– 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. –
Evoking the image of a 1000-year flood represents an attempt to lessen the appearance of risk, the implication being that it will not reoccur for about 1000 years. Such an assertion is based almost purely on faith in cycles. We can extend the concept however, noting how civilizations collapse on a cyclical basis. I would say that there are some shades of truth to such comments from the banking industry.
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Agreed but a large source of the pain and still poorly regulated is the prop/casualty and health insurance industry…some smart legislator looking to make a name needs to propose immediate legislation to make insurance regulated by the feds and not the states(who cave in to whatever the insurance cos wants)…AIG is one of the largest takers of TARP $’s all because Mr Greenberg’s model allowed regulation of only portions of the business. The unregulated sham insuring of CDS’s largely pushed us over. Had there been more regulation maybe we would have a regular recession rather than a near depression. The insurance lobby must be all powerful to prevent this important regulation from occurring.
Excellent article. Lack of regulation based on politics demanding an ever growing economic base. Fiction to be sure. When our manufacturing infrastructure has been decimated by outsourcing overseas, and we as a nation are the largest consumers of foreign oil, and our national debt is of gargantuan proportions, seriously how can America continue to function in this manner ?
And now we have the big 3 automakers begging for handouts, while they have done nothing (but cater to the oil industry) to develop, as the Japanese have done, real fuel efficient and innovative autos. They just continue to manufacture the big gas guzzlers that now sit unsold on retail lots.
Not even mentioning the quality issue that drives many Americans to purchase Toyotas and the like. I would personally like to see a law enacted that permits only 4 cylinders autos to be used in the USA, together with the utilization of railroads in lieu of truck transport whenever feasible. This will reduce fuel consumption dramatically, as well as pollution.
The bottom line is that nothing will get done unless we have real regulation in this country, over all facets of our economy. There is far too much greed that dictates our modus operandi, and we may very well be headed towards that great depression, unless we as a nation are willing to bite the bullet, trim down on our wasteful habits, and our government do what is necessary to insure our longterm viability !!!
????’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.’ ??????
The singular difference here, is that while most of the rest of us are worried about basic food and shelter in our retirement years, these guys will have to endure the torture of reducing from five mansions to three.
???No misalignment of risks???
This is a very insightful commentary and most of the comments are equally insightful and thought provoking. Thank you one and all.
Unfortunately the persons in charge did not want to produce the right type of regulation required for derivatives and the like.
When Enron went down, the right thing would be to legislate the required regulation encompassing markets newly created. For example anything that should be sold by companies that are publicly owned and exceeds a total value in excess of 10 million dollars should be recorded in an independent organization, like the NYSE and regulated by SEC or another organism.
The risks should be transparent, by making the market value a public information…
The fact is the US Government did not want to regulate, they wanted to create an envinronment of easy money so the economy would look healthy. Fundamental facts were disguised, like the loss of leadership in several industries and technologies.
The questions for the near future are:
- what will happen with the military power of the USA?
- How can a country that has no real economic power keep its currency with value to pay its obligations?
- How retired Americans will keep their income?
- How America will pay it’s huge debt?
These questions and other similar to these will be haunting the next American Government as the markets starts to stabilize and everybody start thinking in their investments….
I just can’t agree with his excuse, of course if he is right, the sky is green.
I can’t help but see the main reason for the problem is the oil companies and the sky-rocketed cost of fuel. You have to go to work, you have to have oil for furnaces and that leaves nothing for purchasing other items. Now the makers of those other items can’t make their Co.’s profetable so they have to layoff workers which lowers the available money even more. All the while, the Oil Co.’s laugh all the way to the bank.
Rubin, Greenspan and the their bunch of like minded fools should all be spanked in public, openly admit they are really stupid, apologize and be required to take financial responsibility help out 20 destitute families.
No one is speaking about the Automatic Underwriting programs that both Freddie Mac and Fannie Mae used to approve loans and loan packages. They shared those programs with the vendors who sold them loans and with the purchasers of commercial paper who bought packages of those loans. Every one was brought into synch and every one looking arrived at identical conclusions whether right or wrong about the value of mortgages and debt. Everyone marched to the same beat, toward the same cliff.
Mike, unless I am missing something I do not see
where you got the notion that Mr. Hart was defending christianity. It seems like you have some sort of axe of your own to grind. The point he was making, I believe, was that his statement did nothing to advance his arguments.
