Saving the world is a thankless task. The only thing beyond dispute in the $700 billion plan of Hank Paulson, the treasury secretary, and Ben Bernanke, chairman of the Federal Reserve, is that everyone can find something in it to dislike. The left accuses it of ripping off taxpayers to save Wall Street, the right damns it as socialism; economists disparage its technicalities, political scientists its sweeping powers. The administration gave ground to Congress, George Bush delivered a televised appeal and Barack Obama and John McCain suspended the presidential campaign. Even so, as The Economist went to press, the differences remained. There was a chance that Congress would say no. [And today it did.]
Spending a sum of money that could buy you a war in Iraq should not come easily; and the notion of any bail-out is deeply troubling to any self-respecting capitalist. Against that stand two overriding arguments. First, this is a plan that could work (see article). And, second, the potential costs of producing nothing, or too little too slowly, include a financial collapse and a deep recession spilling across the world: those far outweigh any plausible estimate of the bail-out’s cost.
--The Economist (10.3.08), Leaders, "America's Bail-Out Plan"
I've not cared for investment bankers, not for the most part. And across the final 15 years or so of my career as a corporate tax executive with adjunct acquisition/divestiture responsibilities, I had the opportunity to work with many from Goldman, Salomon, Morgan Stanley, and other investment banking houses. To me, most were just unctuous salespersons--but with Ivy-League MBAs. I came to distrust them, and disrespect them, too.
I know that their principal functions are important, and especially the essential function of efficiently facilitating the flow of capital from where it is available to where it is needed. Over the years, they structured and marketed increasingly complicated equity, preferred equity, and debt capital offerings for participants in US and world markets--and the hybrid instruments and structures they designed became ever more creative. These would include "derivative" instruments such as "interest rate swaps" and "foreign currency swaps," primarily hedging vehicles, which also became increasingly complex.
Some of these instruments were quite ingenious. But as could be predicted, after exhausting real creativity and pressing up against the constraints of common sense, they turned increasingly to raw aggressiveness in bending and reinterpreting tax laws, accounting principles, and financial understandings. This process, this culture, has evolved one step at a time over many years. And it has proceeded without meaningful regulation.
These so-called "products" were sometimes so shamelessly aggressive that they had to go forum shopping for lawyers and accountants who might write them even a carefully qualified opinion--and many of the best lawyers often refused to do even that. And more than once I was advised that there was enough of a "color of argument" to the merits of a particular product that if there were enough companies participating, we would likely be protected by "herd immunity." That is, rather than go after the many big companies participating, the IRS would likely pursue only prospective changes in law and regulations. Caveat emptor. But as if from a scene in Alice in Wonderland, when the potential benefit was viewed as material enough, many companies chose to go down the rabbit hole, making such investments to keep pace with their "peer groups." (The company I worked for was a welcome exception.)
But even I was surprised by the bold abandon and unfettered "creativity" fired by the broad-based greed in the sub-prime mortgage/mortgage-backed securities campaign. And a white-hot, competitive campaign is what it became. Investment bankers competed to acquire as many mortgages as possible--and of necessarily declining quality--and "securitizing" them (or packaging them and selling debt instruments secured by the mortgages), or dividing the packages into pieces so they could be marketed and sold in such a way as to further allocate or "spread the risk" of the riskier elements of these mortgage pools. And there were "insurers" of these mortgaged-backed securities--including the investment banks who issued them--who rushed in at the opportunity for more revenue. But the riskiest sub-prime mortgages came to predominate, and the banks and mortgage companies could hardly write enough of them to meet the demand of the investment bankers' market for these mortgage-backed securities. Even individual speculators ran rampant in their buying and "flipping" of houses and condos in the climate of near free money and endlessly increasing home prices.
Of course, the banks somehow accepted this tortured risk-spreading rationale, writing and keeping many of their mortgages and buying lots of mortgage-backed securities, too--to remain competitive with their peer banks, of course. Ominously, irresponsibly, the government-sponsored but publicly owned and managed "Fannie Mae" (FNMA) and "Freddie Mack" (FHLMC), owners or guarantors of nearly half the nations mortgages, joined fully in supporting the sub-prime mortgage insanity (with the urging of some key congressional leaders, it should be noted). And then there were the insurance companies who insured mortgage-backed securities and invested in them, too. To a point, they all clearly knew what they were doing, these "best and brightest," but their unfettered ambition and boundless greed apparently blinded them to the implications: the likely and severe damage to the US and world financial structure and, as a result, to the US and world economy.
