B of A picks up the largest mortgage servicer in the nation as well as Morgan Stanley for a song and a dance. Years of lost market share is reversed within 1 year. What will emerge is a stronger banking sector with stronger pricing power with tighter regulatory controls to eliminate new start ups. Read “The Creature from Jeckyl Island” and see how well the Federal Reserve looks after it’s own.

 

ugh… ouch…is this America? why do we have soldiers in the streets pointing the eay to the ration lines? time for an emergency and emergency power granted to central government..the ones saying this will last till 2010 are the same ones a year ago were saying the fundmentals of the economy are sound and we are not in a recession. do you believe them now? How low will we go? I think the once in 10,000 year bottom is what we are approaching..for every creation myth there is an appocolyptic myth too, are you sure these are just m

Posted by brian m | Report as abusive
 

seems to me that the cocaine mentality made this bubble even bigger. This will go down as the ‘great coke bubble’ of the modern era. Any market player could engineer investment vehicles in a roaring bull market- the question would always be ‘how much euphoria do you price into assets?’… amswer. always as much as the market will take. And a roaring bull market will take a lot. The amswer to me is simple. Return to a moderately conservative baseline regulated bank system. And then in bear markets let the failures burn. And never revamp the model when all debt skews to AAA in a bull market…

Posted by mark | Report as abusive
 

Trillions of dollars and millions of jobs, and still the New York elite write about the ‘perfect storm’ and quibble over their bonuses. Not one bad guy…when in fact there are not prisons enough to hold you clowns…including what passes for a journalist/commentator/yakking head/analyst these troubled days.

Posted by T J Snodgrass | Report as abusive
 

this article hits it right on the money and wall street is poised to continue on course. the US government gave OUR money to one man with no strings and HE doles it out with no strings. then the banks say they wont even LOAN our money back to us. Many many people tried to tell it like it was, but it was the emperors clothes story. And now the banks ideas of “fixing” things is to let CEOS keep their bonuses, even it they have to be renamed, and tighten credit so much that the recession and layoffs are doomed to worsen. The inmates truly are running the asylum – with OUR money

Posted by bet | Report as abusive
 

This period is simply the calm before the storm. It’s the begining of the end of our relationship with ‘Capitalism’. The trust is gone. What’s next?

Posted by Brad | Report as abusive
 

It’s funny how when people are comfortable with something they will latch onto any shred of logic that supports that comfort. the sad, plain reality is:

fractional reserve banking as it is, and its best friend debt, which has even the U.S. government in its grasp, is completely unsustainable.

for now, as in the depression, the rich are getting richer and the poor are left to suffer. the rich mostly being involved in banking, the poor being involved in the actual goods and services that run the country.
the middle class is disappearing.

this is not capitalism, it is not even excusable.
it is a cancer upon the very idea of democracy and freedom, because it has consumed them alive. a federal banking system that is privately held by so few has been an invite to outright debt slavery and manipulation.

any logic and reason that attempts to justify this is not only a colossal failure of the imagination, but of the human soul.

“I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world. No longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men.”
~ Woodrow Wilson ~
(after creating the Federal Reserve)

Posted by jeremy | Report as abusive
 

@Naomi…..precisely

All bankers should be required to answer a simple question…..”did you anticipate the impending financial crisis”. All those who answer NO should be forced to leave the industry immediately, because they are not bankers.

Posted by anton kleinschmidt | Report as abusive
 

Does anyone really think that injecting billions of USD into these international banks (Wall Street) will actually return things to normal?

Yes, ensure that the banks stay afloat long enough to foreclose on your homes. What is the interest rate that these banks will pay back to the US citizen? What is the collateral? This will likely prove to be the heist of all time.

Thomas Jefferson was right when he said;

“If the American people allow these banking institutions and corporations to rise up around them, within 200 years the decendants of those who conquered this continent shall be homeless upon it.”

America, you have revolted for FAR less! Taxation without representation sounds pretty good right about now… Now it’s ownership without representation.

From your friend up north in Canada.

Posted by Baron von Lufthoven | Report as abusive
 

Of course, a civilian revolution could be interpretted as terrorism under the Patriot Act.

Posted by Baron von Lufthoven | Report as abusive
 

No analysis of financial terms or economic principles is needed. People are not borrowing because banks raised interest rates, added numerous fees and penalties to credit cards, debit cards, checking accounts, and loans. If this were just a repeat of past economic cycles, the ultra-wealthy would have nothing to fear. This series of events is different. America’s wealthy and powerful class underestimated the ambitions of the developing nations and now they are reaping the whirlwind. The bailout is a ruse to divert billions into the hands of a very nervous ruling class. But, hey, its no big deal. Nothing lasts forever.

Posted by Jim carlin | Report as abusive
 

Let’s get rid of the Central Bank. We need to get back to a monitary system that is gold backed. The cental bankers are causing the dollar to de-valve, which is stealing from the American people!

Posted by Art | Report as abusive
 

Mr.Saft has it right, although in my view, it is a cultural response to deregulation, Reagonomics, and the culture of greed that became the rule, rather than the exception. The recent essay by Michael Stewart “The end of the Wall Street Boom” also discussed by Thomas Friedman in the Times, as showing voices crying in the wilderness. There is a series of clips on YouTube where Peter Schiff argues with talking heads who berate him, laugh derisively at his opinions, and generally etc, treat him as a crank over a two year period. The arrogance and lack of humility in people like Rubi and the rottenh herd of sniveling crooks ( they were all making side bets) in a culture of dishonesty has brought us low

 

Like all false theories, the idea that economic markets are somehow isolated and protected from events like wars and famines in the “real” world is probably one of the reasons that the banking crisis occurred. But the absolute main reason is greed. This crisis happened because human nature is what it is. If someone is allowed to basically sell debt, which any normal human being knows is crazy, then hey, why not divided it up and sell it again. Oh, and hey, the company is failing? Well, borrow money from some other entity that holds the derivatives from the loans that first company made to someone else.

The problem being, after dividing and selling ad infinitum, who was left with any real resources? No one. Duh.

We need regulation. We need regulation to protect poor normal humans from idiotic, greedy people who run companies and governments.

 

“There was virtually nobody who saw that low-probability event as a possibility.”
So Mr Rubin thinks incompetence is an acceptable excuse for failure ?
A buddy of mine who works in finance warned me 2 years ago things were going to get very rough.

Posted by john | Report as abusive
 

Hoocoodanode! Sounds like the name of a good whiskey we could use to help get through this. That James Saft dude sorta looks like a whisky sipper.

Posted by kelly p | Report as abusive
 

We not only need to reform and better regulate banking and the financial sector we also need to wake up and evolve mechanisms that enable us to take urgent steps to better regulate our Governments and make sure they are more accountable as the ease with which the banking oligarchs were able to fleece trillions in public money for their own ends from politicians also caught with their snouts in the trough or sleeping on the job is only matched in pure audacity by the free rein industrial oligarchs have been given to rape, pollute and devastate the planet for personal profit.

 

Based on academic training and field experience, I disagree with Saft’s hyothesis in his fourth paragraph that “It’s just that the data we put into the models only covered the boom years.” ; and also disagree with the Best Comment, “..Evoking the image of a 1000 year cycle blah blah blah”. I recall from college and real corporage experience that financiers, bankers, economists, and academists have long known, taught, and experienced the proper asset/debt ratios; including the experience of boom-bust cycles starting with the depression. So give us readers a break.

My 83 year old father has been selling real estate for over 50 years and predicted this 10 years ago. As a result got out of the business because of he perceived as a syndicate of real estate brokers + appraisers + mortgage brokers all in “cahoots” to inflate the price of homes; and bankers for easy money. In his day, the CalVet loan program in California was the only way to get a home loan…or perhaps FHA.

When he got out of the business he asked me; “Son, Why would anyone in their right mind put their $400,000 investment in the hands of lightly trained real estate brokers, mortgage brokers and bankers?, after being in business for over 50 years its time to get out – there are too many amateurs in a high dollar business and that spells trouble – greed!”

So this is nothing new. Perhaps the decision makers have poor memories.

Phillp Wolfe
MBA

Posted by Phillip Wolfe | Report as abusive
 

Your opinion piece was a good one but it and many of the comments that followed lack a context.

