Chadwick: The Next Crisis is Being Formed Now
There is a long trail to the current financial crisis. Listening to our Government leaders blaming Wall Street greed for the entire debacle begs a response. The Government itself is an accessory before the fact to the state of affairs we find ourselves in today. Let’s review:
In the beginning – there were bad lending practices. And they are at the core of this extraordinary mess.
What was at the heart of the bad lending practices? The Federal Government!! Under both the Clinton and Bush administrations, it was government policy to encourage the private sector to ease underwriting standards in order to expand housing ownership in the U.S. The Federal Reserve under Alan Greenspan was an enabler in that development, by employing a monetary policy that kept interest rates exceedingly low, to the benefit of mortgage seekers. So lay blame on the US Government for bad policy.
The mortgage industry jumped on that bandwagon creating millions of new homeowners by advertising ‘no income verification’ mortgages and luring unsophisticated and sometimes barely literate would-be homeowners into debt obligations they did not understand. So lay blame on the mortgage industry for duplicity and greed.
Wall Street found a way to ‘create a silk purse out of a sow’s ear”. They employed their best and brightest - sophisticated software programmers and brilliant mathematicians - to package all that junky mortgage paper and create investment vehicles that suited many sophisticated investors’ risk appetites. They convinced the credit agencies that a million pieces of junk all bundled together really are riskless. So lay blame on the credit rating agencies for stupidity.
Wall Street then leveraged their shareholders’ balance sheets to the hilt to capitalize on the spread between low short term interest rates and the higher rates available from these new investment vehicles they created from all the junk mortgage paper. So lay blame on Wall Street for [w]recklessness.
And then SOME Wall Street firms paid their employees with illiquid stock and made it difficult if not impossible for them to diversify their assets. Their employees were enslaved – trapped by a system that penalized them for doing what they advised all their clients to do: make sure to diversify your assets and do not have all your eggs in one basket. So lay criminal blame on SOME (not all) Wall Street firms for destroying the livelihoods and the assets of their own employees.
AND THERE IS MORE THAT WE CANNOT FORGET:
Back in 2002, the US Government added a deadly long tailed fuse to the fire which has now exploded. By responding to abuses then in existence, it found an expedient solution that sowed the seeds of today’s crisis. That ‘solution’ was Sarbanes Oxley. By forcing companies to mark-to-market investments – something that was decried by many sound economists and academicians – the Federal Government ignored all the logical accounting rules that support pricing models that utilize different pricing rules for different types of assets. Be it naïveté, ignorance or the need to provide their constituencies with a politically aggrandizing ‘solution’ to the ‘evils of corporate America’, it was BAD POLICY and it is wreaking havoc today. So lay blame again on the Federal Government for creating bad policy and bad law.
One can already envision the new wave of regulation that the Government will emerge from this current crisis. Don’t for a moment think it won’t come. And because this financial crisis is bigger than those others we have experienced in our lifetimes – Long Term Capital in 1998, Savings & Loans in the late 1980s and early 1990s, portfolio insurance in the late 1980s, Penn Central in the mid- 1970s – the regulatory response will be far greater than Sarbanes Oxley. Well be warned – the seeds of a future crisis are just now being sown in the halls of Washington. The Government needs to learn from its own mistakes that cinching capitalism too tightly will only create a balloon-like response, causing another bubble which too will be burst.
Patricia W. Chadwick is an asset manager and financial consultant with more than 25 years of investment experience. She is founder and president of Ravengate Partners LLC, a consulting firm that provides advice on financial markets and global economics.