And the hedging/insuring vehicle of choice for the mortgage-backed investments was often the so-called "credit default swap" (CDS), a non-regulated, highly complex "insurance-like" instrument that could be structured, valued and understood, if at all, only using space-age mathematical models. Then speculative players started buying them, too. The investment banks, commercial banks and insurance companies that created and owned them (without any regulatory requirement for adequate loss reserves) eventually had no meaningful way of dealing with or representing what the value at risk in these huge portfolios might be. Warren Buffet famously referred to them as "financial instruments of mass destruction."
So, as the housing market fell and mortgages defaulted, the sub-prime mortgage-backed securities market also defaulted and failed, in turn so did the credit default swaps in the face of the huge obligations with no reserves to cover them. The failure of these instruments played a major role in the failure or weakness of many of these institutions, including Bear-Stearns, Lehman Bros., and particularly in the demise of AIG.
How could they be so smart and yet so blind? Uncontrolled greed is the only apparent answer, I guess. What other explanation is there? And the resulting failure of any sense of accountability or responsibility for the trust, the good-steward's role, implied by their critical place in the financial system and the economy was probably predictable. Many informed observers saw, wrote or spoke about the coming problems, some for several years. And with their insight, even folks like me could see it developing. The only questions were: When will the cards all fall, how much damage will be done, and will anyone do anything about it?
(And, as a friend is quick to remind me, this financial debacle could not have advanced this far if the government had not first set the table. The congress urged the quasi-governmental Freddy Mac to also buy high-risk sub-prime mortgages. And up to their knees in irony, it was a stalwart free-market Federal Reserve chief, Alan Greenspan, urged on by a conservative Bush administration, that engineered the artificially low interest rates that allowed the the housing bubble to develop in the first place. How Greenspan, previously a heroically principled overseer of our money markets, could succumb to the pedestrian voices of George W. Bush and his band of fools I cannot imagine, and couldn't at the time. But he did.)
If there were perfect justice, some of them, many of them, perhaps, would go to prison. And they would have to "disgorge," give back, the huge bonuses and golden parachutes they nonetheless awarded themselves throughout this period of professional and ethical failures. For what they did was "criminal," in a sense. We have appropriate laws that day-in and day-out put white-collar criminals in jail for simple fraud or embezzlement, things far less damaging than what these financial leaders have wrought. After all, the fraud or embezzler usually does no systemic harm, and usually affects only a relatively few people. But these holders of the public trust, these miscreant executives in the investment banks and their counterparts in commercial banks and mortgage companies, working in concert, directly or indirectly defrauded and impoverished vast numbers of American people. And many more--all of us, in one sense or another--remain very much at risk.
But just as there were inadequate regulatory constraints on what they were doing, there were not relevant criminal laws to constrained them as they placed America and Americans in harms way. Some of them belong in prison, but there may be no legal basis for putting them there. They should have to give up their ill-got millions, but there is probably no legal basis to require that either. We will have to wait on any shareholder suits or class-action suits that could succeed only against the companies, not the individuals--and many of those companies are gone or legally restructured. So then, explain to me what's so wrong with regulating professionals in trustee-like roles? We do, you say. Yes, lawyers, accountants, real estate and stock brokers, and many others--but not investment bankers. Why is that again?
The investigations will continue, to be sure; the blame will be more definitively, more accurately assigned--probably in painful, embarrassing detail. The legislators, regulators, their consultants and advisers will take the required time to wisely write appropriate new rules and regulations. They will also consolidate and restructure regulatory oversight of financial markets. This will happen. But right now, we must be more intent on protecting our future than addressing the guilty. Right now, we must be focused immediately and completely on healing our financial markets and protecting our economy.
While no one can be quite sure of how bad "dire" is, or what the perfect rescue plan would look like, we do have to trust someone. The combination of Hank Paulson and Ben Bernanke, with all their advisers and talented teams, with what information there is available to them, are, to me, a reliable team in which to place our hope and our trust. Even though as an investment banker he contributed notably to the problem, no one knows financial markets and the workings of those markets better than Hank Paulson, now Secretary of the Treasury and previously the respected CEO of Goldman Sachs. Unless, of course, it is Ben Bernanke, the respected Chairman of the Federal Reserve, former acclaimed professor of economics at Princeton, and a leading authority on financial market disasters.