The context that I offer is “The End” by Michael Lewis at Portfolio.com. If the name seems familiar, it’s because he wrote a book, Liar’s Poker, about the games on Wall Street in 1989. The situation then was pretty much the same as it was 20 years later but much, much worse.

http://www.portfolio.com/news-markets/na tional-news/portfolio/2008/11/11/The-End -of-Wall-Streets-Boom

If you’re not terrified by Lewis’ brief article, I would be surprised.

 

Very good article except you missed the real myth here: The Crisis itself.

All these companies bought mortgage backed securitues, securiteis and bonds backed by student loans and credit card balances. Where did all that money go.

They act like somene burned huge piles of money in the streets. If you gave a mortgage loan and sold it as a security then you got your money back. Only the companies that gamble on a security increasing in value lost money. Why are we bailing out AIG who is gambling off people’s insurance policies and retirement accounts on risky assets with little or no assets to back them. We are staking the compulsive gambler so they can continue business as usual.

American Express became a bank because it is the first year they could not sell bonds backed by payments due. So they are selling a bogus asset that if you dont make your payments the bond is worthless. This should not be legal and the companies that risk millions on such assets need to lose this money so they will stop risking it on this crap.

Rather than give the FHA the Billions to give mortgage loans and refinance mortgages and give the small business administration money to loan, and issuing hybrid vehicle loans we give the money to these gamblers that buy and sell risky assets, this is a heist.

It is so unbelievable that the world is suddenly broke. This is a scam.

Posted by Larry | Report as abusive
 

The problem is leverage, when you want to ease the transition to the next expansion not possible when not fully deleveraged and no collateral.

Angela Merkel the Federal Chancellor of Germany doesn’t like “Cheap Money” and ” re-flation ” either. She thinks that the re-flation only will last for 5 years before another crises emerges. I think she’s even more on the more positive side than I am. I expect three years max.

Bernanke already admitted himself that he does like dog food; ” such as buying Treasury securities “. Lower interest “certainly feasible”. “Quantitative easing”, no problem! A very chique word for “Who can blow the biggest bubble” .“ Longer-term Treasury or agency securities”; what a illuminating idea, that I didn’t think of this myself. Now we can not only bankrupt a first generation but with 100 years loans we bankrupt the second generation as well.

Posted by Youri Carma | Report as abusive
 

Robert Rubin, CEO’s, managers and directors have been paid obscene amounts of money (especially in the banking and finance sector. Much of the efforts have been in shifting risk from the suspecting to the unsuspecting. It has then been leveraged upwards to increase the return.

But Mr Rubin and his ilk need to be reminded that with those higher incomes comes responsibility – both good and bad. Very few managers, directors or CEO’s appear to have accepted that responsibilty for the destruction of wealth in both their client’s portfolios or indeed their own firms by resigning or at least offering to resign.

This applies to all leaders. Instead you and I, the taxpayer, are being asked to wear that pain so that they can survive intact.

No ,Mr Rubin, this is your fault and you should resign with your reputation damaged as it should be. Greed and avarice are forever present. Those who succumb to its charms must now pay the piper.

Posted by Brian Bell | Report as abusive
 

Hoocoodanode? According to Rubin “There was virtually nobody who saw that low-probability event as a possibility.” A low probability event is not a possibility? Give me a break! Lottery winners depend on it.

Rubin might have added that nobody can see any particular fire breaking out in California at any particular place at any precise moment in time. Or any particular earthquake occurring at any particular time. Or any particular person getting killed in an auto accident at any particular time on any particular road.
So why don’t we just abandon fire departments and traffic laws and anti-earthquake building codes? No need for regulation particularly when there is so much money to be made as a result of those “disasters.”
Getting rid of the regulations would make various people billions of dollars and that’s just good business! And when “low probability” events happen on a regular basis? Hoocoodanode? I was too busy pack ratting away my profits.

Posted by Ray | Report as abusive
 

This has happened before – Long Term Capital Management in 1989.

http://www.nytimes.com/2008/09/07/busine ss/07ltcm.html?pagewanted=1

I’ve been reading about the potential blow-up of RMBS dervatives and CDS for the last couple of years.

These are all poor excuses by, apparently, overpaid frat boys deflecting the blame at our expense.

How could anyone see a 1000 year return period event coming? What a bunch of hooey.

 

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