Monthly Archives: January 2011

The crisis was the result of human action and inaction, not of computer models gone haywire, concludes Financial Crisis Inquiry Commission

The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. That is how the Financial Crisis Inquiry Commission, called upon to examine the financial and economic crisis and explain its causes to the American people, kicked off its final report released on January 2011. The Commission, whose work involved the review of millions of pages of documents, interviews with more than 700 witnesses, and 19 days of public hearings in New York, Washington, D.C., and struggling communities across the country, concluded that this crisis was avoidable, which is not surprising at all; they said, paraphrasing Shakespeare, the fault lied not in the stars, but in us. The Commission found instead widespread failures in financial regulation; dramatic breakdowns in corporate governance; excessive borrowing and risk-taking by households and Wall Street; policy makers who were ill prepared for the crisis; and systemic breaches in accountability and ethics at all levels. You would have to dig a little deeper to find the main culprit, the explosion of  risky subprime lending which led later to the collapse of the housing bubble.

The United Stated had set aggressive homeownership goals with the desire to extend credit to families previously denied access to the financial markets. Yet the government failed to ensure that the philosophy of opportunity was being matched by the practical realities on the ground. Witness again the failure of the Federal Reserve and other regulators to rein in irresponsible lending, recommends the Commission. Homeownership peaked in the spring of 2004 and then began to decline. From that point on, the talk of opportunity was tragically at odds with the reality of a financial disaster in the making.

In fact, while the vulnerabilities that created the potential for crisis were years in the making, the report indicates, it was the collapse of the housing bubble, fueled by low interest rates, easy and available credit, scant regulation, and toxic mortgages, that was the spark that ignited a string of events, which led to a full-blown crisis in the fall of 2008. Many mortgage lenders had set the bar so low that lenders simply took eager borrowers’ qualifications on faith, often with a willful disregard for a borrower’s ability to pay. Nearly one-quarter of all mortgages made in the first half of 2005 were interest-only loans. During the same year, 68% of “option ARM” loans originated by Countrywide and Washington Mutual had low or no-documentation requirements. These trends were not secret. As irresponsible lending, including predatory and fraudulent practices, became more prevalent, the Federal Reserve and other regulators and authorities heard warnings from many quarters. Yet the Federal Reserve neglected its mission “to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers.” It failed to build the retaining wall before it was too late.

While many of these mortgages were kept on banks’ books, a significant amount of money came from global investors who clamored to put their cash into newly created mortgage-related securities. It appeared to financial institutions, investors, and regulators alike that risk had been conquered: the investors held highly rated securities they thought were sure to perform; the banks thought they had taken the riskiest loans off their books; and regulators saw firms making profits and borrowing costs reduced. But each step in the mortgage securitization pipeline depended on the next step to keep demand going.

From the speculators who flipped houses to the mortgage brokers who scouted the loans, to the lenders who issued the mortgages, to the financial firms that created the mortgage-backed securities, collateralized debt obligations (CDOs), CDOs squared, and synthetic CDOs: no one in this pipeline of toxic mortgages had enough skin in the game, said the Commission, chaired by Phil Angelides. They all believed they could off-load their risks on a moment’s notice to the next person in line. They were wrong. When borrowers stopped making mortgage payments, the losses—amplified by derivatives—rushed through the pipeline. As it turned out, these losses were concentrated in a set of systemically important financial institutions.

In the end, the system that created millions of mortgages so efficiently had proven to be difficult to unwind. Its complexity had erected barriers to modifying mortgages so families can stay in their homes and had created further uncertainty about the health of the housing market and financial institutions. Trillions of dollars in risky mortgages had become embedded throughout the financial system, as mortgage-related securities were packaged, repackaged, and sold to investors around the world. When the bubble burst, hundreds of billions of dollars in losses in mortgages and mortgage-related securities shook markets as well as financial institutions that had significant exposures to those mortgages and had borrowed heavily against them. The losses were magnified by derivatives such as synthetic securities.

