#WHO_WAS_TO_BLAME_FOR_THE_CRISIS(THE FINANCIAL CRISIS) Finger pointing over who was to blame had run amok and by early 2009 had become a “national pastime” of sorts. Commercial and investment banks, mortgage lenders, credit-rating agencies, insurance companies, regulators, politicians, government-sponsored entities, investors, and homeowners all played a role. Many people believed that those in senior management positions in banks and investment firms were largely to blame for not understanding the highly complex models devised by their quantitative analysts or “quants,” and for their inability to properly manage how and the degree to which those models became highly sought-after products in the market.Some blamed the quants for creating financial instruments that were simply too complicated for those in senior management to understand. Still others blamed the regulators. In 2004, the SEC had loosened leverage (debt) rules for investment banks, and by 2008 many were plagued by leverage ratios that were 30 to 40 times, as opposed to 10 to 15 times, their core holdings.Others pointed to the lack of relevant expertise that existed within the halls of the SEC. As Lo explained, the SEC was staffed with lawyers who “don’t have the kind of training that’s necessary to be able to deal with some of these more complex kinds of strategies.” Many blamed politicians for repealing Glass-Steagall. the repeal of Glass-Steagall fueled growth in shadow banking (THIS IS THE BANKING HAPPENING IN KENYA CURRENTLY.... SHADOW BANKING) institutions like hedge funds. Hedge funds, he explained, were among the most secretive of financial institutions because: Their franchise value was almost entirely based on the performance of their investment strategies, and this type of intellectual property was perhaps the most difficult to patent. Therefore, hedge funds have an affirmative obligation to their investors to protect the confidentiality of their investment products and processes. It is impossible, therefore, to determine their contribution to systemic risk. While most analysts did not believe that hedge funds caused the current crisis—after all, hedge funds did do good things including raising tens of billions of dollars since the mid-2000s for infrastructure investments in India, Africa, and the Middle East—they were heavy investors in risky mortgage backed securities.Government-sponsored enterprises Fannie Mae and Freddie Mac also shared the blame. These institutions, which had a charter from Congress with a mission of supporting the housing market, were responsible for purchasing and securitizing mortgages in order to ensure that funds were consistently available to the institutions that lent money to home buyers. As private companies with close ties to the government, Fannie and Freddie could borrow money at relatively low interest rates.Pressured by Congress to increase lending to lower-income borrowers back in the mid-1990s, Fannie and Freddie began lowering credit standards and purchased or guaranteed “dubious” home loans. As the full force of the financial crisis hit in October 2008, one month before the U.S. presidential election, there was heated debate in Congress over what to do. There was a call for doing nothing and letting the markets “work themselves out.” After all, that was how capitalism was supposed to work, and having the government step in and help was a form of socialism. Federal Reserve Chairman Ben Bernanke believed that doing nothing would be catastrophic, and told Congress, “If we let the banking system fail, no one will talk about the Great Depression anymore, because this will be so much worse.” Toward the end of President George W. Bush’s second term in office and continuing with incoming President Barack Obama, the U.S. government was doing several things to stop the bleeding and put the country on a path to recovery. First, in October 2008 the government gave certain banks and other financial institutions considerable amounts of money from its Troubled Asset Relief Program (TARP). Citigroup, for example, received $45 billion; Bank of America, $25 billion; and AIG, $180 billion. These loans came with certain restrictions, in particular pertaining to executive compensation, which were expanded under the new Obama administration. The hope was that this money would help stabilize balance sheets to the point where banks would start to lend money again and the credit markets would begin to loosen up. Months after the money had been given, however, many banks still were not scaling up their lending as originally anticipated. Instead, they were holding on to the money they received in order to build up their capital and make their balance sheets healthy again. As a number of economists pointed out, unhealthy banks should loan less, not more. After all, excessive lending was how the U.S. banking industry got to where it was in the first place.Second, in early 2009, Treasury Secretary Timothy Geithner introduced the Public Private Investment Program, which was established to purchase real estate-related loans from banks and the broader market. Financing in the amount of $500 billion had been set aside to subsidize private investors interested in buying pools of the “toxic” loans. The value of the loans and securities purchased under the program was to be determined by the private-sector buyers. Finally, around the same time that the Public Private Investment Program was introduced, Geithner announced that 19 of the nation’s largest banks (those with $100 billion or more in assets) would be subjected to a stress test, also known as a capital assessment. The purpose of the test was to determine if the country’s largest banks had sufficient capital buffers to withstand a further economic downturn. Each participating financial institution was asked to analyze potential firm-wide losses, including those in its loan securities portfolios, as well as those from any off-balance-sheet commitments and contingent liabilities and exposures, under two different economic scenarios—scenarios that many felt were “overly rosy”—during a two year period. Participating financial institutions also were instructed to forecast the internal resources available to absorb losses, including pre-provision net revenue and the allowance for loan losses. Supervisors (as named by the U.S. Federal Reserve) would meet with senior management at each participating institution to review and discuss loss and revenue forecasts. The initial reaction of many to the tests was one of great suspicion that nationalization of the banks would be the next step. However, the results announced in May indicated that the banks were healthier than anticipated. There was widespread belief that most if not all of the banks would be able to boost their capital without needing additional government funds. They could achieve this by raising money privately, selling shares to the public, selling