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Institutional Greed Responsible for Financial Collapse

Companies / Credit Crisis 2008 Sep 20, 2008 - 12:16 PM GMT

By: Money_Morning


Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: There's nothing like greed and avarice to bring the entire U.S. financial system to the brink of collapse.

With the demise of Merrill Lynch & Co. Inc. ( MER ), the thundering herd has galloped off the cliff – taking 94 years of history with it. Same, too, with Lehman Brothers Holdings Inc. (OTC: LEHMQ ). Lehman's bankruptcy filing last week caps 158 years of solid history. No doubt they'll be others with American International Group Inc . ( AIG ) spreading the credit-default-swap contagion like a financial Typhoid Mary .

But you know what?

I'm sick and tired of hearing how “we” caused this … how, according to the mainstream media, “we” somehow did this to our financial system.

Baloney .

For the most part, “we” didn't do squat. The average American had nothing to do with this. For the most part, “we” pay our taxes, “we” pay our credit card debt and “we” pay our mortgages – on time, and in full.

And now “we” are stuck with nearly $10 billion in debt “we” didn't ask for (a tab that's clearly going to escalate).

No doubt we're going to get a whole lot of e-mail reminding us that we're a nation of gluttonous consumers and serial spendthrifts.

So let me head those e-mails off at the pass and answer those allegations right now: Yes, you are correct … “we” are all of those things.

But let's remember one very important point: The vast majority of the credit problems we're dealing with right now stem primarily from two areas:

  • Institutional greed.
  • And a near total lack of individual responsibility to live within our means.

There's no question that the institutions (both corporate and government) deserve the lion's share of the blame here. At a time when the government perpetuated artificially low rates, it also cleverly created new financial instruments to get the yields it was looking for (absent government paper that would achieve the very same objective) and went merrily on its way). Wall Street was only too happy to leverage the proceeds. And the rest, as they say, is history.

But what really burns me up is that our regulators either ignored the problem – despite repeated warnings – or refused to do anything about it.

Or both.

You heard it here first: We'll get to see just how many warnings were proffered as the blizzard of lawsuits that are being assembled even now finally make it to court.

Two of the most notable instances where a different action could have led to a different outcome were:

  • Former Federal Reserve Chairman Alan Greenspan 's refusal to crack down on questionable lending practices – despite being given explicit Congressional authority to do so in 1994.
  • And the reality that Freddie Mac ( FRE ) Chief Executive Officer Richard Syron was repeatedly warned that financing questionable loans threatened not only Freddie's financial health, but the nation's, too, as early as 2004, The New York Times reported . That placed the U.S. economy in an incredibly precarious position. Indeed, fears that foreign central banks in China, Japan, Europe, the Middle East and Russia might stop buying our bonds forced the federal government to bail out both Freddie Mac and Fannie Mae ( FNM ). [For all the details on these deals, look at the Money Morning report: Foreign Bondholders - and not the U.S. Mortgage Market - Drove the Fannie/Freddie Bailout ].

Essentially given free reign, institutions dealing with consumer credit began offering gobs of credit not to their best customers, but to their worst. Credit card companies like Advanta Corp. ( ADVNB ), for instance, spent millions on sophisticated computer models that sorted every bit of data on prospective customers with an emphasis on those who would run up the biggest balances.

Ideally, they wanted those balances to be paid back so they ostensibly targeted affluent customers, but in a twist of fate, wound up with a “reverse” emphasis on low-income customers who would generate the highest fees and, by implication, the highest revenue.

Talk about predatory lending … while there are laws against this sort of thing in the United States, they're tough to prosecute and even tougher to stop. The reason: These companies systematically structure loans in such a way that it is appealing for borrowers to sign up for the credit lines, and yet it's virtually impossible to defend against.

And it doesn't help that the advertisers go right along playing on our most basic of all human emotions – desire.

This was a model that quickly found its way into the home-mortgage-lending business – almost unchanged. So-called “ liar loans ” requiring no documentation became all the rage because of the fees they generated for participants at every step of the way from the loan officers to the Wall Street houses where loans were packaged and then sold. As did adjustable-rate mortgages, interest-only schedules and all sorts of other variations.

But all of that is really academic.

Somewhere along the way, the concept of personal responsibility died in this country and is probably buried right next to common sense.

Yes, there were predatory lending practices. Yes, there were huge corporations deliberately skirting the rules to pack on billions in additional profits. But at some point, people had to sign on the dotted line.