The crisis, the report continues, reached seismic proportions in September 2008 with the failure of Lehman Brothers and the impending collapse of the insurance giant American International Group (AIG). Panic fanned by a lack of transparency of the balance sheets of major financial institutions, coupled with a tangle of interconnections among institutions perceived to be “too big to fail,” caused the credit markets to seize up. Trading ground to a halt. The stock market plummeted. The economy plunged into a deep recession.

Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs, concludes the Commission. There was an explosion in risky subprime lending and consequently securitization, an unsustainable rise in housing prices, widespread reports of egregious and predatory lending practices, dramatic increases in household mortgage debt, and exponential growth in financial firms’ trading activities, unregulated derivatives, and short-term “repo” lending markets, among many other red flags. Yet there was pervasive permissiveness, the report concludes; little meaningful action was taken to quell the threats in a timely manner.

Federal Reserve Ignored Foreclosures

For the Commission, the prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not. The record of the Commission’s examination is replete with evidence of other failures too: financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk. When the housing and mortgage markets cratered, the lack of transparency, the extraordinary debt loads, the short-term loans, and the risky assets all came home to roost. What resulted was panic. We had reaped what we had sown.

CEOs Wish for 50-Hour Day as Business Makes Comeback in Davos

Bloomberg’s Aaron Kirchfeld reports that Indra Nooyi, chief executive officer of PepsiCo Inc., wishes “days had 50 hours” to squeeze in a marathon of meetings at the World Economic Forum in Davos.

Her view was echoed by company executives from around the world as managers turned back to business amid rising optimism. Seeing the worst of the financial and economic decline behind them, corporate and political leaders at the 41st annual conference in the Swiss ski resort shifted their focus from crisis management to growth, managers said.

“I bumped into a couple of CEOs of rather large companies, and they told me: ‘You know, I haven’t attended a single session, I have one meeting after another,’” Anatoly Chubais, CEO of Moscow-based Russian Nanotechnologies Corp., said this week. “We’re in that stage of climbing out of the crisis, and new deals that go with that are being generated.”

Confidence among CEOs has rebounded to pre-crisis levels, according to a survey of 1,201 managers in 69 countries by PricewaterhouseCoopers LLC, released on the eve of the World Economic Forum.

For executives who attended the gathering, which concludes today, that meant a renewed focus on client meetings and networking. JPMorgan Chase & Co. CEO Jamie Dimon, 54, made time to meet with Russian billionaire and United Co. Rusal head Oleg Deripaska. Domenico Siniscalco, who leads Morgan Stanley in Italy and is the country’s former finance minister, said he had about 35 meetings in Davos this year compared with 15 last year.

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Turkish Minister Says China Gaining Unfair Advantage

The Wall Street Journal’s Geoffrey T. Smith reports that it doesn’t matter whether or not China and the U.S. are actively trying to keep their currencies low, the end result is pain for emerging markets, Turkish Finance Minister Mehmet Simsek said Saturday.

In an interview with Dow Jones Newswires on the sidelines of the World Economic Forum, Mr. Simsek said he thinks China is deliberately depressing its exchange rate, and that that is giving it an “unfair advantage” against countries like Turkey “that compete in the same products for the same markets.”

“Why else would a country accumulate almost $3 trillion of foreign reserves?” he asks. “It’s quite obvious.”

He was less damning about the U.S. Federal Reserve’s policy of “quantitative easing”, saying he didn’t think the U.S. was trying to manipulate its currency, but said the consequences were also highly negative for Turkey, by helping to inflate the price of commodities such as oil that Turkey needs to import, and by stimulating inflows of hot money in search of higher returns than those on the dollar.

He also declined to criticize the European Central Bank for running a historically loose policy, saying that “there are real issues with some countries in the periphery. It’s understandable.”

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Yuan’s Value Is Hot Topic at Davos

The Wall Street Journal’ Shen Hong reports that the Chinese currency is such a hot topic at Davos this year a breakfast meeting didn’t even go without it.

At a function hosted by a Chinese financial magazine Saturday morning, with China’s 12th five-year plan as the theme, Chinese executives, academics and their Western counterparts spent a big chunk of their time talking about nothing else but the controversial renminbi, or “People’s Money” as literally translated.