They come from different worlds with different orientations and accountabilities--although they both serve a conservative, Republican administration, one not normally inclined to intervene in market processes (or to regulate them). And if Paulson could be suspected of unconsciously overweighting Wall Street interests, I think it clear that he in fact serves America's interests first--and that he is deeply embarrassed and despairing over Wall Street's egregious excesses. He wants to be part of an effective solution, the best solution for the country and its taxpayers, for you and me. He wants to set it right, so far as he can. And Bernanke owes nothing to Wall Street. I wouldn't be at all surprised if he shared some of the views of those like me toward "the Street." That both the Republican and Democratic presidential candidates support the rescue plan is telling and important, as is the support of business and the US Chamber of Commerce. Even the House Republican leadership now support it, even if many of the ideological purists among their members do not. And I believe we all should, too.
You don't have to be an investment banker or economist to recognize the threat to our markets and economy, and our critical need to free up the flow of capital in the financial markets. Although no one can bring themselves to utter the word "depression," it is implied, alluded to, and all but said by many of the most credible voices. One of those credible voice, that of Warren Buffet, referred to the U.S. "going over the precipice" if something like the Paulson/Bernanke rescue plan were not soon approved and effected.
What might that mean? The now depressed and skewed market for these troubled assets would continue to produce panic-sale write downs of their carrying values, which reduces bank capital further, which further limits lenders' ability to lend and frightens them about doing so--even to each other. The result is frozen financial markets, which damages or destroys many business because they cannot borrow even week-to-week working capital, which reduces production, puts more everyday people out of work, denies them needed loans, and further reduces demand for goods and services. Many people and their 401(k)s are further impoverished as the stock market declines further. And of course, many more mortgaged homes are forced into foreclosure. Not a pretty picture; and I hope it is overstated. But some of this is already happening, and it will surely get worse. I don't know just how bad bad is when we call it "dire," and I don't know how far down we may plummet when we "go over the precipice"--and I don't want to know.
But it is our economy, yours and mine, much more than the investment bankers' and commercial bankers' who have betrayed us. We and our political representatives were just outright fools to trust them with such unregulated control of the financial markets that we all depend upon so much more than we know. But protecting our economy should now be our first priority--and at any cost necessary. (And do bear in mind that a material amount of the cost incurred by the government--perhaps most of it--should be recaptured when these distressed assets are later sold in normalized markets.) We cannot--we must not--fail to understand that in submitting to our vindictive emotions of anger and resentment, we risk doing more harm to ourselves than those most culpable, those bastard executives of Wall Street and other financial institutions.
And by opposing the rescue plan, the so-called "bailout" of these financial institutions who hold these distressed mortgages and mortgage-backed securities, we also influence our politicians to oppose it, too--as they did today--and assure that things will likely get worse for us, not better--and likely, much worse. Am I positive about that? No, but in the absence of more useful information and sufficient historical precedent, I am compelled to rely to a considerable extent on the most authoritative knowledge and experience available in our professional and leadership ranks. And as I've said, I'm far more confident, more comfortable with the knowledge, experience and leadership of the Paulsen/Bernanke team than the spokespersons or leaders of alternative approaches. (But do understand, please, that this rescue plan will likely avert financial market and economic disaster, but will not keep us from continuing down the road of recession we are now on--and likely will be for some time.)
In addition, in circumstances such as these, my bias favors action, especially when things could go very badly if we fail to act. And what precedent there is supports that. Even if the rescue plan had only a 50-50 chance of solving or significantly limiting the potential problem, I'd rather take that chance than what I see as a higher risk if we do nothing. But I expect the probability of the plan's success is higher (although, assessing what is relative success, or what might have been more or less effective will likely be very difficult in retrospect). Then too, the psychology of market confidence is an inherent part of the problem--and a rescue plan like the one proposed will surely help in that area. I recognize that there is a possibility I could be wrong, but lacking sufficient relevant data, precedent, and experiential instincts in such matters, the various factors I've stressed are the most meaningful, instructive considerations for me, the only way I am confident handicapping the basic options.
In summary, considering what is knowable at this point, however painful and unsettling the conclusion, I am persuaded that the most promising rescue plan for our financial markets, for our economy--for all of us, really--is some variation of the plan proposed by the administration's Paulson/Bernanke team. I'm not happy about it. And neither are you. After all, we shouldn't be in this threatening, costly situation. But let's support the most reasonable course left to us, the one our most knowledgeable and experienced leaders in this area assure us is necessary. Let's bail out the miscreant bastards of Wall Street and elsewhere. Let's hold our noses, clench our teeth, and do it--in order to protect our economy and ourselves. I think we have to.
http://www.economist.com/opinion/displayStory.cfm?Story_ID=12305249
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