The Post-Lehman World

A few years ago, real estate was all the rage. Earlier this year, the business magazines were telling us to invest in Lehman Brothers and Merrill Lynch, because those stocks were bound to zoom. Now another herd is on the march.

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David Brooks

We’re in a paradigm shift, its members say. The current financial turmoil marks the end of the era of wide-open global capitalism. Today’s gigantic government acquisitions signal a new political era, with more federal activism and tighter regulations.

This observation is then followed by a string of ethereal gottas and shoulds. We gotta have smart regulation that offers security but doesn’t stifle innovation. We gotta have rules that inhibit reckless gambling without squelching sensible risk-taking. We should limit excesses during booms and head off liquidations when things go bad.

It all sounds great (like buying a house with no money down), but do you mind if I do a little due diligence?

In the first place, the idea that our problems stem from light regulation and could be solved by more regulation doesn’t fit all the facts. The current financial crisis is centered around highly regulated investment banks, while lightly regulated hedge funds are not doing so badly. Two of the biggest miscreants were Fannie Mae and Freddie Mac, which, in theory, “were probably the world’s most heavily supervised financial institutions,” according to Jonathan Kay of The Financial Times.

Moreover, there is a lot of lamentation about Clinton era reforms that loosened restrictions on banks. But it’s hard, as Megan McArdle of The Atlantic notes, to see what these reforms had to do with rising house prices, the flood of foreign investment that fed the credit bubble and the global creation of complex new financial instruments for pricing and distributing risk.

In other words, maybe there is something more going on here than just a bunch of laissez-faire regulators asleep at the wheel. But even if it is true that we need more federal activism, I’m a little curious about what we’re going to need to make the system work.

Surely, we’re going to need lawmakers who understand what caused the current meltdown and who can design rules to make sure it doesn’t happen again. And yet there’s no consensus about what caused this bubble.

Some people blame the Fed’s monetary policies, but some say the Fed had only a marginal effect. Some argue a flood of foreign investment allowed us to live beyond our means, while others say bad accounting regulations after Enron created a chain reaction of losses.

We don’t even have a clear explanation about the past, yet we’re also going to need regulators who understand the present and can diagnose the future.

We’re going to need regulators who can anticipate what the next Wall Street business model is going to look like, and how the next crisis will be different than the current one. We’re going to need squads of low-paid regulators who can stay ahead of the highly paid bankers, auditors and analysts who pace this industry (and who themselves failed to anticipate this turmoil).

We’re apparently going to need an all-powerful Super-Fed than can manage inflation, unemployment, bubbles and maybe hurricanes — all at the same time! We’re going to need regulators who write regulations that control risky behavior rather than just channeling it off into dark corners, and who understand what’s happening in bank trading rooms even if the C.E.O.’s themselves are oblivious.

We’re also going to need regulators who can overcome politics and human nature. As McArdle notes, cracking down on subprime loans just when they were getting frothy would have meant issuing an edict that effectively said: “Don’t lend money to poor people.” Good luck with that.

We’d need regulators who could spot a bubble and squelch a boom just when things seem to be going good, who can scare away foreign investment and who could over-rule popularity-mongering presidents. (The statements by the two candidates this week have been moronic.)

To sum it all up, this supposed new era of federal activism is going to confront some old problems: the lack of information available to government planners, the inability to keep up with or control complex economic systems, the fact that political considerations invariably distort the best laid plans.

This doesn’t mean there’s nothing to be done. Martin Wolf suggests countercyclical capital requirements. Everybody seems to be for some updated version of the Resolution Trust Corporation, though disposing of complex debt securities has got to be more difficult than disposing of commercial real estate.

It’s just that there’s a big difference between dreaming of some ideal regulatory regime and actually putting one into practice. Everybody says we’re about to enter a new political era, rich in global financial regulation. The herd might just be wrong once again.

Ach!!!

Calling David Brooks; Earth to David Brooks. Do you read me, over? I repeat: Calling David Brooks; Earth to David Brooks. Do you read me, over? This is reality-based sanity, over. C'mon David, let us know you're still in our stratosphere, over.

I think we've lost David Brooks!!! After reading his latest column, “The Post- Lehman World,” I'm at least certain he's at least exited the place all too few of us are living in already: Reality.

Pity. Sometimes that guy can really get you thinking and give you hope that the American right wing has almost developed an intellect as evolved as the rest of us; But then he goes and writes a bunch of mumbo- jumbo that leaves me mystified as to how he managed to snag a columnist for the N.Y. Times and hold onto it as well for so long.

For example: In his column “The Post-Lehman World” Brooks expresses his doubts about the new regulations the federal government is planning to create for our financial markets in response to the current problems beseeching the global financial system currently.

“The current financial crisis is centered around highly regulated investment banks,” Brooks misleadingly states. Then he actually pulls out one of the oldest right wing plays out of the book to follow that assertion up; Blame the Clinton years.

“There is a lot of lamentation about Clinton era reforms that loosened restrictions (???) on banks,” alleges Brooks.

