Thursday, January 14, 2010

Whose Fault Is The Financial Crisis?

The Politicians are all trying to figure out who to blame for the financial crisis, other than themselves, of course.

Well, I'm now going to provide a perfectly accurate list of the guilty parties. By guilty, I mean people who were either grossly negligent, or outright fraudulent in their activities that lead to the housing bubble, and the resulting financial collapse. But the main component of being "guilty" is that these actors violated duties, moral and likely legal, to other people that trusted them, who as a result of that trust, got screwed.

The first guilty party is the Wall Street Investment Banks like Goldman Sachs, JP Morgan, and others that made obscene amounts of money packaging mortgages and selling them to people and institutions seeking "conservative" investments. By packaging risky mortgages, and getting the ratings agencies to give them "AAA" ratings, the Investment Banks created a supposedly safe product that yielded returns far above other "AAA" bonds. This, in turn, created a huge worldwide demand for these investments. The banks needed more mortgages to create more of these "bonds" (which they earned huge fees creating and distributing), so they put out word to mortgage brokers and homeowners that they would buy any mortgage as long as the borrower had a pulse. This, the ability of anyone to get any amount of money to buy any house, is what led to the housing bubble, period.

The reason the Investment Banks are "bad guys" is because they violated their duties, moral and probably legal, to their clients, customers, and others. They were the ones selling the bonds, supposedly to conservative investors. In essence, they conned investment managers, ratings agencies (see below), and individuals into believing that what they were selling was a "AAA" bond. But it wasn't. Imagine a client of an Investment Bank, who tells them that he wants to create a "very conservative" investment portfolio that produces steady income. The Investment Bank tells the client or potential investor that the best thing he can do is buy these mortgage backed "bonds" that they have created, and that they are "AAA" rated, meaning they're as safe as government bonds. In other words, the Investment Bank tells the conservative investor to invest in the most risky asset imaginable, a bond that is sure to become worthless as soon as the housing bubble bursts.

So the Investment Banks are "bad guys" because they either (1) knowingly defrauded their clients and ratings agencies or (2) were so incompetent that their conduct rises to the level of gross negligence in recommending (or even mentioning) these "bonds" to clients. Add to that their obvious motive to peddle these "bonds", in the form of huge origination and distribution fees, and the case is closed. These people should either be in jail, or at the very least sued into poverty. And, just in case there were any doubt, one can recall that some Investment Banks (Goldman Sachs) were actively betting against these "bonds", and made lots of extra money when they went bad.

The second "bad guys" are the rating agencies that gave these "bonds" "AAA" ratings. To make a long story short, they gave the "AAA" rating because the bonds were insured by an insurance company that itself had a "AAA" rating, like AIG. Because the insurer of the bonds (bond insurance guarantees that the bonds will pay out as promised) was "AAA", the bonds themselves were "AAA", according to the rating agencies. Problem is, the insurance companies had issued so much insurance on bonds, that they were headed for a certain bankruptcy if the bonds went bad. Thus, the insurance companies themselves were not "AAA" by any stretch of the imagination, but rather they were "junk" investments. And thus, the bonds were actually "junk".

It was the ratings agencies duty to investors and the system to figure this out. Their failure to do so is at best gross negligence. But a jury would probably conclude that it was intentional based on circumstantial evidence: The ratings agencies had a huge monetary motive to give the bonds "AAA" ratings, because they were getting huge fees every time a new bond was issued. It wasn't that hard to figure out that insurers like AIG were at risk of bankruptcy, if the Ratings Agencies had bothered to look (assuming they didn't, which is a stretch). The people responsible for the bogus "AAA" ratings of the insurance companies should go to jail for fraud. The people who, though not charged with assessing the insurance companies credit worthiness, nevertheless gave mortgage bonds "AAA" ratings without looking into the rigor of the "AAA" rating of the insurer were negligent, and should be sued into poverty.

The third "bad guy" is the Federal Reserve. It kept interest rates far below a market rate, which caused lots of over-investment in housing. Thye have a duty to society not to be downright stupid. Their stupidity is negligence at best.

The final bad guys are politicians, state, local, and most importantly Federal (Congress and past Presidents), for putting in place a host of idiotic programs and Ponzi schemes. But they are always the bad guy.

The following actors were not " bad guys", in that they never violated any duty to a specific third person, although their conduct may have deviated from the perfectly moral path: Mortgage originators like banks and mortgage brokers. People who took out crazy zero-down adjustable rate mortgages. With Wall Street BEGGING people to borrow money, and BEGGING mortgage brokers for more mortgages to buy, these people were just acting in their interest. Of course, there are bad eggs in every basket, but generally, these groups are not to blame for the financial crisis.

No comments: