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September 2008, Part II
As I continue to look back at the financial crisis, a year later, the following is from my column of 9/27/08…week two…covering 9/22/08-9/26/08.
I was golfing with three friends who work in the financial industry this week and we were talking about the mess Wall Street and Main Street find themselves in when Jude said “We really need a revolution…the system is old. Just freshen it up a bit.” It’s a sentiment I would guess almost every single one of you has had, joking at a cocktail party, the golf course, or in the line at the grocery store in small talk about this or that, but if you watched Washington in action this past week the thought of a big shake up certainly would have crossed your mind more than once. There are virtually zero honest politicians and the system has been long corrupted. Then you have Wall Street, also corrupt, with financial markets that often are little more than a casino. Yet, despite all this we still have the best, most dynamic market economy in the world and somehow we’ll get through this period…really.
This week our leaders, including of the unelected variety, strode forth to scare the hell out of us. Federal Reserve Chairman Ben Bernanke said our nation faces “grave threats” to our financial stability. President Bush spoke of the “serious financial crisis” and how we risked a “long and painful recession,” adding we could see a true “financial panic.” In a joint statement early in the week, presidential candidates Barack Obama and John McCain spoke of the need to prevent “an economic catastrophe.”
Investor Warren Buffett, perhaps the most respected figure in America today, said “We can’t take another week like the last one,” meaning two weeks ago, though in the end this past week was just as bad. Bernanke said, “Economic activity appears to have decelerated broadly.”
That’s what happens when the credit spigot is turned off. Every business in America is already being impacted. In a highly-publicized item, even the best corporation in the world, McDonald’s, told its franchisees that Bank of America, savior of Merrill Lynch, declined to extend credit so the franchisees were on their own in terms of obtaining financing for store improvements. Of course it trickles on down from there. The system is frozen, and confidence on both the part of corporations and individuals has dried up.
In Newsweek, Treasury Secretary Paulson said “We can spend a lot of time talking about how it happened and how we got here. But we have to get through the night first.” Then in congressional testimony, Paulson added this whole episode is “embarrassing for the United States of America,” echoing my favorite statement from years ago; the securities that helped cause the crisis “are overly complicated and complex” and the firms peddling them “didn’t understand (what they had created) themselves.”
Ah yes, Hank Paulson. King Henry I. Through his bailout/rescue plan he is asking for a ton of power and a lot of us aren’t comfortable with this. But there is no time to debate this particular topic. We need action.
I come at this job from a unique perspective because of my Wall Street background and at times like these, in my own small way, I’d like to think I can bridge Main and Wall.
There is no doubt Wall Street is deserving of the opprobrium being cast on it. Many of its leaders should be strung up in the public square and it’s the hope here that those guilty of outright fraud receive life in prison, not 6-12 months in Club Fed.
But when it comes to Paulson’s rescue plan, yes, the details of the proposal are vague at best. And, should the plan go through in its basic form, there are zero guarantees that once the bad paper is stripped out of the banks and put into the marketplace, the lending institutions will in turn go back to lending.
What, though, is the alternative? As Bernanke and Paulson have said on countless occasions, you don’t want to know.
So, friends, this is about you and me. Wall Street played no small role in getting us into this mess, but at the same time many of us didn’t fulfill our own end of the bargain in living well beyond our means. One point that hasn’t been made enough in the debate over the crisis is ‘personal responsibility.’ Personal responsibility is not just a key to democracy, it’s a key to capitalism, and many of us failed the test. Those of us who feel we did everything right, including corporations and financial institutions who did act responsibly, and there are many, have a right to be frustrated, and angry, but that doesn’t solve the problem of today. Access to credit.
Many times in life you have to take a leap of faith. This is one such moment. Let’s pray not only that Congress gets its act together soon, but that our admittedly waning faith in King Henry and our system in general is warranted. Otherwise we’re headed towards that revolution, only this time it won’t be a joking matter.
“The leveraging-up in this cycle is reversing, and we are now deleveraging. When a huge system – that is, the global credit system dominated by the investment bank giants that have been the major creators of credit in the last cycle – turns down, the fallout is going to be terrible.
“Deleveraging is a very painful process, and will run longer and deeper than anybody can imagine. I’ve been fearful of this.
“So far, what we’re seeing is the pain in the financial system. Later on, we’ll see the echo effect of the pain in the real economy. I can’t understand economists talking about no recession or mild recession. This is the worst financial crisis since the 1930s. It’s different than the 30’s, but is the worst since then, and the consequences will be very, very painful for virtually everybody in our economies.”
Brazilian President Luiz Lula da Silva: “We must not allow the burden of the boundless greed of a few to be shouldered by all.”
U.N. Secretary General Ban Ki-moon: “The global financial crisis endangers all our work. We need a new understanding on business ethics and governance, with more compassion and less uncritical faith in the ‘magic’ of markets.”
Mark Malloch Brown, British cabinet minister: “What you are seeing here is the letting off of some political steam. They are all remembering the very hard, unforgiving advice that they got from American financial institutions” to “deflate your economy, let your banks go to the wall. There is a resentment at what they would see as a further evidence of double standards.”
German Finance Minister Peer Steinbruck: “The U.S. will lose its status as the superpower of the world financial system” with the emergence of stronger, better-capitalized centers in Asia and Europe. “The world will never be the same again.” Steinbruck emphasized it was “irresponsible” for the U.S. government to oppose stricter regulation even after the subprime crisis broke out.
“The dangers, as Bernanke and Paulson see them, are in the liabilities. Who knows where they might lead? They include AIG’s obligations to pay off credit-default swaps – private contracts in which AIG promised to support billions of dollars of bonds if their issuers defaulted. These were developed to comfort speculators and make them believe they were investing.
“It was a delusion: At the worst, credit-default swaps on Lehman Brothers Holdings still were quoted at about 5% of the face value of the bonds being protected less than five days before the firm went under. It was like selling flood insurance on Galveston Island, while Hurricane Ike was in the Gulf of Mexico.
“Credit-default swaps created a nation of speculators who don’t want to take their losses. The financial establishment has been afraid to start unwinding these swaps. They know that when you pull on a loose bit of yarn dangling from a sweater, you never know how much sweater you will have left at the end. So the government is buying the sweater. As President Bush declared in the Rose Garden Friday, ‘These are risks America cannot afford to take.’ Too bad. The risks have already been taken. Now: Can America afford to cover its bets?....
“Listen carefully to the cries of ‘chaos’ on Wall Street: Some of those shouting loudest are trying to make others pay for bankers’ and borrowers’ mistakes. Finding no others willing to step up, the Fed and Treasury are becoming the nation’s stand-in speculators.
“The Treasury will borrow to buy mortgages and the Fed will print money to buy Treasuries. The danger is that they are igniting a great inflation to stave off a great depression. If so, this week will enshrine President Bush with President Carter, and Ben Bernanke with G. William Miller.
“Just as the Weimar Republic printed money to pay war reparations that the Germans couldn’t afford, the United States of America is putting its full faith and credit – until neither remains – behind mortgages that its citizens can’t afford. All investors can do is hope that the ultimate sacrifice of capital destruction won’t be necessary."
“Nobody understands who owes what to whom – or whether they have the ability to pay. Counterparties have become afraid to trade with each other. Sovereign wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in. The crisis continues because nobody knows what anything is worth. You simply cannot have a functioning market under such circumstances.
“Will this latest round of proposals end the crisis? I know the stock market reacted joyously on Friday [9/19], but I’m not hopeful. One solution being promoted by the Securities and Exchange Commission – to make life more difficult for short sellers – is a shameful sideshow. A second solution, which Mr. Paulson announced Friday morning, requires money market funds to create an insurance pool to cover themselves against losses.
“That may provide comfort to investors who equate money funds with savings accounts, but it is fraught with moral hazard.”
“It is no easy task to deal with a crisis that, in spite of its similarities to previous ‘financial gales’ is unprecedented because of the complexities of today’s capital markets. We must hope for all our sakes the U.S. government’s solution works and that it is not too late. It was the economist John Kenneth Galbraith who said: ‘One can relish the varied idiocy of human action during a panic to the full, for, while it is a time of great tragedy, nothing is being lost but money.’ Unfortunately, it is not just money, but the lives and hopes of ordinary people that are increasingly likely to be damaged after this week.”
Anatole Kaletsky / London Times
“The Emperor has no clothes. If you want to know why American capitalism is on the brink of disaster, but also want to understand what will save it, then log on to the C-Span congressional website and watch the interrogations of Henry Paulson, the U.S. Treasury Secretary, by the Senate and House banking committees.
“Until last week, I was in a minority of one in arguing that Mr. Paulson was personally responsible for suddenly turning the painful but manageable credit crunch that had been grinding away 18 months in the background of the U.S. economy into a global catastrophe. Mr. Paulson’s appearances on Capitol Hill, marked by the characteristic Bush-era combination of arrogance and incompetence, are turning my once-outlandish view into conventional wisdom: Henry Paulson is to finance what Donald Rumsfeld was to military strategy, Dick Cheney to geopolitics and Michael Chertoff to flood defense.
“Mr. Paulson may be a former chairman of Goldman Sachs, but as U.S. Treasury Secretary he does not know what he is doing. His recent blunders, starting with the ‘rescue’ of Fannie Mae, have triggered unintended consequences around the world, resulting in the death-spiral of financial values. But last Friday Mr. Paulson outdid even these Rumsfeldian achievements, when he demanded $700 billion from Congress for a ‘comprehensive and fundamental’ solution to the global financial crisis, without apparently having any idea of what he would actually do.”
Meanwhile, the FBI announced it has been investigating AIG since last March for hiding losses (flat out fraud in manipulating earnings), while it is now looking into the activities of executives at Fannie, Freddie, Lehman and a host of others.