parts of their business, or converting preferred shares into common shares, a move that would increase tangible common equity without providing banks any new cash. One bank analyst called such a measure “window dressing” in that it would not add one extra dollar to a bank’s capital buffer against losses: “It’s just moving capital from one place to another.”If such a measure were taken, the government (and therefore taxpayers) would go from being lenders to part owners. The government’s multi-prong approach had its share of critics, The ‘stress’ scenario used by the government turns out to be a mild and short-lived downturn, so the tests were effectively designed to allow everyone to pass. Actual official outcomes for each bank are the result of complicated closed-door negotiations, and at the bank level all we have learned is who has more or less political power.Consumers and businesses are still dependent on banks that lack the balance sheets and the incentives to make the loans the economy needs, and the government has no real control over who runs the banks, or over what they do.The government is dictating how GM needs to start behaving, but it is not doing it with the banks. There is asymmetry in how the financial sector is being treated and how manufacturing is being treated. The government is not afraid of manufacturing going into bankruptcy, but they are afraid of finance going into bankruptcy. the administration’s current deal-by-deal strategy, whereby what was done for one bank was different than what was done for another, would not work: “You don’t know what the rules are. It’s complete chaos and confusion.”it was proposed that “you do it once and for all. You do it systematically. You have very clear rules that are pre-announced.” Reflecting back to his years as chief economist at the IMF, Johnson asked rhetorically:What would the U.S. tell the IMF to do if this were any country other than the U.S.? If you covered up the name of the country, and just showed me the numbers, just show me the problems, talk to me a little about the politics in a generic way. With the financial system, you have a boom, and then a crash.... I know what the advice would be, and that would be, taking over the banking system. Clean it up; re-privatize it as soon as you can. Johnson feared that by not responding to the crisis in a more consistent, systematic way, the United States could go in the direction of the Japanese banking system during the 1990s. The IMF’s advice that the Japanese government take over the banks; break them up into healthy, functioning smaller operations; and re-privatize them fell on deaf ears. What arose instead were “zombie banks,” or banks that were allowed to keep operating even though they had massive debts.The 1990s were considered Japan’s lost decade, when economic growth was stagnant. Recognizing that the word “nationalization” was a red flag, Johnson was calling for a “government managed bankruptcy program” or “government-run receivership” in which the toxic assets of banks were put into a separate entity and then the healthy parts were broken down and sold off in smaller chunks to the private sector. Johnson repeatedly made the point that these were the exact actions the IMF had taken many times with emerging markets—including Korea, Indonesia, Russia, and Argentina after their respective financial meltdowns in the late 1990s and early 2000s. Breaking down the banks into local or regional entities also would break up the banking “oligarchy” that Johnson believed played a central role in creating the crisis: “By selling off the banks into smaller, more concentrated ownership stakes, you will get more powerful owners who will hold management accountable.” Keeping the banks under government control long term was not something that Johnson advocated: How much do you enjoy going to get your driver’s license renewed, going to the DMV, or, even worse, moving to a new state and having to get a new driver’s license? The government does [not do] a very good job of managing things as simple as a driver’s license, and certainly something as complicated as a bank would almost certainly not go well at all. Of course some people will complain about the ‘efficiency costs’ of a more fragmented banking system, and these costs are real. But so are the costs when a bank that is too big to fail—a financial weapon of mass self-destruction—explodes. Anything that is too big to fail is too big to exist.A loud contingent of economists, politicians, and business leaders believed that nationalizing banks was a “crime against the capitalist system.” Johnson thought otherwise: “My view is [that] the offense against American capitalism was committed by the big banks who brought us to this point: Their mismanagement, their compensation schemes, their attitude towards the public.”The government’s priority, he believed, should be to protect the payment system: “You want to protect deposits and anything that is like a deposit. If you force people to take losses on the payments part of the system, then all hell is going to break loose.”Several hurdles needed to be cleared if the government was to take the route advocated by Johnson. First, there was a manpower issue. One expert predicted that it would take thousands of people for each bank takeover. A second problem had to do with timing. As Columbia’s Beim noted:Nationalizations are kind of like potato chips. It’s hard just to have one. You’d have to come out with a plan for all of the banks, and you’d have to do the whole thing in one day, at one time. Because if you just start taking over one bank, people with money at other banks will start worrying that their bank will be nationalized next, and that will cause investors to panic and they’ll pull all their money out of that bank.When it came time to re-privatize, the question was whether there was enough well-capitalized demand for all the potential supply. As one economist pointed out, “Finding enough private equity to buy one bank would not be a problem. Finding enough money to buy all the banks was another story.”In addition to the logistical hurdles, Johnson noted, there would inevitably be a lot of political resistance: The politics are awkward. Cleaning up a banking system, in my view, technically, is not that difficult. But when you clean up a banking system, and you do it properly, some powerful people lose. They lose their bonuses, they lose their banks, they lose their access; so who is going to lose? Who is going to decide who is in and who is out? I don’t think the people at the top are yet ready to have that conversation. In his November 2008 testimony to the House Oversight Committee Hearing on Hedge Funds, recommendations for regulatory reforms and other changes to prevent and/or soften the landing the next time a bank crisis hits
Posted on: Tue, 29 Jul 2014 13:44:57 +0000
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