How important was Ben Bernanke’s testimony given to the Financial Crisis Inquiry Commission?
Well, the New York Times reported it on page B3 of the Business section and the Wall Street Journal reported it on page A6 of its first section. Ho hum!
This more or less puts the testimony in the class of Alan Greenspan’s efforts to recover his reputation once he stepped down from the position Bernanke now holds.
The important thing, to me, about the testimony is what it says about one of the leaders of economic and monetary policy in Washington, D. C. these days. I have just commented on this leadership recently.
“Economic leadership of the United States currently rests in the hands of individuals that were an instrumental part in the excessive credit inflation of the 2000s. Ben Bernanke was a member of the Board of Governors of the Federal Reserve System and a vocal supporter of Alan Greenspan’s move to keep the Federal Funds target rate around one percent in 2003 and beyond, having joined the Board in 2002. Timothy Geithner became President of the Federal Reserve Bank of New York in 2003. This position has a permanent vote on the Open Market Committee, so that Geithner was in on all votes during this time as was Bernanke. After a short stint as the Chairman of the President’s Council of Economic Advisors in 2005-2006, Bernanke became Chairman of the Board of Governors of the Federal Reserve System in February 2006. Geithner moved from the New York Fed to become Treasury Secretary in January 2009.
These two leaders, arguably the most important leaders in economics and finance in the United States government, have held top positions and been voting members of policy boards during one of the most un-disciplined times in United States history. And, their lack of discipline continues, as is evident by the speech given by Bernanke last Friday at Jackson Hole, Wyoming. The only policy that these two people follow is one of throwing everything they can at a problem and seeing what works.
The problem is that their interest rate efforts in the 2003 to 2005 period led to a housing bubble and stock market bubble which resulted in the collapse of the sub-prime market in 2006 and 2007. Their response to this break-down resulted in the financial disaster of the 2008 to 2009 period when the government threw just about everything it could at the disaster in order to try and avoid worse. We are now in 2010 and the evidence of the lack of discipline is still around us. Consumers are plagued with debt fostering record numbers of foreclosures and personal bankruptcies. Businesses are overwhelmed with debt, not only with high-yield bond debt but also with commercial real estate loans and foreclosures and bankruptcies are also high in this area. State and local governments are piled high with debt and we find that states and cities are cutting back on the most basic of services including the release of fire fighters and police. And, the federal government faces budget deficits that some estimate will result in $15 trillion or more in additional debt over the next ten years.”
And, Mr. Bernanke is so disingenuous as to say about letting Lehman Brothers fail: I wasn’t “straightforward” in my statements about the condition of the company. In his view “Lehman didn’t have enough collateral to support a loan from the central bank.” That is, there were no choices!
Then Mr. Bernanke says, “This is my own fault, in a sense...”
What is this “in a sense” business! Either you did or you didn’t!
Going on, “I regret not being more straightforward there because clearly it has supported the mistaken impression that in fact we could have done something. We could not have done anything.”
Thank you Mr. Greensp…whoops…Mr. Bernanke.
I have yet to hear anything, from Mr. Bernanke, Mr. Paulson, or anybody, that has changed my mind concerning that time back in September of 2008. My post on the events of that specific period is titled “The Bailout Plan: Did Bernanke Panic?” (See http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.”
This is the leadership we are now getting in Washington, D. C. Need I say more?
Showing posts with label Lehman Brothers. Show all posts
Showing posts with label Lehman Brothers. Show all posts
Friday, September 3, 2010
Wednesday, May 5, 2010
Why Should We Trust the Financial System?
Every day, it seems as if people are given more reasons to distrust financial institutions and the leaders of those financial institutions.
Lloyd Blankfein has become a joke!
Banks are not to be believed!
And, governments and members of governments have even lower ratings!
Finance is supposed to operate on trust and financial markets are said to function because people have confidence in them.
Well, if this is the case anywhere at the present time it must be in a parallel universe.
And, the stories continue. “It’s an open secret on Wall Street that many big banks routinely—and legally—fudge their quarterly books.”
“Window dressing is so pervasive on Wall Street…”
“The big question is the extent to which other banks (other than Lehman Brothers and Bear Stearns) used, and still use, creative financing, and whether they, like Lehman, broke any rules.”
These quotes are from the New York Times article “Crisis Panel to Probe Window-Dressing at Banks”: http://www.nytimes.com/2010/05/05/business/05repo.html?ref=business.
It is not just the big banks. It is on the public record that the Greek government lied to the world about its fiscal position. What other governments might be falsifying their records?
State and local governments in the United States are not forthcoming about their financial commitments and liabilities such as those connected with the funding of pensions and other contracts. And, many of these entities are facing the bankruptcy court these days.
Ponzi schemes come in many different flavors.
