I blogged a few months ago about my concern regarding the precedents being set by the Northern Rock and Bear Stearns debacles - that investment bankers and city executives can take outrageous risks, bag huge bonuses and get into a situation that for the sake of the economy, the government has to step in and sort it out.
If only that had been the end of it; I don’t think anyone really thought it was, but since then things have really gone south. In the USA we’ve had the state effectively re-nationalising Fanny Mae and Freddy Mac, and they’re now debating a $700bn rescue package to buy bad assets from a host of financial institutions in order to ‘extract the poison’ from the markets.
Now, as before I completely understand that, in the immediate aftermath of a train-wreck such as this, you have to concentrate on damage limitation and short-term recovery. That doesn’t mean, however, that we should stop asking searching questions - the world has been placed in a woeful position thanks to a comparatively small group of people who benefitted from continuously feeding the insatiable credit monster, no matter what the realistic repayment prospects were for those debts. It’s typical commission-based salesman behaviour - close the sale, let the accounts department worry about the rest.
I’m glad to see that the US congress haven’t just rubber-stamped the rescue bill, and are asking serious questions about future guidance & regulation on the market and its operators. The Wall Street guys will tell you that interference and regulation just inhibit the market and make everything worse, but I believe that recent events rubbish that claim; if the market was truly self-sufficient and self-regulating, it wouldn’t have gotten itself into the position where it needed a handout from regular people’s tax dollars to avert a total meltdown. Clearly short-term greed overwhelmed good sense, and those in this market acted like children who didn’t know when to stop eating junk food - except in this case, everyone ends up with a stomachache. Like children, if they can’t figure out for themselves how to behave, then they need a responsible adult to make those decisions for them. Trust is earned, and the financial sector essentially frittered all that trust away having a giant party, and there must be consequences.
Some people will blame the culture of credit and say that the market was just responding to that, and so it shouldn’t be held entirely accountable, and I say hogwash. Sure you can blame the people who took out loans they couldn’t afford to a degree, but come on - these were unlikely to be financially savvy people, and at the end of the day it’s up to the lender to evaluate repayment prospects rationally. After all, if they don’t get their money back, they’ll go out of business. In this case though, the financial wizards concocted another one of their ‘vehicles’ which magically allowed dubious debt to be repackaged and resold, effectively becoming somebody elses problem. What a marvellous invention! We can take all the risks we want, collect our fat bonuses and just keep hiding all our crap under a giant rug in the spare room. No-one will ever find it, right?
This is not responsible behaviour, it’s reprehensible. The vast majority of regular people work hard, are prudent with their money, think hard about lending or borrowing money, and don’t make the kinds of basic affordability errors these so-called financial experts were making. After all, regular people have to live with the results of their actions, so prudence is a wise stance. Mistakes in the financial sector, however, result in damage mostly to the lower echelons of their workforce, crippling problems for the rest of the public, desperate measures from government; yet the execs still get to keep their huge bonuses earned during the previous years.
After all the mess is cleaned up, I hope those that benefitted from the years leading up to this situation are held to account. Enron, Nick Leeson - they were nothing compared to this. The culture in the upper echelons of corporate banking is clearly fundamentally broken, and both governments and the industry owe it to regular people to resolve it, not just with short-term bail-outs, but with fundamental change. Something is badly wrong in the financial sector, and they’ve proven themselves incapable or unwilling to sort it out before it resulted in pain for everyone else. Because of that, they’ve forfeited their right to decide what happens next - behave like a greedy child, and you deserve to be treated like one.
September 25th, 2008 at 3:29 pm
The best explanation in the simplest terms I have seen on the issue so far has been Bill Clinton when he has been doing interviews (Letterman, Daily Show) as to why they got into this position in the first place.
You should also note that in America the person who has taken out a lone can walk away at any stage and have no further payments (as the bank gets the house or whatever else was the collateral for the lone). Other countries require them to still pay back the difference after the house is sold, which makes you more inclined to not over stretch yourself.
September 25th, 2008 at 3:43 pm
The bonus led culture lead to decisions that gave maximum short term profit at the cost of long term stability.
What happened to saving away for a rainy day? Putting money aside in a fund while the going was good? These are things ‘they’ tell us to do?
Doesn’t stop at banks either, the government has been spending money like it’s out of fashion. I mean that whole “oh we have lost money we thought we would have because we can’t put up the fuel tax again”… wtf? Really? You never had that money to begin with! At least in the States extra taxes seem to cause intense debate and often are temporary… in the UK obviously the current bunch of whats-its in charge think it’s okay to play the whole bait and switch “yeah we’ll take more money but we’ll give it back to you in credits (that you aren’t eligiable for)” “Look we cut taxes here (and put them on top of something else”. RUBBISH.
