Communion Of Dreams

I have a friend who complains that when he goes to check his usual blogs on Monday mornings, he has to brace himself about the bad economic news I’ve written about on Sunday.  I hadn’t really realized that I had this weekly schedule, but what the hell. In that spirit, if you want another insight into just how f*cked-up the Wall Street financial crisis really is, spend some time with a long piece by Michael Lewis, author of Liar’s Poker. Here’s an excerpt from The End:

To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue.

I’d never taken an accounting course, never run a business, never even had savings of my own to manage. I stumbled into a job at Salomon Brothers in 1985 and stumbled out much richer three years later, and even though I wrote a book about the experience, the whole thing still strikes me as preposterous—which is one of the reasons the money was so easy to walk away from. I figured the situation was unsustainable. Sooner rather than later, someone was going to identify me, along with a lot of people more or less like me, as a fraud. Sooner rather than later, there would come a Great Reckoning when Wall Street would wake up and hundreds if not thousands of young people like me, who had no business making huge bets with other people’s money, would be expelled from finance.

He’s talking about his experience on Wall Street over 20 years ago.

It’s long.  It’s fairly dense in places.  But it does a phenomenal job of explaining how we got to the point we have, and how the situation is actually much more grim than most people realize.

OK, I’ll try and post a nice cheery travelogue later.

Jim Downey

Why, yes I did!

OK, this is basically S&L Crisis, Part II: Revenge of the Greedoids. You, and me, and every other US taxpayer are now on the hook for trillions of dollars of bailout money. Why? Deregulation and unwise real estate lending.

That was Sept. 7. And someone in the comments at UTI called me on it, saying that I was grossly overstating the case.

Hmm:

$2 Trillion

Total Fed lending topped $2 trillion for the first time last week and has risen by 140 percent, or $1.172 trillion, in the seven weeks since Fed governors relaxed the collateral standards on Sept. 14. The difference includes a $788 billion increase in loans to banks through the Fed and $474 billion in other lending, mostly through the central bank’s purchase of Fannie Mae and Freddie Mac bonds.

OK, I’m not just posting this because I want to say “I told you so.” Rather, take a look at this opening passage from a long piece in today’s Washington Post:

The financial world was fixated on Capitol Hill as Congress battled over the Bush administration’s request for a $700 billion bailout of the banking industry. In the midst of this late-September drama, the Treasury Department issued a five-sentence notice that attracted almost no public attention.

But corporate tax lawyers quickly realized the enormous implications of the document: Administration officials had just given American banks a windfall of as much as $140 billion.

The sweeping change to two decades of tax policy escaped the notice of lawmakers for several days, as they remained consumed with the controversial bailout bill. When they found out, some legislators were furious. Some congressional staff members have privately concluded that the notice was illegal. But they have worried that saying so publicly could unravel several recent bank mergers made possible by the change and send the economy into an even deeper tailspin.

“Did the Treasury Department have the authority to do this? I think almost every tax expert would agree that the answer is no,” said George K. Yin, the former chief of staff of the Joint Committee on Taxation, the nonpartisan congressional authority on taxes. “They basically repealed a 22-year-old law that Congress passed as a backdoor way of providing aid to banks.”

OK, it’s a long piece, so let me summarize: This provision of the tax law limited tax shelters which would arise during a merger of large banks. For over two decades conservative economists and lobbyists for the banks wanted to repeal this law, which would make mergers more attractive (and thereby push consolidation of the banking/financial industry). But Congress – even a number of Republican stalwarts such as Sen. Chuck Grassley of Iowa – refused to budge on this. So, under cover of the financial crisis, Sec. Paulson just got rid of it by fiat – had it murdered quietly in the night. The result was to make a number of the mergers which occurred in September and October more likely, because the tax liabilities for the resulting larger banks would be much smaller.

This may have actually been a good move in terms of helping to save the financial industry, but it was very bad governance. And that gets me to the point of this post: when I said that the US taxpayer was on the hook for trillions of dollars of our tax money, I was saying so because I understood all too well the prevailing attitude of the Bush administration: “Ignore the law. Trust us, we know what is best. And yes, you will pay for it, whether you like it or not.”

When we have seen the actions and behaviour of the Bush administration in action for almost 8 years, it was fairly easy to conclude that they would use the panic in the financial markets to do just whatever the hell they wanted, and that the initial sums being talked about were likely just the tip of the spear about to skewer the American taxpayer. As I said, these actions may actually have been the right ones – when you come across a car crash, you don’t worry about breaking into someone’s vehicle, you just get the people away from the burning car. But given the ineptitude and crass violation of law demonstrated by the current administration, it was also fairly easy to predict that even if they got through the crisis there would be all kinds of extraneous extra-legal stuff happening to further their own goals and please their friends.

Damn, sometimes I just hate being right.