But, those that work in financial markets claim, at least in theory, that the markets are efficient, that the prices that exist in financial markets reflect all relevant information. They assume that participants in financial transactions are “sophisticated” meaning that the participants are canny professionals who have all the information they need.
That is why the executives at Goldman Sachs can, in good conscience, argue that their customers are “sophisticated” and are “big boys, fully capable of looking after themselves.” (See “Goldman and the ‘Sophisticated Investor” in the Wall Street Journal this morning, http://online.wsj.com/article/SB20001424052748703866704575224511672855990.html#mod=todays_us_opinion.)
What! The financial wizards claim that investors have all the information they need, yet they hide information from the public on a regular basis!
And, why does Lloyd Blankfein look silly testifying before Congress or on the Charlie Rose program?
Government officials hide information from the public on a regular basis!
And, then these same officials cry foul when financial markets sell off once the information on their lies becomes known.
Hello, Bernie Madoff…
We now know that Lehman Brothers and Bear Sterns used “shadow financial vehicles” and produced results that mislead investors and regulators. This seems to be the case most of the time in terms of companies that fail.
I know from the bank turnarounds that I was involved in, one of the first requirements of the new management was to open up the books and let the world know what actually was going on in the “troubled” institution. When this was done, the basic response I got from the investment community was one of “incredulity” and “disbelief.” The investment community could not believe that I was willing to make the books as open to them as I did. But, once they got used to this “openness” they began to trust me and what was being done at the troubled institution.
Secrecy, to me, is the worst thing the leadership of an organization can pursue. But, then, people tend to run to secrecy when things go wrong because they either were not capable of running the organization or because they made bad decisions.
As a consequence, my experience has made me a firm believer that openness and transparency, in all financial institutions…and governments…are a requirement for sound finance. Openness and transparency are a requirement for the building of trust in organizations and the system so that investors will have confidence in markets.
Openness and transparency should be one of the building blocks for any new financial reform and re-regulation that takes place.
Yet, the Obama Administration and the Congress seem to be focused on the past; they are fighting the last war. And, this means that any reform package they get will be out-of-date and irrelevant when it is passed. As the New York Times article reports “JP Morgan Chase and Goldman Sachs are examining how to use shadow vehicles to help them borrow money in the future.” The article points to such major players as BSN Capital Partners in London as one firm that has created such vehicles for banks in the past. Even the best seem to need secrecy!
International financial markets still don’t know all they need to know about the Greek situation…and the Spanish situation, and the Portuguese situation, and the Irish situation, and the Italian situation, and the English situation, and so on and so on. International financial markets still don’t know all they need to know about who holds the debt of these countries and how much of an impact would take place if the debt where to be substantially written down.
So we see that another financial crisis has taken place because the expectations of investors were surprised. (See my post http://seekingalpha.com/article/201382-greece-the-surprise-that-breaks-the-camel-s-back.) Maybe we are asking the wrong question, that question being “Why have investors lost confidence in these euro-zone securities?” May the question should be “Why did investors have confidence in them in the first place?”
Lloyd Blankfein has become a joke!
Banks are not to be believed!
And, governments and members of governments have even lower ratings!
Finance is supposed to operate on trust and financial markets are said to function because people have confidence in them.
Well, if this is the case anywhere at the present time it must be in a parallel universe.
And, the stories continue. “It’s an open secret on Wall Street that many big banks routinely—and legally—fudge their quarterly books.”
“Window dressing is so pervasive on Wall Street…”
“The big question is the extent to which other banks (other than Lehman Brothers and Bear Stearns) used, and still use, creative financing, and whether they, like Lehman, broke any rules.”
These quotes are from the New York Times article “Crisis Panel to Probe Window-Dressing at Banks”: http://www.nytimes.com/2010/05/05/business/05repo.html?ref=business.
It is not just the big banks. It is on the public record that the Greek government lied to the world about its fiscal position. What other governments might be falsifying their records?
State and local governments in the United States are not forthcoming about their financial commitments and liabilities such as those connected with the funding of pensions and other contracts. And, many of these entities are facing the bankruptcy court these days.
Ponzi schemes come in many different flavors.
But, those that work in financial markets claim, at least in theory, that the markets are efficient, that the prices that exist in financial markets reflect all relevant information. They assume that participants in financial transactions are “sophisticated” meaning that the participants are canny professionals who have all the information they need.
That is why the executives at Goldman Sachs can, in good conscience, argue that their customers are “sophisticated” and are “big boys, fully capable of looking after themselves.” (See “Goldman and the ‘Sophisticated Investor” in the Wall Street Journal this morning, http://online.wsj.com/article/SB20001424052748703866704575224511672855990.html#mod=todays_us_opinion.)
What! The financial wizards claim that investors have all the information they need, yet they hide information from the public on a regular basis!
And, why does Lloyd Blankfein look silly testifying before Congress or on the Charlie Rose program?
