Thursday, March 12, 2009

Lessons Not Learned

The lessons our financial leaders should have learned from the "mortgage crisis" but did not, show how slow we are as an economic structure to react by anticipatory behavior. It does matter whether the financial markets overheated because of a giant Ponzi scheme hundreds of times the size of Madoff's, unknowingly and unwittingly perpetrated by its very victims, or due to a lack of regulation, or having as a cause the unbridled greed of the now oft ill thought of "Wallstreeters". Of course, one could also point to the failure of the economists to predict and discern the emerging pattern which ended in an implosion in the world of imaginary numbers - not the type to which mathematicians refer, but to the type hedge fund managers, speculative investors, commodities traders, bankers needing to satisfy stockholders, and just every day people with 401k plans, used as their calculus.

The concern we should all have is not only to identify when the recession began and when the regulators should have stepped-in, but rather how to see the next "black hole" which will threaten the fabric of our financial world. We have turned our telescopes on the past; we should also look at the present to see the future. Easy mortgages were the symptom of the securitization flu. The effect of the burst of mortgage-backed securities and credit default swaps et al has been a shut-down of credit: that will be the killer.

As the Wall Street Journal pointed out, the next credit crunch will be credit cards and similar smaller, but just as widely used lines of credit like over-draft lines, HELOCS (home equity lines), the ubiquitous 90 day note, etc. These means of keeping consumers and small businesses running when cash is tight, are being shut down. Jobs are being lost and housing defaults are rising which are causing more lines to be closed or limited as a pre-emptive strike against larger losses. Yet there is no regulatory concern about there being no credit available to "just ordinary people" and "just ordinary small business".

Understandably, the emphasis is on saving the patient - the hell with a few limbs: perhaps a more cogent analogy however would be that the sacrifice of the few to save the many is okay, not necessary but OKAY. It's great if you are not one of the few. The "few" here are consumers - both businesses and individuals. If there is no credit, and jobs are being lost, people will horde. If there is hoarding, small businesses will fail, which will cause larger businesses to fail...

The same Banks that are taking billions to "stimulate" the economy are limiting credit to people and small businesses. In fact, they are withdrawing credit and calling loans, reminiscent of the late 80s & early 90s. Further, interest rates are sky-rocketing creating spreads that loan sharks would pay ½ of their "vig" to get. Borrow from the Fed/Treasury at 0% or maybe 0% plus 25 basis points and lend it out at prime plus 18.99%. Default rates are still up into the 30% range. Worse is that people will use every last dollar of credit, creating huge defaults, which the industry can predict but "Who cares? We'll just securitize it and sell 'em"

[NOTE: The following link will bring the reader to Wharton School of Business' website where a recap of Federal Reserve Chairman Ben Bernecke's recent speech is contained] http://knowledgetoday.wharton.upenn.edu/2009/03/changing-the-rules-.html

1 comment:

Joe Rotger said...

Two suggestions:
1) I liked Stiglitz idea that we should form a sort of financial Food & Drug agency which would require all new financial instruments to have its seal of approval before sending them out to trade. CDS would be a totally different animal.
2) If on recognizes that the mice will always find a way to get to the cheese, no matter how good the trap is, then, one should keep one's money in one's pocket --the farther it is, the more games mice play with your cheese. Understand that it also applies to intellectual fuzziness distancing, and that financial engineers were used in a marketing ploy to prepare wrappers for tainted goods --a mortgage backed security trench AA, sounds a lot better than contains some subprime mortgage loan.