I have not heard one elected official or government bureaucrat in Washington, D. C. apologize to the American public for all the problems they have caused the American people over the past fifty years. All I have heard from this august bunch is “Get the Greedy Bastards from Wall Street”!
Yet, it is the “Greedy Bastards” from Washington, D. C. that put into place the incentives that everyone else in the country had to respond to and that created the environment that resulted in the mess the country has been going through over the last four years. These “Greedy Bastards from Washington” were greedy for power and for the benefits and rewards of being elected and re-elected over and over again. So they developed the incentives for the rest of the country that would allow them to get re-elected over and over again.
I could go into a long list of “incentives” that the White House and Congress created over the past fifty years, but I thought that today I would work from my list of personal experiences that, to me, show how Washington can impact the private sector and put in place “incentives” that end up causing more trouble for people than they do benefits, even though the programs are put into place to “make things better for people”…and to get elected people re-elected.
In the public sector I was a spectator to the build-up of the securitized mortgage. All this “stuff” we are hearing so much about really began in the late 1960s. Fannie Mae (FNMA) was split in two in 1968, the new wing became Ginnie Mae (GNMA), the Government National Mortgage Association. In 1968, GNMA guaranteed the first mortgage pass-through security. In 1970 FNMA was authorized to purchase private mortgages. Also in 1970, Freddie Mac was created to do the same thing as FNMA. I was able to see the early years of the operation of these institutions as a liaison between the Secretary of HUD and these agencies. I also experienced the effort to create more viable mortgage backed securities so that longer term funds from insurance companies and pension funds could flow into the housing market and provide more money to help “American citizens” own their own home. (By the time Michael Lewis wrote “Liar’s Poker” in the late 1980s, the market for mortgage backed securities was the largest part of the capital markets in the world! This is up from almost zero in the 1960s.)
From where I sat there was only one reason why so much effort was put into these “financial innovations” and that was to help the people in the White House and in Congress get re-elected. The stated goal of these programs was to put Americans their own homes. Okay!
The housing sector was “bankrolled” by the United States government, to get government officials re-elected. Both parties took advantage of this effort and both parties added to the incentives available to all those participating in the “give-away.” And, today we face the reality that over half the residential mortgages in this country are held by either Fannie Mae or Freddie Mac and that each of these institutions is losing so much money that it will eventually cost the taxpayer an estimated $350 billion. Little is being done about this, and, no one in Congress or the White House is apologizing for this loss. Shame on them!
Back in the private sector I joined the Senior Management of a mutual savings bank in late 1983 with assets of about $1.0 billion. In January 1984 I became the Chief Financial Officer of the organization. There were some pretty severe restrictions on the balance sheet of a savings bank at that time. Sixty percent of the assets of the bank, and no more, could be placed in residential mortgages. The other forty percent could be placed in a limited list of marketable securities, primarily Treasury securities. The organization I joined had about 60% of its assets in residential mortgages, 30% in longer-term U. S. Treasury securities, and 10% in very liquid assets.
The bank was in trouble! Not from the mortgages. The residential mortgages were performing well. The problem was in the portfolio of longer-term U. S. Treasury securities. They were deeply “underwater” and this threatened the life of the institution which had been in existence since the 1830s.
United States Treasury issues with a maturity of 10 years traded around 7.5% in 1975. In the 1983-1984 period these securities traded in the 11.5% to 12.5% range. Needless to say, the 30% of the assets the institution held was not in good shape.
Notice, however, this bank was not in trouble because of “bad” assets. The quality of the assets on the books of the bank was of the highest level. This was an institution that was very prudently managed.
The problem came from the inflationary expectations that were built into longer term interest rates, an inflation that came about due to the inflationary policies of the United States government in the 1960s and 1970s. Remember, a small amount of inflation was good at that time because it put people back to work and that was good for the politicians. The tradeoff between inflation and unemployment was called the “Phillips Curve.” Too bad about the highly restricted thrift industry!
Let me just mention two responses that were made to this situation. The first was to convert the mutual institution into a stock institution. This was done successfully and $42 million in new capital was injected into the bank. But, the nature of the bank had changed forever. We were in a new era where “maximizing shareholder returns” became the dominant goal of the organization.
Second, we examined a new financial innovation, a “risk controlled” interest rate arbitrage of $100 million, one-tenth in size of the whole organization, to “off-set” the low interest rates that were being earned on the Treasury portfolio. The justification for the arbitrage transaction was pages and pages of computer printouts that showed how the transaction would perform in dozens of interest rate environments similar to the ones that had existed in history…the last twenty years. Ah, the benefits of computer-based quantitative simulations. Financial innovation was grand!
What happened to the bank? Well, interest rates fell back into the 7.0% to 7.5% range in 1986 (thank you Paul Volcker) and the Treasuries were sold and the olvency problem was resolved. The bank is still in existence today.
The second turn-around I was involved in was a sleepy old savings and loan association that was run by the same old man and old board of directors that had been around for years. The portfolio was solid residential real estate mortgages. This institution did not have to convert and go public, but the environment was such that in 1986 they went public and raised $18 million dollars for an institution that had less than $300 million in assets. They didn’t know what to do with the money but now they had to maximize shareholder value. So they started up a commercial real estate development subsidiary and began to explore getting into more and more commercial activities and also acquisitions. This S&L was run by a “pillar” of the community who had done nothing more than make residential mortgages and manage a large number of women tellers for forty years or so. With the “new” money, the bank grew to about $1.0 billion with many problem areas because the “old guy” just didn’t get it! I was with this institution from 1987 through 1991.
The CEO was finally forced out of his position in 1991 along with many board members. This came about because the financial community substantially discounted the stock because of the “old guy” and the regulators finally forced some board members into doing something. The bank was finally sold to what is now one of the twenty-five largest banks in the country. A board member of the acquiring institution who I knew well told me later that this acquisition was so cheap it was the only acquisition he was familiar with that was accretive in the first year after the acquisition. The regulators did not know what to do with all the problem banks they had on their hands during this time period and so forced many “good” institutions into situations they were totally unprepared for.
I then moved into a commercial bank turnaround. This bank had been one of dozens of “startup” banks which took place in the late 1980s and early 1990s. When I was brought into the bank I was amazed that the bank had policies and procedures that were well suited for a multi-billion dollar bank, but not for a startup institution that never got above $100 million in assets. The management of the bank had grandiose ideas about what they could do and a board of directors that knew almost nothing about banking. But, Washington wanted more and more banks to keep money flowing into the community. The bank had severe problems but we succeeded to the extent that we were the only “boutique” bank in Philadelphia that was not either closed or forced to merge with another institution. So much for providing funds to the local community.
I have worked in both the public sector and the private sector in my career. I have seen how the incentives set up by government have distorted markets as the incentives played to the “greed” of many in the private sector. In the short run, these “incentives” seemed to work for the good of the society. In the longer run as people found out how to “play” the system, the greed of the private sector came to dominate the news angering the people from “Main Street” and making it easy for politicians to point their fingers at the “Greedy Bastards on Wall Street” and walk away as if they had nothing to do with all the problems that they had created. Those “Greedy Bastards from Washington”! Beware of what these “Greedy Bastards” do because they only have one incentive…to get re-elected.