Government officials hide information from the public on a regular basis!
And, then these same officials cry foul when financial markets sell off once the information on their lies becomes known.
Hello, Bernie Madoff…
We now know that Lehman Brothers and Bear Sterns used “shadow financial vehicles” and produced results that mislead investors and regulators. This seems to be the case most of the time in terms of companies that fail.
I know from the bank turnarounds that I was involved in, one of the first requirements of the new management was to open up the books and let the world know what actually was going on in the “troubled” institution. When this was done, the basic response I got from the investment community was one of “incredulity” and “disbelief.” The investment community could not believe that I was willing to make the books as open to them as I did. But, once they got used to this “openness” they began to trust me and what was being done at the troubled institution.
Secrecy, to me, is the worst thing the leadership of an organization can pursue. But, then, people tend to run to secrecy when things go wrong because they either were not capable of running the organization or because they made bad decisions.
As a consequence, my experience has made me a firm believer that openness and transparency, in all financial institutions…and governments…are a requirement for sound finance. Openness and transparency are a requirement for the building of trust in organizations and the system so that investors will have confidence in markets.
Openness and transparency should be one of the building blocks for any new financial reform and re-regulation that takes place.
Yet, the Obama Administration and the Congress seem to be focused on the past; they are fighting the last war. And, this means that any reform package they get will be out-of-date and irrelevant when it is passed. As the New York Times article reports “JP Morgan Chase and Goldman Sachs are examining how to use shadow vehicles to help them borrow money in the future.” The article points to such major players as BSN Capital Partners in London as one firm that has created such vehicles for banks in the past. Even the best seem to need secrecy!
International financial markets still don’t know all they need to know about the Greek situation…and the Spanish situation, and the Portuguese situation, and the Irish situation, and the Italian situation, and the English situation, and so on and so on. International financial markets still don’t know all they need to know about who holds the debt of these countries and how much of an impact would take place if the debt where to be substantially written down.
So we see that another financial crisis has taken place because the expectations of investors were surprised. (See my post http://seekingalpha.com/article/201382-greece-the-surprise-that-breaks-the-camel-s-back.) Maybe we are asking the wrong question, that question being “Why have investors lost confidence in these euro-zone securities?” May the question should be “Why did investors have confidence in them in the first place?”
Thursday, March 25, 2010
Audits and Auditors
I would like to recommend to the readers of this post the column by Jennifer Hughes in the Financial Times this morning. The title of the article is “Lehman Case Revives Dark Memories of Enron”: http://www.ft.com/cms/s/0/c9516dea-3792-11df-88c6-00144feabdc0.html.
The issue at hand is the relationship between a firm and its external auditors. The reason for the attention given to this issue by Hughes is the examination of the collapse of Lehman Brothers by Anton Valukas. Although not a major thrust of the review, questions did arise in the study concerning the role of Lehman’s external auditor Ernst & Young in the accounting practices adopted by the firm.
Ernst & Young began auditing Lehman Brothers in 1994 and two Lehman of Chief Financial Officers came from this external auditor. One, David Goldfarb, joined Lehman in 1993 and became CFO of the firm in 2000. The other, Chris O’Meara, joined Lehman in 1994 and was the CFO from 2004 to 2007. It was under Goldfarb that the accounting policy with respect to “Repo 105” transactions was developed.
To Hughes, this brought up memories of the accounting relationship between Enron and the external auditing firm Arthur Andersen. Again, a very close relationship had been established between the two organizations and many Andersen staff worked for Enron over the years.
I am not out to just criticize the accounting profession and the good and proper working relations that exist between many companies and their external auditors. However, the relationship between companies and their auditors can become too cozy and can present the opportunity to do things with company books that are, let’s say, not quite what the owners would like them to pursue.
My interest in this relationship comes from my experience as a senior executive, including President and CEO, of several publically traded banking companies. Each case was a turnaround situation.
In such a situation it is vital to get the accounting books in order and presentable to shareholders and the investment community for their close scrutiny. Internally, it is good to have “fresh eyes” to perform such a review. In a troubled institution it is problematic to have the same people, from inside as well as from outside the organization, performing this exercise. The first reason for this, of course, is that these same people watched the organization become troubled and they have a self-interest in defending the status quo. This is neither good for the company nor the shareholders and, thus, certainly not good for the executives hoping to turn-around the firm.
But, this pointed me to the problem that the financial controls that had existed were not sufficient for the company or for the executives in charge to prevent the firm from collapsing into a troubled institution. So, either the work was not getting done adequately or the executives that had been in charge did not want the work to get done adequately. Either way, the situation was not a good one for the institution or the shareholders.
