the end of wall street

Review :

In 1873, Walter Bagehot, the noted financial columnist for the Times of London, wrote the bible on banking and the measures central banks, then the Bank of England, should be prepared to take when a nation's banking system is plagued with dysfunction or the economy has receded. Bagehot wrote in Lombard Street,"every banker knows that if he has to prove he is worthy of credit, however good may be his arguments, in fact his credit is gone."
J.P. Morgan made an identical observation, more pithy and direct than Bagehot's, when he famously stated "a man I do not trust could not get money from me on all the bonds in Christendom", an observation meaning if I don't trust the borrower, I refuse to trust his collateral.

This, it seems to me, was the essence of the collapse of the bond, banking, credit, and capital markets from mid 2007 though late 2009, when the world experienced a preventable, catastrophic economic collapse joining the pantheon of catastrophes alongside the Great Depression and the Dark Ages which followed the black plague.

We have come to believe that our knowledge, our systems, and our technologies will steer us away from doom. What we have not realized is that those charged with running the banks, the credit markets, and the businesses which comprise our economy, despite the sophistication of our processes, our knowledge, and our technology, still ignore the lessons of history and bring us to the precipice of collapse because we somehow believe that our systems and markets are "transformative" and will self-correct.

Lowenstein very simply and, I think, correctly believes that failures of the credit markets and issuance of credit securities brought the collapse upon us. He sets the stage early in his work when he writes, "part of the conceit of the new finance was that every risk could be laid off--that is, transferred to some other party". Lowenstein could have gone one step further and asserted that no one with authority at the helm of the banks, the regulatory system, the credit markets believed the volume of debt and, more importantly, the character of the debt being structured in tiers and issued as securities--CDO, CDS, SIVs and the virtual unlimited number of times that any form of debt was securitiezed--could have resulted in what essentially was the cessation of the functioning of the credit markets to lend because all trust in the creditworthiness of the borrowers, the lenders, and the collateral had dissipated.

Of all the books written about the financial and economic collapse of 2008, Lowenstein's treatment is perhaps the clearest and the most orderly in terms of understanding and preserving the chronological (and historic) march of the events that culminated in the US government essentially nationalizing (without calling it that) the banks, ordering some lenders to merge and investment houses into liquidation, in the end, a full use of the powers of central banks and regulators to take all steps to calm markets and restart a devastated economy through central banking.

Some will argue persuasively that borrowers and lenders were both responsible for the calamity of 2008, the lenders constructing debt securities with layer upon layer of debt; the rating agencies--Standard and Poor's, Moody's, Fitch--relinquishing their to duty provide an intense review and prudent analysis of creditworthiness; insurers who insured debt instruments without regard to the possibility that the instruments essentially had little prospect of paying investors what was promised; banks which loaned depositor's funds without an eye to creditworthiness and the reserves required to protect depositors and the borrowers who, because of lenders' marketing, actually believed that little or equity in a home purchase was required to enable the value of the asset to increase so that a borrower's creditworthiness as well as the initial price of a home was irrelevant. But, such an argument does account for the stalking of the ghost of Milton Friedman and Alan Greenspan's unwillingness of regulators to regulate (the famous stories of Sheila Baer and Brooksley Borne calling for regulation of credit instruments in the same manner as commodities are regulated) because of the free and self correcting markets theories postulated by Mand the lack of bottom to invoke all the powers of central banking to stall and reverse the collapse, at least initially. As Bagehot wrote in 1873,if you face panic in the credit markets, your best recourse is to lend to everybody without exception on every kind of security at the lowest rate, "because they fear destruction in the panic" and "this bold policy is the only safe one."

At first, the signs were there, but all chose to ignore them: The TED spread (ratio of rates of interest on corporate debt to that offered on US Treasuries, a measure of safety, rising to 3-4; banks paying 6% for borrowing overnight repo money when federal funds traded at around 5.25%; CDS premiums gradually increasing as both borrowers, issuers, and insurers realized that a lot of the debt being issued was uncollectible.

Then, there is the question of economic ideology governing decision making and the marked disbelief that the credit and capital, left to their own devices, would self-correct to prevent the devastation that eventually was wrought upon every economy in the world. Even today, some of that same economic hardline is preventing government policy makers from taking action to prevent or negate other crippling features of the recovering economy--irrational income disparities that government action could correct, low wages, insufficient safety net programs, especially the lack of uniformly available medical assistance to the poor and many workers.

It is fairly standard that wealthy people, educated at elite colleges (Harvard, Yale, Stanford, Chicago, Princeton) who have found success in business and finance come to populate regulatory agencies and positions which give them authority over financial matters. This may be--in fact I believe it most assuredly--is a mistake. These people marched to their success because they believed the system that gave them wealth and security provides prosperity and security to all, and this system is the one they have created. This may explain part of the problem, or as Aeschylus wrote, "[a]ll arrogance will reap a harvest rich in tears. God calls men to a heavy reckoning for overwheening pride." In other words, the pride that comes to those who have succeeded may prevent them from seeing the mistakes being made all around, for which the greater population will pay the costs of a heavy reckoning.

Arrogance and hubris. The consequences are no different now than they were at the time Aeschylus wrote his prophetic words.

2 downloads 256 Views 409 KB Size