Tell me this Reuters! How can we have increased spending when people are losing their jobs like your reporters are saying? Something is completly NUTZ! see your headline in home/ stockmarket John
Mr. Hart, every society and civilization does have a creation myth, among others myths. The only difference between yours and anyone elses is that you do not consider yours a myth. Mythology is mythology however, christian or not. By traking offense to the comment, you miss the point… as many christians seems to do.
for anyone interested in unbiased economics and explanation of depresions etc. I recommend Hayek - Nobel price winner or Rothbard, both Austrian School econmists, http://www.mises.org, … Peter Schiif was able to forsee this crises thanks to Austrians …
These bankers know exactly how this crisis happened. It is no coincidence it is happening now and in the order it is transpiring. Oil is suddenly tettering above $40.00 a barrel just as the 3 Big Automakers are begging for a dime. The cheap crude is bait, keep the broke automakers in operation and you’ll have cheap oil to fuel the cars…Bait and switch. The real story is how badly the media and the government controlled Banks and Industry believe the American people to be stupid and in a dead coma. The bankers are banking on us being lulled to sleep by cheap oil and welfare checks versus angry and upset that they are fleecing–have already completely pimped us out–to foreign investors. It’s enough to make me puke my guts out…but I’m saving my guts for after January 20th, I made them need to protest the very country that I love and am growing to despair of.
Jerri: Most loan officers knew that borrowers were stretched to the max with the loan they were going to undertake. It does not imply that they were incapable of managing the debt. Since most loans had a teaser rate with ceilings, clients were aware that they had to refinance before the two years was up to avoid possible increase in rates. These programs allowed the borrower to get into the home, made lenders money. Majority of borrowers should have refinaced but never did as they did not heed the call of loan consultants.
Most of them(banking and investment world) will tell you they did not know of this mess coming, but they knew. Just the severity is beyond their expectations. The sad part is the core of this economy revolves around it and it has caused mistrust from investors globally. The outcome: Investors from overseas will not want to invest in American securities. Lack of this capital will shrink the American very fast.
There’s also one thing that nobody mentioned, yet it’s one of the things, if not the main one, that caused the current economic malaise. And that thing - oil.
Gasoline - no matter how you slice it - is a necessity right there with food and before housing. When people have to choose between falling behind in mortgage payments and getting where they HAVE to be NOW, guess what they’d do? Yep you guessed right - fill’er up. And especially this is about less affluent people tending to drive older, bigger vehicles consuming more gas. Shiny new Prius or Lexus RX400h is the well-to-do suburban thing. The American heartland drives older pickup trucks and Suburbans, and inner cities are full of used vans and SUVs. The same people make the bulk of subprime borrowers. It is not just a coincidence that many of them were pushed over the top when oil prices became insane. In 2005 oil crossed $50/bbl and then went up, up and away all the way to $146.81 last Summer. The consequences soon followed.
While the oil sheiks wallowed in unearned cash, Americans struggled to make ends meet. And it was not only at the pump - everything delivered by road or rail went up. Finally they started breaking down and default on credit cards and mortgages. And then it started feeding on itself, sucking in housing prices, banking, financials, retail, autos, jobs - no need to go into details of the vicious cycle here, everyone remembers the timeline.
Everyone is talking about $700BN bailout. But multiples of that were overpaid to OPEC (that consists mostly of regimes not-so-friendly towards USA by the way). Oil can be at $147/bbl only in the dreams of Chavez and Ahmadi-whatever-his-name of Iran. Even $47 is too much. Just about the century turn I remember the Saudis spoke about stabilizing it around $30 that they called “fair price”. I have a close relative at one of oil majors - he recently told me that they calculate profitability of new projects based on twenty-something price (don’t remember exact number, some mid-to-upper $20es).
Rubin: “There was virtually nobody who saw that low-probability event as a possibility.”
Krugman, Roubini, Faber, Ackman even the NY Times of May 2005.
Back around 1997 I sat in an economic conference where a high level US gov economic official, an aged wise economist, in a moment of unguarded honesty, said:
“I deeply fear our entire monetary, budgetary, foreign trade and financing architecture is awfully dangerous. We are using are reserve-status currency power to create massive free-lunches by feeding off the world’s savings, then leveraging that savings to insane proportions. We will have a decade of undreamed but unearned riches. Bubbles after bubbles. Then one day we will find we are screwing ourselves. There will be one too many bubble. Because what’s unsustainable simply won’t. But our entire society is into it, and nobody can stop it. So it will have to stop itself. I fear our high economic power might be finished along with it.”
That was a decade ago. When those in-the-know already knew. What they cannot know was the trigger. That trigger, turned out, was not economic. It was mass insanity caused by runaway greed.
We will never get rid of these bums until people realize that both political parties are equally at fault.
President Bush spurred growth in the economy by lowering tax on the rich and eliminating capital gains on the sale of homes on up to $500,000.00 in profits. This spurred enormous growth in construction of homes. Suppliers or raw material, designers, builders, mortgage brokers, investment banks and insurance companies made huge profits and paid tax on a bubble, while the U.S. was borrowing to pay for two wars - so the other public would not be distressed. The bail out is a financial “pardon” for those who went along while heaping future debt on the wage earning majority of the public.
Knowing as much as I can find out from the media, it looks like House and Senate leadership should have put their political jobs on the line and practiced statesmensship instead of enabling a chief executive drunk with power.
While your article might be very good, I was unable to get passed your inappropriate, argumentative opening statement, “Just as every society has a creation myth.” Additionally, statements like that weaken your position and narrows your audience.