It became my rule that any organization in which I was the CEO would put the job of external auditor out for bids in the fifth year of an engagement. I felt this was necessary for me to keep on top of what was going on in the organization and to have “fresh eyes” review the books and the accounting procedures on a regular basis. Furthermore, doing this periodically encouraged the openness and transparency on the part of the employees that I believed was necessary for the shareholders and the investment community.
This “rule” of mine may have been a little severe, but I was doing turnarounds at that time and the tighter time schedule seemed important to me then. Perhaps a seven year turnover of external accountants would be better, except in cases where the CFO of the company happens to be a former employee of the accounting firm doing the external auditing.
Hughes mentions in her article that Italy, among other countries, have limits on audit firm tenure. There the length of time allowed is nine years. Other countries require that the “lead partner” from the accounting firm be changed every five years. Also, there are rules about hiring individuals from the external auditing firm, rules that require a “cooling off” period for anyone joining an audit client.
To me, this requirement seems of particular importance to banks and other financial institutions. Yes, the banks are examined by the regulators and this should provide a check on what banks are doing. But, this is not enough in my mind.
When I was a bank President and CEO, I wanted the bank to have stricter requirements on what it did than the regulators. The reason is that I wanted the company to control the position of the bank and not the regulators. This also applied to the safety and soundness of the bank. That is why I wanted to ensure that the external auditors were truly independent of me and the staff of the bank. Having the external auditor “turnover” on a regular basis was one way to help achieve this goal. To my mind, any CEO that has the best interests of his/her shareholders in mind would want this to be the case.
I know that this is not the case of all CEOs in all industries. That is why some regulation of company/external auditor relationships is important. This is true especially for the commercial banking industry. Any regulatory reform that is passed should have some statement about the presence of an external auditor and the regular replacement of external auditors. This is a first round effort to insure the safety and soundness of the banking system and should, if it existed, ease some of the burden placed on the examination efforts of the regulatory agencies. It is a part of the openness and transparency that should be required for all companies, but especially for those related to banking.
I know that there is little academic research, as Hughes reports, connecting “audit, or auditor tenure, and the quality of the work.” I know that most situations and people work out well. I know the value that hiring someone familiar with your books is a “good thing” because of the complexity and sophistication of accounting practices today.
Still, I always wanted to be on top of things and continually have “fresh eyes” looking over the operations and the books. I always wanted to be challenged to do things in the best way possible. I always wanted people to push me to do better. Openness and transparency never bothered me. To me, performance always went back to how well you executed your game plan and not on how much trickery or deception you needed to win.
To me, it all comes back to fundamentals and ability. If you lack one or the other or both…I guess you need to rely on other means, like “cooking the books”, to come out on top.
The issue at hand is the relationship between a firm and its external auditors. The reason for the attention given to this issue by Hughes is the examination of the collapse of Lehman Brothers by Anton Valukas. Although not a major thrust of the review, questions did arise in the study concerning the role of Lehman’s external auditor Ernst & Young in the accounting practices adopted by the firm.
Ernst & Young began auditing Lehman Brothers in 1994 and two Lehman of Chief Financial Officers came from this external auditor. One, David Goldfarb, joined Lehman in 1993 and became CFO of the firm in 2000. The other, Chris O’Meara, joined Lehman in 1994 and was the CFO from 2004 to 2007. It was under Goldfarb that the accounting policy with respect to “Repo 105” transactions was developed.
To Hughes, this brought up memories of the accounting relationship between Enron and the external auditing firm Arthur Andersen. Again, a very close relationship had been established between the two organizations and many Andersen staff worked for Enron over the years.
I am not out to just criticize the accounting profession and the good and proper working relations that exist between many companies and their external auditors. However, the relationship between companies and their auditors can become too cozy and can present the opportunity to do things with company books that are, let’s say, not quite what the owners would like them to pursue.
My interest in this relationship comes from my experience as a senior executive, including President and CEO, of several publically traded banking companies. Each case was a turnaround situation.
In such a situation it is vital to get the accounting books in order and presentable to shareholders and the investment community for their close scrutiny. Internally, it is good to have “fresh eyes” to perform such a review. In a troubled institution it is problematic to have the same people, from inside as well as from outside the organization, performing this exercise. The first reason for this, of course, is that these same people watched the organization become troubled and they have a self-interest in defending the status quo. This is neither good for the company nor the shareholders and, thus, certainly not good for the executives hoping to turn-around the firm.
But, this pointed me to the problem that the financial controls that had existed were not sufficient for the company or for the executives in charge to prevent the firm from collapsing into a troubled institution. So, either the work was not getting done adequately or the executives that had been in charge did not want the work to get done adequately. Either way, the situation was not a good one for the institution or the shareholders.
It became my rule that any organization in which I was the CEO would put the job of external auditor out for bids in the fifth year of an engagement. I felt this was necessary for me to keep on top of what was going on in the organization and to have “fresh eyes” review the books and the accounting procedures on a regular basis. Furthermore, doing this periodically encouraged the openness and transparency on the part of the employees that I believed was necessary for the shareholders and the investment community.