What precisely is that supposed to mean, anyway? “A lot of lamentation?” By who? Is Brooks actually trying to pin the ill effects of deregulation on Democrats??? Deregulation??? The crown prince of Reagan policies???

Sorry David; Michael Milken was pulling Ponzi schemes on Savings and Loan Institutions back in the early 80's by taking advantage of the (then) deregulation of the industry.... Bill Clinton might not have had his first affair by then!

Anyway- didn't you tell us that deregulation wasn't the real problem, because “the current financial crisis is centered around highly regulated investment banks?” So why blame Clinton for causing problems by loosening restrictions on banks- aka deregulating them- laughable of an accusation as that is?

First: Remember the 80's??? Ah, there were those Air Traffic Controllers that Reagan fired because they went on an 'illegal' strike, and there was the S & L scandals, as I mentioned. Who could forget the rise of the Yuppies and Gordon Gekko proclaiming that “Greed is Good!” in the movie Wall Street? Ever wonder how John De-Lorian is doing and if any of his cars still run?

Those are all memories created specifically because of the deregulation of the 80's!!! Ronald Reagan. George Bush Sr. The lovable Danny Quayle.

No Bill Clinton, David Brooks. Lotta cocaine, lotta fast money, no horny, sax playing presidents from Arkansas.

The Clinton Years= Whitewater + Ken Starr x Monica Lewinsky (2) – 1 stained blue dress + NAFTA x 2. “Lamentation about Clinton era reforms that loosened restrictions on banks-” or deregulation- ain't part of the equation.

However Brooks is right to point the finger at deregulation as the primary culprit that made the current problems now gutting stock exchanges around the globe possible... even though that makes his claim that deregulation isn't the problem (laughably) wrong.... and even though Brooks seems to be saying deregulation is only wrong when a Clinton can be blamed for the destruction it inevitably causes in a society that celebrates- even worships- capitalism, free markets, Milton Friedman, and Ann Rand- such as ours.

“Two of the biggest miscreants were Freddie Mae and Fannie Mac,” institutions which, Brooks tells us, “were probably the world's most heavily supervised financial institutions.” Brooks backs this statement up by crediting it to Johnathon Kay of The Financial Times, but in reality he's simply misleading his readers once again by mixing and matching quotes from credible sources that may or may not have been taken out of context to back up his statements.

Freddie Mae and Frannie Mac ran into problems with Sub Prime Mortgages precisely because of a lack of regulations being applied or followed by: The Mortgage industry. The Credit Rating companies that were able to legally 'repackage' those mortgages as being a triple A rated investment opportunity and resell them to investment banks and individual investors around the world who had no clue what they were buying.

There is no one, no country, no agency, in charge of the global economy; As Thomas Friedman famously described it the globalized economy is like a giant herd that sets it's own rules. You either figure those rules out and follow them or you fall out of the herd, which means you're all alone, and in the financial world it's impossible to survive by yourself.

It also made it vital for each investor around the globe to 'repackage' and resell the worthless sub prime mortgages after they'd invested in them and realized they'd invested in nothing; On average each repackaged 'bundle' of sub prime mortages (and other derivatives... if you don't know what a derivative is, google it..) was resold 4 times around the global financial system and because of a pervasive belief in unfettered free markets, belief in a laissez-faire business environment, and influential men like Alan Greenspan and Milton Friedman that believed in deregulation religiously, it was able to happen.

Small government? Deregulation? That damn joke McCain always credits Reagan for telling him that he always retells to his audiences- you know- McCain mentions how Reagan used to say “Congress spends money like a Drunken Sailor,” and then he got a call one day from a man who said “As a Drunken Sailor, I resent that remark” to McCain?

Hah!

No big government, no bailout of AIG.
No bailout of AIG, tens of thousands of Hurricane victims wind up screwed.

Free markets + Deregulation= huge income gap, cuts in social services, tax inequities, a Great Depression in the 30's, and a near collapse of the global financial system today.

Ditch the Ann Rand cultists, David; C'mon back to reality. Leave Bill alone and just face up to the failures of deregulation, please.

Those of us living in the reality based world would love to see just one member of the ideological right do it.

Fingers have pointed at "spivs"

Newspapers on either side of Atlantic are leading the inquest into just how the current economic crisis got this bad, gripping the United States and UK and spreading to Russia and Asia.

Several categories of individuals and institutions stand accused.

The root of much of the current difficulties lies in the sub-prime loans market, predominantly in the US. The sub-prime category refers to the category of borrowers at the highest risk of defaulting on their loan - perhaps those with a poor credit history or unreliable income.

The reason why this market became popular among lenders is simple, says Alex Brummer, City editor of the Daily Mail and author of The Crunch.

The turmoil seems unlikely to end soon

"The poorest people pay the highest interest rates," he says. In the low interest rate years after 2001, sub-prime borrowers might pay two or three times the interest of a prime borrower.

And if some defaulted, it wasn't the end of the world. Property prices were rising so fast in the US that the odd repossession wasn't a major problem. In an atmosphere of speculation, many people saw there was money to be made in property and so the spiral continued.