And the whole way inflation is measured is a complete joke. Inflationary rise? Well… depends on what you call “inflation”.
Politicans get elected on a manifesto… that should become their employment contract. And if they break that contract they should be kicked out. There is just no consequence to their actions. What about these bank bosses? Nah, they can stay there because… they are experienced and no one could do a better job. Oh yeah, and they can still have their bonus.
[/end rant]
September 25th, 2008 at 4:06 pm
I’m firmly of the opinion that any organisation that achieves a size or level of insulation from the ‘real world’ that breaks the causal link between what happens in the board room and what happens on the ground is guaranteed to become disfunctional. Add vast amounts of money into the mix and you have a deadly cocktail. And if the head has gone off into its own batshit crazy world, swimming in cash and incentives, then the rest of it will surely follow.
Government has the exact same problem, except at least they can be voted out (and they can’t get away with quite so many extravagant personal indulgences). Global corporations (financial or otherwise) are far worse, because in practice they ultimately answer to no-one, even when they make titanic mistakes like this - their staff get screwed, but in the interests of the economy and business, they get bailed out and I doubt their execs will ever be called to account for the incredibly poor, selfish decisions they made, barring perhaps the odd unfortunate scapegoat. The message is that it’s ok to ruin lives by being a greedy asshole in the financial markets, but if you donned a balaclava and raided the US treasury for even a tiny fraction of the $700bn you’d get twenty years. Go figure.
September 25th, 2008 at 6:51 pm
Greedy asshole is one thing, another is investment bankers are the one who take in the highest paycheck, second is Oil & Gas - that is what I heard. And this money is earned even though they are not part of value-chain in goods produced. They don’t add value to the product, but yet they earn the most. And this drains out certain amount of money to the more deserving parties.
September 25th, 2008 at 11:48 pm
Steve, and here I was going to pay you for your next contract in distressed debt and convertible bonds. Not interested anymore? Tuna fish?
September 26th, 2008 at 2:42 am
I am not sure why the outrage.
The financial markets responded the way all markets respond to incentives.
Fannie and Freddie created a lucrative (albeit obviously artificial) market for sub prime mortgages and , surprise surprise, everyone jumped on it.
The whole thing was driven by ?socially conscious? politicians like Barney Frank who put the whole scheme in place precisely because banks traditionally were reluctant to offer loans to relatively large segment of population deemed by them ?financially unreliable?.
Here is Barney Frank himself basically blowing off Alan Greenspan as an alarmist, claiming that Fannie and Frank are doing excellent job etc ?
The interesting thing about this video is the fact that is dated from 2005 ?
Ignore the commentary and just look at the original CSpan video.
http://www.youtube.com/watch?v=3QBRIsCkGQ0
If people are looking for heads ?. I suggest we should start with Barney Frank.
September 26th, 2008 at 8:34 am
@Asi: I wouldn’t have accepted that even in the good times
@warmi: Absolutely Fanny / Freddy were a dumb idea. We have nothing like that here, despite being more socialist, and neither does mainland Europe, despite being even more socialist. The closest thing is Building Societies here, except that they’re still relatively careful about who they lend to, certainly compared to crazy US lenders.
About incentives, the problem is that you can’t have incentives without adequate oversight and risk management. Saying “it’s just the way the market works” is chronically complacent given that when the market gets itself into a hole because of those incentives, everyone else suffers and has to bail it out for the ‘greater good’. It’s like saying it’s ok for the food industry to have incentives to make as much cash as possible, and have poor regulation of what they put in it, leading to cases like in China with the contaminated milk, and then saying “oh, they did that because it made financial sense, the health service will clean it up and the market will rebalance itself”. It’s bollocks - there are repercussions, and the market-worshippers can no longer ignore that. If people’s incentives lead them to do things that are in their own short-term interests at the expense of thousands or millions of others, and those actions are left unchallenged until the shit hits the fan, something is badly wrong with that system. You don’t see the outrage? Wait until you have to pay for the financial industry screw ups through your taxes.
Clearly not even the republicans believe markets can be allowed to fail, so why should the execs have free reign to do stupid things and reap disproportionate rewards in the good times, because they know Daddy (the government) will bail them out if they get into trouble? The belief (always strongest in the US) that free markets are self-regulating has been discredited probably beyond repair in this generation, and it may very well take the pre-eminence of the US as a financial model with it as things move more towards Asia where there’s plenty of cash sloshing around, something the west is short of right now. A group of banking / investment CEOs (50% US) discussed this on an hour-long BBC panel last night, and even they think this is the case: http://news.bbc.co.uk/1/hi/business/7636497.stm . Ignore the slightly sensationalist introduction, the majority of the discussion was very sober and from people in the industry, not politicians or reporters.