This “rule” of mine may have been a little severe, but I was doing turnarounds at that time and the tighter time schedule seemed important to me then. Perhaps a seven year turnover of external accountants would be better, except in cases where the CFO of the company happens to be a former employee of the accounting firm doing the external auditing.
Hughes mentions in her article that Italy, among other countries, have limits on audit firm tenure. There the length of time allowed is nine years. Other countries require that the “lead partner” from the accounting firm be changed every five years. Also, there are rules about hiring individuals from the external auditing firm, rules that require a “cooling off” period for anyone joining an audit client.
To me, this requirement seems of particular importance to banks and other financial institutions. Yes, the banks are examined by the regulators and this should provide a check on what banks are doing. But, this is not enough in my mind.
When I was a bank President and CEO, I wanted the bank to have stricter requirements on what it did than the regulators. The reason is that I wanted the company to control the position of the bank and not the regulators. This also applied to the safety and soundness of the bank. That is why I wanted to ensure that the external auditors were truly independent of me and the staff of the bank. Having the external auditor “turnover” on a regular basis was one way to help achieve this goal. To my mind, any CEO that has the best interests of his/her shareholders in mind would want this to be the case.
I know that this is not the case of all CEOs in all industries. That is why some regulation of company/external auditor relationships is important. This is true especially for the commercial banking industry. Any regulatory reform that is passed should have some statement about the presence of an external auditor and the regular replacement of external auditors. This is a first round effort to insure the safety and soundness of the banking system and should, if it existed, ease some of the burden placed on the examination efforts of the regulatory agencies. It is a part of the openness and transparency that should be required for all companies, but especially for those related to banking.
I know that there is little academic research, as Hughes reports, connecting “audit, or auditor tenure, and the quality of the work.” I know that most situations and people work out well. I know the value that hiring someone familiar with your books is a “good thing” because of the complexity and sophistication of accounting practices today.
Still, I always wanted to be on top of things and continually have “fresh eyes” looking over the operations and the books. I always wanted to be challenged to do things in the best way possible. I always wanted people to push me to do better. Openness and transparency never bothered me. To me, performance always went back to how well you executed your game plan and not on how much trickery or deception you needed to win.
To me, it all comes back to fundamentals and ability. If you lack one or the other or both…I guess you need to rely on other means, like “cooking the books”, to come out on top.
Tuesday, September 15, 2009
Too much power to too few people: the Lehman debacle.
It is so easy to blame the private sector. And, the government can hide behind “good intentions” and “the public interest.”
For a different view, read the article by John Cochrane and Luigi Zingales who write on “Lehman and the Financial Crisis” in the Wall Street Journal, http://online.wsj.com/article/SB10001424052970203440104574403144004792338.html#mod=todays_us_opinion. The argument is presented here that it was not the failure of Lehman Brothers that set off the financial crisis. It was the panic move by Ben Bernanke and Hank Paulson that resulted in the financial crisis. This mirrors something I wrote last fall on November 16 titled “The Bailout Plan: Did Bernanke Panic?”: http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.
As Cochrane and Zingales write, Fannie Mae and Freddie Mac were taken over on September 7, 2008. Lehman Brothers filed for bankruptcy on September 15. AIG was bailed out on September 16. I believe, as I say in the post above, that everything changed that Tuesday evening when the bailout of AIG was announced.
Bernanke called Paulson on Wednesday September 17. As reported later in the Wall Street Journal, and I quote from my post: The Wall Street Journal article reports that by Wednesday afternoon “Bernanke reached the end of his rope.” He called Paulson and “with an occasional quaver in his voice” he spoke “unusually bluntly” to the Treasury Secretary. Paulson did not move immediately. He had to sleep on it, and on Thursday morning, he committed.
Friday evening Bernanke and Paulson met with Congressional leaders and again I quote from the earlier post: Paulson called the leadership in Congress and asked them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and “scared the daylights out of everyone.” Bernanke knew his history of the Great Depression and he knew currents events. He was very logical and very articulate. The leaders were told that they had to act and they had to act fast. The plan was to have a bill before Congress on Monday seeking Congressional approval (of both houses) by the following Friday. The Treasury Department had a bill ready (three pages long) by midnight Saturday evening. The price tag - $700 billion. Why $700 billion? Because it was a big number!
But, Cochrane and Zingales state that on Monday September 22, “bank credit-default swap (CDS) spreads were at the same level as on September 12…The Libor-OIS spread—which captures the perceived riskiness of short-term interbank lending—rose only 18 points the day of Lehman’s collapse, while it shot up more than 60 points from September 23 to September 25, after the TARP testimony.” That is Bernanke and Paulson appeared in front of Congress on September 23 and 24 and gave speeches on the need for the TARP funding.