Surprisingly, this time, it was Joseph Stiglitz, the American Nobel laureate, who showed some degree of sympathy toward Beijing while his Chinese counterparts were arguing for a stronger yuan. Mr. Stiglitz said the U.S. has clearly won the political debate of accusing the Chinese of undervaluing the yuan but the rhetoric betrayed the mentality of a weakening superpower.

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Gold rally biggest in 8 weeks as Egypt army rolls

(Reuters, Frank Tang) – Gold posted its biggest gains in eight weeks on Friday, gaining nearly 2 percent as the prospect of unrest in Egypt spreading across the Middle East fueled a rush of safe-haven buying in the financial markets.

The nearly $40-an-ounce jump in active trading revived investor interest in bullion, which is still set for its first monthly decline in half a year after investors fled the market on signs that the Euro zone debt crisis was receding and the U.S. economy was on a firmer recovery footing.

After several days of unprecedented protests, the sight of armored cars in the streets of Cairo on Friday finally got the attention of global markets. Oil spiked by more than 4 percent, the dollar rose sharply and Treasuries gained as investors feared the political instability could spread.

Gold bars are pictured at the Ginza Tanaka store during a photo opportunity in Tokyo September 17, 2010. REUTERS/Yuriko Nakao

“Confusion breeds contempt for all investments other than gold. Clearly, money is flowing to gold as the ultimate safe haven … because nobody knows how this situation is going to resolve itself,” said Dennis Gartman, publisher of the Gartman Letter, a daily investment commentary.

Gartman, a long-time gold bull who liquidated some of his position this month, said he did not expect Egypt’s unrest to be over anytime soon and that gold could further benefit from the possibility of chaos spreading to other countries in the region.

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Goldman Boosts Pay of Partners

The Wall Street Journal’s Liz Rappaport reported that Goldman Sachs Group Inc. boosted the base salary of its executives and partners for the first time since the securities firm went public in 1999, tripling Chief Executive Lloyd Blankfein’s salary to $2 million.

The move, disclosed in a securities filing late Friday, is the latest sign of how Wall Street’s pay culture is moving away from bonuses criticized for fueling reckless risk-taking that contributed to big losses during the financial crisis. Goldman’s salary increases, which affect all 470 partners out of the company’s 36,500 employees, follow similar announcements by Bank of America Corp., Citigroup Inc. and Morgan Stanley.


Regulators and lawmakers are pushing Wall Street firms to dole out higher salaries and smaller bonuses. Some regulators contend that doing so will encourage employees to focus on longer-term performance.

Goldman also disclosed the restricted-stock awards made as bonuses to numerous top executives for 2010. Mr. Blankfein, who also is Goldman’s chairman, got $12.6 million, or 78,111 shares based on the company’s stock price Wednesday, according to a separate filing Friday. The restricted-stock award is 40% higher than his $9 million bonus for 2009.

The restricted shares will vest over three years, and Mr. Blankfein and other Goldman executives can’t sell or transfer their shares until 2016.

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Never Again?

The New York Times’ Sewell Chan think that the final judgment of the official inquiry into the 2008 financial crisis — that it was an avoidable disaster, brought about by regulatory neglect and Wall Street recklessness — was an admonition to the government never to let it happen again. Most experts aren’t holding their breath.
J.P. Morgan, left, with his counsel at the Pecora commission hearings in 1933. The hearings brought a new climate for financial regulation, unlikely with the most recent inquiry, experts say.

Bubbles and manias, followed by crashes and hangovers, seem endemic to capitalism. The Wall Street overhaul enacted last year hopes to blunt the impact of such boom-and-bust cycles — by reining in the use of exotic financial instruments, better supervising big banks and limiting the damage if one of them fails.

But the first two efforts are under attack by the new Republican majority in the House, and the new process for containing the fallout from a giant bank’s collapse is untested. Meanwhile, the financial sector’s outsized role in the economy hasn’t changed; the giant banks that were considered “too big to fail” have only gotten bigger.

It was not the same the last time around.

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