September 26th, 2008 at 3:53 pm
Who in their right mind here would trust a company named Fannie Mae or Freddie Mac? They sound like clueless DJs!
Hopefully the people responsible at the top of the tree for this mess suffer some sort of consequence. I understand the need for the $700bn (as much as a non-financial idiot like me can), but I just loathe the lack of moral standards where no-one is being held accountable. It’s ok guys, just do what you can to make as much money as you can and if it all goes to pot, we’ll just walk away and work for someone else. We’re rich, we can get away with it. Though I tend not to watch the news and may have missed any stories relating to the big-wigs suffering the consequences.
September 26th, 2008 at 4:07 pm
“Clearly not even the republicans believe markets can be allowed to fail, so why should the execs have free reign to do stupid things and reap disproportionate rewards in the good times, because they know Daddy (the government) will bail them out if they get into trouble”
But that was not the case.
This would have never happened if it weren’t for market distortion which was introduced by government backed semi-market oriented institution.
Remember, the whole reason for the existence of Freddie and Fannie was precisely because all these “stupid execs” weren’t willing to be as stupid as to invest in risky sub-prime lending and had to be coerced into it and these two GES were the tool used to get them on board with the new lending policy.
What we have here is a failure of trust but not on the part of Wall Street but on the part of government - they have poisoned the market with their cavalier and politically motivated lending practices and now it is only natural we will all have to pay for it - and we will , either with higher taxes or higher inflation, both of them amounting to pretty much the same thing.
September 26th, 2008 at 4:22 pm
@warmi: I think you’re focussing far too much on Fannie & Freddie, they’re but one part of it. Indeed no-one on the panel of senior bankers (if you watched the show I linked) even mentioned that as a root cause.
Nobody coerced Northern Rock execs into growing their mortgage books via money market gambling, or any other of the big commercial institutions - the goal was profit, pure and simple. Now, it is definitely possible that governments ’set the tone’ by quietly underwriting a number of smaller dodgy gambling problems in the markets in the past, which then led to the commercial institutions getting too cocky, especially given the length of the boom. But to suggest the US government was solely responsible for co-ercing multitudes of international banks into pursuing a growth market, albeit a risky one? That’s just ridiculous. Companies listen to one group more than any other, and that’s their shareholders - they pursued this because of the potential profit, and even though they knew it would all come to an end eventually, none of them could possibly pull out while all their competitors were reaping the ‘profits’ from it. This is where the market falls apart - everyone knew it was going to be a long-term disaster, but the market says you have to compete right now, so everyone put the blinkers on and pretended it wasn’t goingn to happen. There were no ‘governers’ controllling how fast the crazy money spinning machine went, and eventually it shook itself to bits, taking out plenty of bystanders in the process. Yes the market is self-rectifying, but that’s like saying ’stuff grows back really well after a forest fire’ - it’s not going to be any consolation to the people who burned to death in it just because they lived nearby. Sometimes the cycles the completely free market creates are too costly.
Governments certainly have their fair share of blame, certainly for removing much of the regulation that used to stop this kind of irresponsible lending happening (you have Mr Bush to thank for that), and meddling in mortgage issuance was stupid - but to say the market was blameless and simply forced to do what it did is absolutely crazy.
September 27th, 2008 at 1:07 am
I am not familiar with Northern Rock but here in US Fannie & Fredie are much more than just part of the problem.
Fannie and Freddie handle betwen 70% and 80% of all the mortgages in this country … that’s virtual monopoly.
“Governments certainly have their fair share of blame, certainly for removing much of the regulation that used to stop this kind of irresponsible lending happening (you have Mr Bush to thank for that),”
You must be talking about the famous 1999 deregulation signed by Clinton and supported by 92% of senators, something Bush had nothing to do with.
In any case, you can’t regulate market risks .. you can only remove them and if you do ,you will be removing potential benefits as well so why even bother having a market in the first place.
September 27th, 2008 at 2:07 am
Steve,
Here’s a highly-entertaining podcast on the financial debacle from National Public Radio (NPR). Titled “Global pool of money”, it is a great listen.
http://www.thislife.org/Radio_Episode.aspx?episode=355
Uneducated bar-tenders come mortgage brokers making $100k a month, no-income no-asset (NINA) loans to truck drivers claiming unverified $200k/year incomes. Top-down pressure to keep lowering the lending bar. If it didn’t involve hard-earned pension funds, it would almost be comical.
At least a lot of greed monkeys on Wall St. got burned in this meltdown, being paid in (now worthless) options.
September 27th, 2008 at 1:45 pm
@warmi: The 1999 bill was passed by a majority republican congress, if you remember: http://mises.org/story/3098 . Bush has followed up on this with 8 more years of the same ideas.
Fannie & Freddie may manage a huge percentage of the mortgages in your country, but the vast majority of those are not the cause. It’s the mortgages in the last 5-10 years that are the problem, and those are spread very, very widely indeed.
Your black & white, no-regulation or bust view of the market is a great theory, but look around if you want to see where it gets you in practice. Risk management is certainly not about ‘no risk’, it’s about moderated risk, something the banks have clearly forgotten in the chase for short term profit. The ‘perfect market’ is just as transparent a fiction as the ultra-right conservative view that if you cut taxes for the rich, it will trickle down to the rest of society and everyone will be better off. In reality all it creates is a situation where everyone wants to be in that elite top group and will step on everyone else and take any risk to get there, to avoid joining the refuse pile at the bottom. It’s akin to the First World War approach to warfare where if you thrown enough regular people at a wall of bullets, a lucky few will get through and be the ‘winners’. Not a balanced way to run a country at all.
Yes, I’m a liberal
@futnuh: great podcast, thanks. warmi, you should definitely listen to it - again people *from the industry* talking about the situation.
September 28th, 2008 at 4:39 pm
I think you are forgetting that there are winners here to. There are many financial institutions that were run properly and are now reaping the benefits. Banks like JP Morgan Chase are buying up the remnants of these mismanaged banks and investing firms at fire sale type prices. Right now the market is rewarding those companies who were managed well and punishing those who weren’t, which is how it should be.
No matter how much regulation you pass, you can’t get rid of bad management. Companies like AIG are incredibly strong, but someone stupid up top decided it would be a good idea to insure crazy mortgage backed securities. The losses from that one division single handily dragged down the entire company. How can regulation stop make a company calculate risk properly?
I wish we could come up with a rescue plan that could keep enough capital in the market to keep the lending system working while still letting all these institutions take the losses they deserve.
“In reality all it creates is a situation where everyone wants to be in that elite top group and will step on everyone else and take any risk to get there, to avoid joining the refuse pile at the bottom.”
What you are disparaging there is the competition which is fundamental engine of the world economy. Yes it might not be pretty, and no everyone will not always win (it is “competition” after all), but it’s the best system the world has come up with.
September 28th, 2008 at 5:54 pm
Free competition without regulation would let food companies put anything they like in your food - so long as you can’t taste it, and it doesn’t kill you for a few years, they can make a packet, right? Regulation is needed in any situation where collateral damage is possible.
There’s nothing wrong with competition, but focussing solely on that with no adequate safety nets for innocent bystanders, and those who aren’t ‘winners’ is wrong. Take the US system - the largest economy in the world and the healthcare system is completely shot for anyone who doesn’t pay private health insurance. You have a situation where privatised water companies charge too much, and who cut people off for not paying the inflated prices, reducing them to 3rd-world conditions where they have to go fetch water from down the road. It’s the ‘Hollywood model’, where everyone focusses on the possibility of being a winner, and brushes all the people that don’t make it under the carpet to rot. I certainly buy the argument that people should be encouraged to work and to better themselves, but there is a bare minimum that everyone should be entitled to; not to die when there is medical technology to save them, the basics of human existence like access to food & water, not to be poisoned by food companies making a profit, and not to have their economy & job prospects dashed by people in mortgage companies taking short-term profits at the expense of medium-term economic stability. Now sure, they should work hard if they want a big house and a Porsche, but they shouldn’t have to fight for the basics.
You absolutely can have a capitalist system where hard work and personal sacrifice is rewarded, while still protecting the public and making sure the less fortunate have a decent (if not luxurious) life. No you can’t regulate out individual management stupidity, but you can regulate against gross, mass stupidity of the kind we’re seeing here. The problem was that when one bank in this sector started chasing this ‘new’ business model, all the others in similar situations had to too, to keep their shareholders & investors happy. Regulation that said ‘you can’t lend 125% of a house price’, or ‘you must have verified income statements before accepting mortgage business’ would have avoided the worst excesses. There was definitely a sheep mentality here, with lots of institutions chasing & building on the same crappy business model, and it really needed someone from outside to say ‘hold on, this is dumb’. No-one inside would do it because they were too busy competing with each other, doing the same stupid thing, and not thinking about what might happen next month, or next year, because making money *right now* was paramount. This is what regulation is for - the market / competition system is not perfect, nor rational in many cases, and unless you’re willing to accept the collateral damage that results from a completely free market (and not even the republicans are), then you must have regulation to avoid the huge swings that unsound experimental business models in a gigantic free market can cause.
September 29th, 2008 at 12:03 pm
I don’t think you could have summed up my opinions on this any better Steve.
These fat-cat amoral execs need to be more accountable. In any other line of business (except energy and utilities) such high salaries mean more responsibility - these guys got away scot-free, not even a slap on the wrists!
I think the world need a financial reset. Viva la revolution!