The reason for the subsequent market activity? Cochrane and Zingales claim that “In effect, these speeches amounted to ‘The financial system is about to collapse. We can’t tell you why. We need $700 billion. We can’t tell you what we’re going to do with it.” The authors conclude with “That’s a pretty good way to start a financial crisis.”
The conclusion: putting all the blame on the Lehman failure takes the focus off the main story. The main story is not that there was just one policy failure at this time. The main story is that the government continued to screw up after creating the financial environment and credit inflation that resulted in the asset bubble of earlier in the decade. It continued to screw up in the series of band aids that the Fed and the Treasury imposed on the economy and financial system beginning in December 2007. And, in doing so, the government continued to build up the moral hazard in existence in the system and continued to expand the federal debt outstanding to met ever larger needs for financial bailouts.
By not focusing on the main story, we risk an even larger series of policy failures in the future. That is, the federal government now is doing pretty much what the federal government did last year and the year before and is creating even more massive amounts of debt in the process.
For a different view, read the article by John Cochrane and Luigi Zingales who write on “Lehman and the Financial Crisis” in the Wall Street Journal, http://online.wsj.com/article/SB10001424052970203440104574403144004792338.html#mod=todays_us_opinion. The argument is presented here that it was not the failure of Lehman Brothers that set off the financial crisis. It was the panic move by Ben Bernanke and Hank Paulson that resulted in the financial crisis. This mirrors something I wrote last fall on November 16 titled “The Bailout Plan: Did Bernanke Panic?”: http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.
As Cochrane and Zingales write, Fannie Mae and Freddie Mac were taken over on September 7, 2008. Lehman Brothers filed for bankruptcy on September 15. AIG was bailed out on September 16. I believe, as I say in the post above, that everything changed that Tuesday evening when the bailout of AIG was announced.
Bernanke called Paulson on Wednesday September 17. As reported later in the Wall Street Journal, and I quote from my post: The Wall Street Journal article reports that by Wednesday afternoon “Bernanke reached the end of his rope.” He called Paulson and “with an occasional quaver in his voice” he spoke “unusually bluntly” to the Treasury Secretary. Paulson did not move immediately. He had to sleep on it, and on Thursday morning, he committed.
Friday evening Bernanke and Paulson met with Congressional leaders and again I quote from the earlier post: Paulson called the leadership in Congress and asked them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and “scared the daylights out of everyone.” Bernanke knew his history of the Great Depression and he knew currents events. He was very logical and very articulate. The leaders were told that they had to act and they had to act fast. The plan was to have a bill before Congress on Monday seeking Congressional approval (of both houses) by the following Friday. The Treasury Department had a bill ready (three pages long) by midnight Saturday evening. The price tag - $700 billion. Why $700 billion? Because it was a big number!
But, Cochrane and Zingales state that on Monday September 22, “bank credit-default swap (CDS) spreads were at the same level as on September 12…The Libor-OIS spread—which captures the perceived riskiness of short-term interbank lending—rose only 18 points the day of Lehman’s collapse, while it shot up more than 60 points from September 23 to September 25, after the TARP testimony.” That is Bernanke and Paulson appeared in front of Congress on September 23 and 24 and gave speeches on the need for the TARP funding.
The reason for the subsequent market activity? Cochrane and Zingales claim that “In effect, these speeches amounted to ‘The financial system is about to collapse. We can’t tell you why. We need $700 billion. We can’t tell you what we’re going to do with it.” The authors conclude with “That’s a pretty good way to start a financial crisis.”
The conclusion: putting all the blame on the Lehman failure takes the focus off the main story. The main story is not that there was just one policy failure at this time. The main story is that the government continued to screw up after creating the financial environment and credit inflation that resulted in the asset bubble of earlier in the decade. It continued to screw up in the series of band aids that the Fed and the Treasury imposed on the economy and financial system beginning in December 2007. And, in doing so, the government continued to build up the moral hazard in existence in the system and continued to expand the federal debt outstanding to met ever larger needs for financial bailouts.
By not focusing on the main story, we risk an even larger series of policy failures in the future. That is, the federal government now is doing pretty much what the federal government did last year and the year before and is creating even more massive amounts of debt in the process.
Monday, September 14, 2009
The Regulation of Banks and Financial Markets: One Year Later
The papers and the news broadcasts over the last week have been filled with stories about the failure of Lehman Brothers and the need to re-regulate the financial system. The second-guessing has been enormous on the failure of the federal government to come to the aid of the troubled investment banking firm, especially when put into the context of the bailout of AIG and the help given to other investment banks and commercial banks.
Furthermore, the report card on the government’s effort to re-regulate the financial system seems to be hovering between D and F! The consensus review of what has happened over the past year is: nothing!