While I truly feel sorry for the people who honestly didn't know better, or for whom there was no other option, I cannot extend my sympathies to others like my neighbor who spent through his home equity to buy a Hummer, a new boat, two jet skis, and a lavish European vacation.

He's now about to lose his toys – and his home – not to mention his marriage.

Nor can I extend my sympathies to the modern robber barons like the corporate chieftains of Fannie, Freddie and the other bailout candidates – who pocketed millions while shareholders lost billions.

I don't see any of these guys offering to return their bonuses, or to forgo their “ golden parachute ” severance packages, to help their former employers pay off the debts they helped these companies accrue. And forget about them reimbursing the U.S. taxpayers, who are stuck with the bill for cleaning up this mess.

No, instead these ex-boardroom warriors are now lying low somewhere in Old Greenwich, out at The Hamptons , or out on their yachts somewhere – until the storm blows over. Then they'll receive multi-million dollar advances to write so-called “kiss-and-tell” expose books that document the darkest days of the U.S. financial system. Or they'll go out on the public-speaking circuit – at $100,000 an engagement, or more.

No doubt they'll frame themselves as victims, or as valiant warriors in the capitalist struggle, positioning themselves as financial innovators whose efforts were hamstrung by circumstance, or just plain misunderstood. Whatever the path they choose, you can bet your final 401(k) dollar they'll come off as “heroic,” as they detail the all-night meetings, frantic transatlantic phone calls or eleventh-hour negotiations that were part of the attempts they made to bring their companies back from the brink.

That none of these efforts worked … well, in true U.S. fashion, they'll just say it wasn't their fault.

The whole situation is unbelievably galling.

What I'd really like to see is a book about how everyday families are making it – or trying to – despite the overwhelming irresponsibility of a very small portion of our population, and some financial-market miscreants, who have saddled the rest of us with $10 trillion in debt.

A book like that would really mean something.

News and Related Story Links :

By Keith Fitz-Gerald
Investment Director

Money Morning/The Money Map Report

©2008 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email:

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

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23 Sep 08, 09:20
financial collapse

I have a question. How can the scope of this be so large, affecting so many financial institutions when, I assume, the majority of the U.S. citizens have normal mortgages and do not have a massive amount of credit debt? Is there something else going on here?

Nadeem Walayat
23 Sep 08, 09:55
Insitutional Greed

Because the greedy banks to elevate profits employed leverage. I.e. put up say 7% of exposure against a position size of 100% Therefore a 7% fall in value means a 100% loss. The market was magnified some 20 to 30 TIMES its original size through the use of OTC derivatives, such as CDO's

And as the default rates on mortgages soared so not only did the value of the mortgage backed securities fall, but also the off exchange derivatives became illiquid.

23 Sep 08, 10:08
Institutional Greed

I'm still having a hard time understanding the scope of this. Is this not a small percentage of loans that are affected? How can a small percentage of loans devastate the economy? Or did 1 small sub prime loan get sold over and over as a new subprime loan and therefore create a bloated market? Are we being railroaded into acting like we were with the Iraq war and WMD's?

23 Sep 08, 18:56
Credit Crisis Explained.... sort of.

Yes, there is a great deal of complexity as to what has happened.

For instance theres the mark to market models, that gave valuations to CDO's being traded that did not reflect reality.

Then, theres the rating agencies continiously giving Triple AAA status to junk. Thats basically giving the best ratings to subprime loans that should never have been made. High risk given low risk status ! The ratings agencies seriously need to be regulated !

Banks have borrowed between 20 and 40 times their assets to buy this toxic junk, therefore a small increase in the default rate acts as a chain reaction hitting all of the banks because of the risk of default, hence credit freeze.

Simple example ?

Bank has $100 in deposits, borrows $3000 to buy subprime and other debt that should be say 5% interest.

Bank therefore a is therefore earning $150 against assets of $100, whilst paying say $100 in interest therefore earning a huge profit of 50% of their assets.

However, the housing market crashes, and many mortgages are in default, therefore the banks investments are no longer worth $3000, perhaps only $2000. At the same time the interest earned has fallen and the rate they can borrow against has shot up.

So they are bankrupt!

It would take an article of several pages to explain with diagrams to explain properly.

And even then there will be missing pieces of the puzzle that won't become apparent until AFTER the crisis has passed.

Whilst in the early days you could not accuse the big banks of fraud due to potential libel action, seriously thats what the outcome will increasingly look like - a BIG FRAUD many magnitudes larger and more complex than Enron !

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