In my past blogs, I've tried to concentrate on the theme that, despite the economic downturn, there are exact management tools that one can learn and apply to put themselves in a proactive position regarding their practice and business. I've tried to impart something new regarding that viewpoint in each of my blogs.
But, after reading this piece, I thought it would be wise and helpful to pass this information along, although it doesn't impart specific management information. What it does, though, is greatly enlighten us all on how we ended up in this position as well as providing some recommendations on what we, as individuals, can do to protect ourselves.
Due to the length of this piece, I will issue it in separate sections over several blogs. I hope you enjoy it and find it as eye opening as I did. I'd be greatly interested in any feedback you have once you've read through it. You can respond through our discussion forum at Silkin Facebook Page.
Larry Silver
President, Silkin
Here's Part 1:
THE FINANCIAL CRISIS: A LOOK BEHIND THE WIZARD’S CURTAIN
March, 2009, written by Bruce WisemanI’m tired of hearing about sub-prime mortgages. It’s as if these things were living entities that had spawned an epidemic of economic pornography. Sub-prime mortgages are as much a cause of the current financial chaos as bullets were for the death of JFK. Someone planned the assassination and someone pulled the trigger. The media, J. Edgar Hoover and the Warren Commission tried to push Lee Harvey Oswald off on the American public. They didn’t buy it.
They shouldn’t buy sub-prime mortgages either. Someone planned the assassination and someone pulled the trigger. Only this time the target is the international financial structure and the bullets are still being fired.
Oh yes, people took out adjustable rate mortgages they could ill afford, that were then sold to Wall Street bankers. The bankers bundled them up like gift wrappers at Nordstrom’s during the Holidays and sold them to other banks after raking off billions in fees. The fees? They were for…well…they were for wrapping the mortgages in the haute couture of Wall Street. But it didn’t start there. No, no, not by a long shot.
And as the late, great Paul Harvey would say, “And now you’re going to hear the Rest of the Story.”
Are sub-prime mortgages part of some larger agenda? And if so, what is it? Stay with me here, because Alice is about to slide down the rabbit hole into the looking glass world of international finance.
EASY MONEY ALAN
There are various places we could start this story, but we will begin with the 1987 ascendancy of Rockefeller/Rothschild home-boy, Alan Greenspan, from the Board of Directors of J.P. Morgan to the throne of Chairman of the Federal Reserve Bank (a position he was to hold for twenty years). From the beginning of his term, Greenspan was a strong advocate for deregulating the financial services industry: letting the cowboys of Wall Street sow their wild financial oats, so to speak.
He also kept interest rates artificially low as if he had sprayed the boardroom of the Federal Reserve Bank with some kind of fiscal aspartame. While aspartame (an artificial sweetener branded as “Equal” and “NutraSweet”) keeps the calories down, it has this itty bitty side effect of converting to formaldehyde in the human body and creating brain lesions.
As we are dealing here with a gruesomely tortured metaphor, let me explain: I am not suggesting that Chairman Greenspan put Equal in his morning coffee, but rather that by his direct influence, interest rates were forced artificially low resulting in an orgy of borrowing and toxic side effects for the entire economy.
THE COMMUNITY REINVESTMENT ACT
Greenspan had been the Fed Chairman for seven years when, in 1994, a bill called the Community Reinvestment Act (CRA) was rewritten by Congress. The new version had the purpose of providing loans to help deserving minorities afford homes. Nice thought, but the new legislation opened the door to loans that set aside certain lending criteria: little things like, a down payment, enough income to service the mortgage and a good credit record.
With CRA’s face lift, we have in place two of the five elements of the perfect financial storm: Alan (Easy Money) Greenspan at the helm of the Fed and a piece of legislation that turned mortgage lenders into a division of the Salvation Army. Perhaps you can see the pot beginning to boil here. But the real fuel to the fire was yet to come.
GLASS STEGALL
To understand the third element of the storm, we travel back in time to the Great Depression and the 1933 passage of a federal law called the Glass Stegall Act. As excess speculation by banks was one of the key factors of the banking collapse of 1929, this law forbade commercial banks from underwriting (promoting and selling) stocks and bonds.
That activity was left to the purview of “Investment Banks” (names of major investment banks you might recognize include Goldman Saks, Morgan Stanley and the recently diseased Lehman Brothers). Commercial banks could take deposits and make loans to people. Investment banks underwrote (facilitated the issuing of) stocks and bonds. To repeat, this law was put in place to prevent the banking speculation that caused the Great Depression. Among other regulations, Glass Stegall kept commercial banks out of the securities.
Greenspan’s role in our not-so-little drama, is made clear in one of his first speeches before Congress in 1987 in which he calls for the repeal of the Glass Stegall Act. In other words, he’s trying to get rid of the legislation that kept a lid on banks speculating in financial markets with securities. He continued to push for the repeal until 1999 when New York banks successfully lobbied Congress to repeal the Glass Stegall Act. Easy-Money Alan hailed the repeal as a revolution in finance.
Yeah Baby! A revolution was coming.
With Glass Stegall gone, and the permissible mergers of commercial banks with investment banks, there was nothing to prevent these combined financial institutions from packaging up the sub-prime CRA mortgages with normal prime loans and selling them off as mortgage-backed securities through a different arm of the same financial institution. No external due diligence required. You now have three of the five Horsemen of the Fiscal Apocalypse: Greenspan, CRA mortgages and repeal of Glass Stegall.
WAIVER OF CAPITAL REQUIREMENTS
Enter Hammering Hank Paulson. In April of 2004, a group of five investment banks met with the regulators at the Securities and Exchange Commission (SEC) and convinced them to waive a rule that required the banks to maintain a certain level of reserves. This freed up an enormous reservoir of capital, which the investment banks were able to use to purchase oceans of Mortgage Backed Securities (cleverly spiked with the sub-prime CRA loans like a martini in a Bond movie). The banks kept some of these packages for their own portfolios but also sold them by the bucket load to willing buyers from every corner of the globe.
The investment bank that took the lead in getting the SEC to waive the regulation was Goldman Sachs. The person responsible for securing the waiver was Goldman’s Chairman, a man named Henry Paulson. With the reserve rule now removed, Paulson became Wall Street’s most aggressive player, leveraging the relaxed regulatory environment into a sales and marketing jihad of mortgage backed securities and similar instruments. Goldman made billions. And Hammering Hank? According to Forbes Magazine, his partnership interest in Goldman in 2006 was worth $632 million. This on top of his $15 million per year in annual compensation. Despite his glistening dome, let’s say Hank was having a good hair day.
In case this isn’t clear, it was Paulson who, more than anyone else on Wall Street, was responsible for the boom in selling the toxic mortgage backed securities to anyone who could write a check. Many of you may recognize the name Hank Paulson. It was Paulson who left the Goldman Sachs’ chairmanship and came to Washington in mid 2006 as George Bush’s Secretary of the Treasury. And it was Paulson who bludgeoned Congress out of $700 billion of so called stimulus money with threats of public riots and financial Armageddon if they did not cough up the dough. He then used $300 billion to “bailout” his Wall Street home boys to whom he had sold the toxic paper in the first place. All at taxpayer expense. Makes you feel warm all over, doesn’t it? Congress has their own responsibility for this fiscal madness, but that’s another story. This one still has one more piece – the Pièce de résistance.
End of Part 1. More to come in our next blogs.
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