In terms of letting Lehman Brothers go, let me just say that the second-guessing is a fun game and provides a diversion for journalists and makes good reading but is not very productive. This is the problem with decision making under very stressful conditions with very little information on what the potential outcomes of actions might be.
For one thing, very few people in the summer of 2008 even considered that the financial might be on the verge of collapse. That is what makes situations risky, the lack of knowledge of what might happen in the future. Yes, we can talk about Black Swans and so forth, but the probability of a severe financial crises occurring is a very unlikely event and business is not conducted on a “what-if-the-worst-happens” scenario. Second, no one has “experience” in dealing with a very serious financial crisis. It is entirely different studying previous examples of financial crisis, but to have to deal with one face-to-face is an entirely different matter. Third, the biases and prejudices and world views of the individuals in charge of making these decisions play a role in how people respond to a crises and no one, before-the-fact, can make an adequate prediction of how leaders will perform in a “once-in-a-lifetime” situation.
The financial system is still functioning and the economy seems to be working its way out of a deep recession. Could things have been done better? Yes. Could things have turned out worse? Of course. But, we seem to have muddled through the real crisis period. Hopefully, we will not have a second shock wave that sends us back into another panic mode.
In terms of re-regulating the financial system, I have several opinions I would like to share. First, to try and re-regulate a financial system immediately after a financial crisis occurs is, in my mind, not the thing to do. For one thing, you don’t really know what happened or what caused the crisis and to rush to judgment is often to rush into folly. Furthermore, villains are usually identified that may or may not really be the “bad guys” that need punishment or controlling. Powerful politicians or government officials impose their own biases and prejudices into the discussion and they are not always the best forces to design a new regulatory system. Also, new regulatory systems that are quickly put into place following a debacle are often designed to “fight the last war” and are not really appropriate for the environment the world is moving into.
The problem with not moving to re-regulate relatively quickly is that the movement to re-regulate loses its urgency.
My second concern has to do with the causes of the financial crisis. Since the financial collapse has to do with financial institutions and financial instruments, people look first at the individuals running these organizations or dealing in these instruments for the culprits of the crisis. The problem I have with this is that the leaders and practitioners of finance are responding to the economic and financial environment that they work within. The macro-incentives that exist within an economy are oftentimes created by others with very little insight into the incentives that they are actually setting up. The “others” I am talking about are, of course, our governmental leaders. Who created the macro-environment that produced the incentives for individuals to act in the way they did? What about Mr. Greenspan and Mr. Bernanke and the credit inflation that they spawned in the early part of this decade? What about the Bush 43 administration that created the huge fiscal deficits that resulted in a more than 40% decline in the value of the dollar?
The federal government represents more than 25% of GDP in the United States and with this impact on economic activity as well as through the rules and regulations it creates, the government has a very pervasive influence on the incentives that individuals and businesses have to respond to and operate within. The leaders in the federal government go free of blame while the people that have to live within the environment these leaders created must bear the burden of shame and guilt for the financial crisis that resulted.
My concern here is that maybe the re-regulation of the financial system is not the entire problem. My concern here is that people do not really understand who created the environment in which a financial meltdown could occur. Maybe better government policy making is in order, but maybe that is too much to ask for.
Finally, I would like to argue that financial types, human beings, are going to continue to innovate in the future and there is ultimately very little that governments or regulators can do to prevent financial innovation from taking place. (Human beings, by their very nature are problem-solvers and innovators.) Financial innovation has existed throughout history. Finance, really, is nothing more than information. That is one reason why financial innovation was able to explode beginning in the 1990s with the advancements in computer technology. The computer just allowed people to “slice and dice” massive amounts of information flows more efficiently and more quickly. (Even one of the staunchest proponents of behavioral finance, Robert Shiller, proposes using computer assisted financial innovation to take contribute to the evolution of new financial markets and instruments: see his books “Macro Markets” and “The New Financial Order.”) The whole idea of “information markets” builds upon models of financial innovation and how these models can be extended to other markets using massive new data base systems and the advanced computing power that is available in the ever-evolving world of information technology.
There must be oversight of the financial system and this oversight must be accompanied by increases in the openness and transparency of financial transactions and financial reporting. The innovation, in my mind, cannot be controlled. Therefore, we (business leaders, investors, and regulators) must also have more and more information available to us on a more timely basis in order to try and understand what is happening and to react to it. This, to me, is the world of the future.
It is this world of the future that must be considered in any effort to re-regulate the financial system. Fighting the last war is not going to produce the regulatory system we need. Ignoring the incentives that government creates is not going to produce the regulatory system we need. Regulations to produce specific “results” will not work. To my mind, it is not all bad that the rush to re-regulate or to develop a new regulatory system has stalled or been put on the bad burner.
Furthermore, the report card on the government’s effort to re-regulate the financial system seems to be hovering between D and F! The consensus review of what has happened over the past year is: nothing!