Jim Downey

(Cross posted to UTI.)

I wanted to follow up this post with a note about what has happened in the two weeks since.  Particularly over on UTI there was some discussion about my assessment of the true scope of the situation being wildly overblown:

Trillions? Really? Do you have a source for this prediction other than “I have a degree in economics”? You’re predicting that 10% or more of these loans will go bad, or that interest rates on these mortgage backed securities will go up after the government starts guaranteeing them. Both of these outcomes seem unlikely.

Well, guess where we are just two weeks later:

WASHINGTON – The Bush administration is asking Congress to let the government buy $700 billion in toxic mortgages in the largest financial bailout since the Great Depression, according to a draft of the plan obtained Saturday by The Associated Press.

The plan would give the government broad power to buy the bad debt of any U.S. financial institution for the next two years. It would raise the statutory limit on the national debt from $10.6 trillion to $11.3 trillion to make room for the massive rescue. The proposal does not specify what the government would get in return from financial companies for the federal assistance.

And:

Delinquencies Soar

Nearly one-in-10 American mortgages is delinquent or in foreclosure. The government would be buying debt backstopped by the U.S. home values that have been falling in value for eight consecutive quarters, according to the S&P Case-Shiller U.S. Home Price Index.

And there is still more to come.

9/21EDIT TO ADD: for an excellent summation of how we got to where we are, how bad it really is, and who is primarily responsible, take a look at this post on Daily Kos.

Jim Downey

(Cross posted to UTI.)

So, remember the S&L Crisis of the late 1980s? I do. It was a direct result of the deregulation pushed by Reagan which resulted in unwise real estate lending. In the end, it cost American taxpayers something like $160 billion to clean up the mess (that’s about $270 billion in today’s money). Notable names associated with this debacle include John McCain and Neil Bush.

Well, guess what happened this morning?

WASHINGTON — U.S. federal regulators outlined their takeover of Fannie Mae and Freddie Mac Sunday morning, including control of the firms by their regulator and a Treasury Department purchase of the firms’ senior preferred stock.

The plan, outlined jointly by the Treasury Department and Federal Housing Finance Agency, also includes a plan for the Treasury to purchase mortgage-backed securities from the firms in the open market, and a lending facility through the Treasury from its general fund held at the Federal Reserve Bank of New York.

OK, this is basically S&L Crisis, Part II: Revenge of the Greedoids. You, and me, and every other US taxpayer are now on the hook for trillions of dollars of bailout money. Why? Deregulation and unwise real estate lending.

Yes, that is a gross oversimplification. But it is essentially true, and even one of the men responsible said so last year. Between them, Fannie Mae and Freddie Mac control something like half of the mortgages in the US, to the tune of about $12 trillion. Now, not all of those mortgages are going to go ‘bad’. But it’ll probably take trillions of dollars to clean this mess up.

Why do it? Well, the argument is that this is just too large a component of the US economy to allow things to spiral down. So the government has stepped in to secure ‘preferred stock’ in these two entities – the kind of stock held by other banks and foreign governments – in order to cushion the impact of the ongoing credit crisis.

But there is a problem in doing this. From the Wikipedia entry on the 2007 Subprime Mortgage Crisis:

A taxpayer-funded government bailout related to mortgages during the Savings and Loan crisis may have created a moral hazard and acted as encouragement to lenders to make similar higher risk loans.^[68]Additionally, there is debate among economists regarding the effect of the Community Reinvestment Act, with detractors claiming it encourages lending to uncreditworthy consumers^{[69] [70]} and defenders claiming a thirty year history of lending without increased risk.^[71][72][73]Some have argued that, despite attempts by various U.S. states to prevent the growth of a secondary market in repackaged predatory loans, the Treasury Department‘s Office of the Comptroller of the Currency, at the insistence of national banks, struck down such attempts as violations of Federal banking laws.^[74]

Yeah, you got that right: the feds *stopped* individual states from enacting legislation which would have limited the damage.

Your tax dollars at work. In the service of the big national banks who wanted to operate under the easier rules on the Federal level.

And now, we’re going to wind up with the tab for the bulk of the mess. And, in doing so, will once again establish that we’re not willing to let big businesses suffer the consequences of their errors in judgment (in this case the monetization of bundled subprime mortgages). I hold the current administration predominantly responsible for this debacle, just as I held the Reagan administration predominantly responsible for the failure to regulate the banking industry in the 1980s, but both political parties share some of the blame for refusing to stand up to the special interests who wanted to be insulated from their bad business practices.

I believe in the free market. But intelligent regulation has to temper the excesses of business. We learned that lesson in the 1930s. It looks like we’re going to have to learn it again.

Jim Downey

(PS: yeah, I do have a degree in Economics. It doesn’t usually come up here, but I actually understand this stuff.) Cross posted to UTI, where there are more comments you may find interesting.