"There were strippers in Las Vegas who became real estate brokers," says Brummer.

But when the housing market took a turn for the worse, the problems started. Many borrowers were on deals that for the first two years had low rates and then switched to a much higher rate. Once house prices fell, borrowers who were struggling started defaulting on loans. Repossessed houses flooding onto the market caused a vicious circle.

By April this year, the FBI was already investigating 19 allegations of corporate fraud relating to sub-prime loans.

Of course, if it was just a case of sub-prime lenders suffering a rash of defaults, then the layman might assume that the damage would be limited to those lenders - like IndyMac and New Century - that have collapsed.

Architects of their own misery?

But these sub-prime loans were parcelled up and turned into complex financial products traded on markets all over the world. The esoteric nature of some of the products related to these loans has been blamed by many for the extent of the crisis.

"You have to ask what was driving the sub-prime market," says Brummer. "It was the demand from the Wall Street investment banks. It had such good returns. They were incentivising [the lenders].

"The PhD mathematicians found ways of doing sub-prime loan derivative products and an insurance system."

One year ago, "short-selling" was a term that would have baffled most.

Now it is being widely blamed on both sides of the Atlantic for some of the worst symptoms of the current crisis.

WHAT IS SHORT-SELLING? Short sellers borrows share Sells share on market Share price falls Short seller repurchases share Share returned to original owner The price difference is mostly profit

A short seller effectively bets on the price of an asset, often a share, falling. Typically this is done by borrowing the share from the owner. The share is then sold and when the price drops it is repurchased and returned to the original owner. The short seller pockets the difference.

A headline from Britain's Daily Express sums up the mood: "Don't let the spivs destroy Britain." The Daily Mail's take was not dissimilar when it said: "Spivs, sharks and why the champagne corks were popping on meltdown Monday."

In the US, Republican presidential candidate John McCain may have spoken for many when he attacked some types of short selling.

The practice has now been temporarily banned for shares in many listed financial companies in both the UK and the US.

Overvalued shares

But the stance of Hector Sants, boss of the Financial Services Authority, is revealing: "While we still regard short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets."

But there are some who say short-selling helps bring overvalued shares to heel.

The Securities and Exchange Commission kept in place trading rules that let speculators and hedge funds turn our markets into a casino John McCain

"All that short sellers do is kind of force prices which are the true price even faster," says Dr Thomas Kirchmaier, a member of the London School of Economics' Financial Markets Group and an expert in corporate governance.

In other words, what leads sellers to short is finding out a particular asset is overvalued. But the process can be traumatic and generate its own momentum.

"[There is a view that] all it does is speed up reassessment of an institution - in a few days rather than a few months," says Brummer. "But it is the suddenness that produces this immediate shock."

At the moment the speed of the price drop robs governments and central banks of a chance to formulate a plan for intervention, meaning that the next domino soon falls.

In the US, the three-pronged regulation of finance by the Treasury, Federal Reserve and the Securities and Exchange Commission has been criticised. In the UK, the roles of the Financial Services Authority, Bank of England and government has also been questioned.

John McCain has openly called for the head of the SEC to go. "The Securities and Exchange Commission kept in place trading rules that let speculators and hedge funds turn our markets into a casino," he said in one speech.

US Treasury Secretary Henry Paulson knows the markets well having been head of Goldman Sachs

And there are plenty who take an equally dim view of the British equivalent, the FSA.

"In Britain light touch regulation in the case of Northern Rock and HBOS was no touch regulation," says Brummer. "The degree of supervision on who becomes chief executive of these banks is just not good enough."

But some, like Brummer, feel the FSA faces a struggle, armed as it is with small numbers of staff paid far less than those they police.

For Professor Richard Portes, founder of the Centre for Economic Policy Research, regulators and central bankers have been extraordinarily myopic.

"They should still have seen a lot of warning signs, in particular in looking at off-balance sheet operations."

A key issue is the opacity of the banking system. If no-one can truly assess the liabilities of a given financial institution, how can they confidently lend it money? But this has helped people make money.

"You make money when it is opaque, you make money when you have got information that other people don't have," says Prof Portes.

And there are those who point the finger at the light touch of Alan Greenspan, chairman of the Federal Reserve from 1987 until 2006.

"He let them get away with murder," says Dr Kirchmaier. "At the same time he had this monetary expansion - he would always bail out the market."

The theory is that as financial institutions knew they were not bearing all of the risk, they have not acted as prudently as they might.

"You can't let these banks go down because the impact on society is enormous. It is the state who has to bail out the banks."

The first major casualty of the credit crunch in Britain was the Northern Rock bank, and there has been plenty of criticism of Chancellor Alastair Darling and Prime Minister Gordon Brown over the handling of its crisis and nationalisation.

The government in the UK, as in the US, has argued that this is a global crisis which cannot be put at the door of a handful of politicians.

But there are some who believe it can indeed, if only for the failure to speak out against certain excesses while the going was good.