In terms of letting Lehman Brothers go, let me just say that the second-guessing is a fun game and provides a diversion for journalists and makes good reading but is not very productive. This is the problem with decision making under very stressful conditions with very little information on what the potential outcomes of actions might be.
For one thing, very few people in the summer of 2008 even considered that the financial might be on the verge of collapse. That is what makes situations risky, the lack of knowledge of what might happen in the future. Yes, we can talk about Black Swans and so forth, but the probability of a severe financial crises occurring is a very unlikely event and business is not conducted on a “what-if-the-worst-happens” scenario. Second, no one has “experience” in dealing with a very serious financial crisis. It is entirely different studying previous examples of financial crisis, but to have to deal with one face-to-face is an entirely different matter. Third, the biases and prejudices and world views of the individuals in charge of making these decisions play a role in how people respond to a crises and no one, before-the-fact, can make an adequate prediction of how leaders will perform in a “once-in-a-lifetime” situation.
The financial system is still functioning and the economy seems to be working its way out of a deep recession. Could things have been done better? Yes. Could things have turned out worse? Of course. But, we seem to have muddled through the real crisis period. Hopefully, we will not have a second shock wave that sends us back into another panic mode.
In terms of re-regulating the financial system, I have several opinions I would like to share. First, to try and re-regulate a financial system immediately after a financial crisis occurs is, in my mind, not the thing to do. For one thing, you don’t really know what happened or what caused the crisis and to rush to judgment is often to rush into folly. Furthermore, villains are usually identified that may or may not really be the “bad guys” that need punishment or controlling. Powerful politicians or government officials impose their own biases and prejudices into the discussion and they are not always the best forces to design a new regulatory system. Also, new regulatory systems that are quickly put into place following a debacle are often designed to “fight the last war” and are not really appropriate for the environment the world is moving into.
The problem with not moving to re-regulate relatively quickly is that the movement to re-regulate loses its urgency.
My second concern has to do with the causes of the financial crisis. Since the financial collapse has to do with financial institutions and financial instruments, people look first at the individuals running these organizations or dealing in these instruments for the culprits of the crisis. The problem I have with this is that the leaders and practitioners of finance are responding to the economic and financial environment that they work within. The macro-incentives that exist within an economy are oftentimes created by others with very little insight into the incentives that they are actually setting up. The “others” I am talking about are, of course, our governmental leaders. Who created the macro-environment that produced the incentives for individuals to act in the way they did? What about Mr. Greenspan and Mr. Bernanke and the credit inflation that they spawned in the early part of this decade? What about the Bush 43 administration that created the huge fiscal deficits that resulted in a more than 40% decline in the value of the dollar?
The federal government represents more than 25% of GDP in the United States and with this impact on economic activity as well as through the rules and regulations it creates, the government has a very pervasive influence on the incentives that individuals and businesses have to respond to and operate within. The leaders in the federal government go free of blame while the people that have to live within the environment these leaders created must bear the burden of shame and guilt for the financial crisis that resulted.
My concern here is that maybe the re-regulation of the financial system is not the entire problem. My concern here is that people do not really understand who created the environment in which a financial meltdown could occur. Maybe better government policy making is in order, but maybe that is too much to ask for.
Finally, I would like to argue that financial types, human beings, are going to continue to innovate in the future and there is ultimately very little that governments or regulators can do to prevent financial innovation from taking place. (Human beings, by their very nature are problem-solvers and innovators.) Financial innovation has existed throughout history. Finance, really, is nothing more than information. That is one reason why financial innovation was able to explode beginning in the 1990s with the advancements in computer technology. The computer just allowed people to “slice and dice” massive amounts of information flows more efficiently and more quickly. (Even one of the staunchest proponents of behavioral finance, Robert Shiller, proposes using computer assisted financial innovation to take contribute to the evolution of new financial markets and instruments: see his books “Macro Markets” and “The New Financial Order.”) The whole idea of “information markets” builds upon models of financial innovation and how these models can be extended to other markets using massive new data base systems and the advanced computing power that is available in the ever-evolving world of information technology.
There must be oversight of the financial system and this oversight must be accompanied by increases in the openness and transparency of financial transactions and financial reporting. The innovation, in my mind, cannot be controlled. Therefore, we (business leaders, investors, and regulators) must also have more and more information available to us on a more timely basis in order to try and understand what is happening and to react to it. This, to me, is the world of the future.
It is this world of the future that must be considered in any effort to re-regulate the financial system. Fighting the last war is not going to produce the regulatory system we need. Ignoring the incentives that government creates is not going to produce the regulatory system we need. Regulations to produce specific “results” will not work. To my mind, it is not all bad that the rush to re-regulate or to develop a new regulatory system has stalled or been put on the bad burner.
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