Eric D. Hovde / Washington Post
“What is even more remarkable is that (while) firms such as Goldman Sachs and Lehman not only made billions of dollars packaging and selling toxic loans, they also wagered with their own capital that the values of these investments would decline, further raising their profits. If any other industries engaged in such knowingly unscrupulous activities, there would be an immediate federal investigation.
“Why is Washington so complicit in this intricate and lucrative affair? First, the Fed laid the groundwork for both these asset bubbles by lowering interest rates to historic lows. In an attempt to protect his legacy after the Internet-bubble collapse, Greenspan provided unprecedented stimulus to re-inflate the economy and maintain his popularity with Wall Street. (Remember the ‘Greenspan put’?) But in doing so, he spawned the largest debt and asset bubble in U.S. history.
“At the same time, federal regulatory agencies such as the SEC stood idly by as Wall Street took advantage of the investment public during both the Internet and the housing bubbles. The SEC took almost no action against Wall Street after the dot-com implosion. And in the midst of the housing bubble, in 2006, only the Office of the Comptroller of the Currency pushed for any level of regulation to address subprime lending.
“One has to wonder why Treasury secretaries under Presidents Clinton and Bush – Robert Rubin and Hank Paulson, respectively – took no action to curb these abuses. It certainly was not because they did not understand Wall Street’s practices – both are former chief executives of Goldman Sachs. And why has Congress been so silent? The Wall Street investment banking firms, their executives, their families and their political action committees contribute more to U.S. Senate and House campaigns than any other industry in America. By sprinkling some of its massive gains into the pockets of our elected officials, Wall Street protected itself from any tough government enforcement….
“Wall Street’s actions are now profoundly hurting American families, communities and the entire U.S. financial system. People are being thrown out of their homes. Once seemingly indestructible financial entities are succumbing to the crisis they have created and have jeopardized the stability of the global financial system. Isn’t it ironic that the same firms that preached free-market capitalism are now the ones begging for a taxpayer bailout?”
Lastly, regardless of how successful any rescue plan proves to be, the federal budget deficit, and thus the national debt, is obviously going to soar. Commentator George Will summarizes one aspect of this problem.
“This crisis has arrived during the ninth month of a vast demographic deluge – the retirement of 78 million baby boomers. As the population ages, the welfare state – primarily, a transfer-payments pump providing pensions and medical care for the elderly – requires more rapid economic growth to generate increasing revenue. To the extent that today’s crisis results in large amounts of capital being allocated by considerations other than those of economic efficiency, the nation will be consigned to less-than-optimal economic growth.
“The next administration, but especially an Obama administration, will chafe under severely narrowed economic restrictions. But subsequent generations will pay the radiating costs of the rising role of the state in allocating financial resources.” [Washington Post]
--The Dow Jones fell 2.2% to 11143, while the S&P 500 lost 3.3% and Nasdaq declined 4% to 2183, the latter’s lowest weekly close in over two years. Aside from all the uncertainty, General Electric didn’t help matters when it slashed guidance for the third quarter and the full year owing both to the global slowdown as well as a reassessment of prospects at its financing arm, GE Capital. And BlackBerry maker Research In Motion warned on its prospects, sending the stock down a whopping $26.50, or 27%.
--U.S. Treasury Yields
The short end of the curve continued to convulse on every rumor of another bank failure or other sign of financial instability. There was also some straightforward economic news and it wasn’t good, with existing home sales plummeting further, and durable goods (big ticket items) tumbling 4.5% for August. The weekly jobless claims number was also atrocious and didn’t augur well for the next monthly payroll report. Finally, 2nd quarter GDP was revised for a final time and it slipped to 2.8%.
--The 6th-largest bank in America, Washington Mutual, became the biggest bank failure in U.S. history, though in this case no taxpayer dollars were expended. Instead, JPMorgan Chase acquired the deposits, judged to be in the $180 billion neighborhood (as of June 30, though depositors were beginning to walk with their cash the past month in particular), for all of $1.9 billion, while acquiring a loan portfolio of some $300 billion, of which it will immediately write off $31 billion. Bottom line, a total steal for JPM. [WaMu stock and bondholders were wiped out.]
And Goldman Sachs received a shot in the arm from Warren Buffett, $5 billion in the form of a perpetual preferred, at 10%, plus the right to buy another $5 billion in Goldman stock at a future date, priced at $115. [Goldman finished the week at $137.]
--Goldman Sachs, Morgan Stanley, and Raymond James are all transforming themselves into bank holding companies, subjecting each to greater federal regulation, significantly reduced leverage, and, particularly in the case of the first two, the end of an era on Wall Street as Goldman and Morgan sought to avoid the fate of Lehman Brothers.
[Morgan Stanley then received an investment of between 10 and 20 percent from Japan’s Mitsubishi UFJ, details of which are sketchy, while Goldman got the infusion from Buffett.]
--Barclays Plc, the U.K. bank that bought parts of Lehman Brothers, initially talked of retaining 10,000 employees from Lehman’s trading and investment banking business, but now there is word they may still cut up to 5,000.