Complicit E-Book

Gilbert Mark

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Bloomberg
• Sprache: Englisch

Seitenzahl: 242

Veröffentlichungsjahr: 2010

Beschreibung

The credit crunch is affecting every investor and every consumer, every industry and every government program, yet few people truly understand how it happened. Subprime mortgages have been center stage, but behind the scenes a conspiracy of greed among bankers, investors, rating agencies and regulators has imperiled everyone's financial future. We need to know what went wrong and how to change the practices that led to this calamity. Bloomberg columnist Mark Gilbert shows how Wall Street's tolerance for extremes made the global credit crunch both foreseeable and inevitable. He offers a blow-by-blow account of what went wrong and what lessons need to be learned from the crisis. * Gilbert's argument--that everyone with skin in the money game had a vested interest in pretending that nothing could go awry--is a well-defended, compelling indictment of the financial community. * Gilbert is able to make complex financial events easy to understand. * His outlook is truly global: this financial crisis respects no geographical boundaries, and Gilbert draws on anecdotes and examples from around the world to make his case.

Leseprobe

Table of Contents

Praise

Title Page

Copyright Page

Introduction

ONE - Bubbles Are for Bathtubs

Suspending Disbelief

Bubbles Are for Bathtubs

Houses as ATMs

A Crunch Heard ’Round the World

Bonfire Kindling

TWO - Unsafe at Any Rating

Collusion and Conflict

Not-So-Crystal Balls

Risk—and Profits—from Thin Air

Dislocation’s Aftershocks

THREE - Priced for Perfection

Warnings at Davos

Financial Nirvana

The Hedge Fund Bogeyman

Volatility Disappears

Risk and Reward: A Relationship Comes Apart

House Prices Stumble

An Illusory Nirvana

FOUR - Bubbles, Bubbles Everywhere

The China Syndrome

Lending to Uncle Sam

Be Careful What You Wish For

Popping Risk Kernels

Money Moves to Private Equity

Measuring Liquidity

FIVE - Judgment or Luck

Inputs Versus Outputs

Compliant Compliance

Alpha and Beta

Black Swans and Unknown Unknowns

The Beginning of a “Savage Bear Market”

SIX - Knight in Rusty Armor

Bear Stearns Funds Go Bang

Banks’ Ill-Advised Loans

Mark to Market—and to Panic

Ratings Cuts

A Different Food Chain

Guessing at Write-Downs

SEVEN - The Noose Tightens

Libor Freezes Over

Trust Unravels

Liquidity Falls

A Central Bank Emergency

Bagehot’s Blueprint

Commercial Paper Breakdown

Panic Stations

Public Policy Bends to Markets

Another Great Depression?

SIVs Slither Back onto Bank Balance Sheets

EIGHT - Central Banks, Unbalanced

Not So Rock Solid

Panic on the Streets of Britain

Moral Hazard

Refusing Responsibility

King’s Flip-Flop

Reverting to Secrecy

CEOs Pay the Price

NINE - Et Tu, Money Markets and Municipals?

Money Market Funds Break the Buck

Supercharged Returns—and a Supercharged Disaster

M-LEC: First of the Acronym Rescue Attempts

Monolines’ Thin Capital Cushions

Credit Ratings Drop—Again

Worldwide Recession Fears

Embarrassing Rescue Attempts

From Liquidity Scare to Solvency Worries

TEN - Giants Fall

Banking Moves Out of Its Box

A Repeat Performance

Bear Bailed Out

Emergency Funding and a Shotgun Wedding

Lehman Falls

Merrill Sells

The Safety Net That Wasn’t

For AIG, Yet Another Policy Shift

Credit Crunch Climax

ELEVEN - Conclusions and Policy Prescriptions

Moral Hazard

Don’t Bank on Academia

Ratings for Sale

Payment in Kind

Don’t Take My Money to the Casino

Bursting Bubbles

Test for Testosterone

Index

About the Author

About Bloomberg

Praise for

Complicit

How Greed and Collusion Made the Credit Crisis Unstoppable

by Mark Gilbert Bloomberg News

“Complicit explores the devastating chain of events of 2008, offering a colorful firsthand account of instrumental players in the crisis. Mark Gilbert does an excellent job of explaining the historical relevance and current importance of events that will take years to work through, describing the policy responses and inherent risks, which will continue to impact capital markets for years to come.”

—STEVEN DROBNY, Cofounder, Drobny Global Advisors Author of Inside the House of Money

“Mark Gilbert brings an important and fresh examination as well as a global perspective to the recent financial crisis. Complicit reveals that Wall Street’s bubble-inflating machinations could not have reached such destructive extremes without eager international support.”

—NOMI PRINS, Senior Fellow, Demos Author of It Takes a Pillage

Also available from Bloomberg Press

Hedge Hunters:How Hedge Fund Masters Survivedby Katherine Burton

Confidence Game:How a Hedge Fund Manager Called Wall Street’s Bluffby Christine Richard

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This publication contains the author’s opinions and is designed to provide accurate and authoritative information. It is sold with the understanding that the author, publisher, and Bloomberg L.P. are not engaged in rendering legal, accounting, investment-planning, or other professional advice. The reader should seek the services of a qualified professional for such advice; the author, publisher, and Bloomberg L.P. cannot be held responsible for any loss incurred as a result of specific investments or planning decisions made by the reader.

Library of Congress Cataloging-in-Publication Data

Gilbert, Mark.

p. cm.

Includes index.

Summary: “Reporter and editor Mark Gilbert plumbs the origins of the subprime debt crisis, tracing it back to ‘a silent conspiracy of the well rewarded’ in banking, real estate, trading, insurance, investing, politics, regulation, credit rating, law, and economic theory”- Provided by publisher.

ISBN 978-1-57660-346-8 (alk. paper)

1. Subprime mortgage loans-United States. 2. Credit-United States. 3. Financial crises- United States. 4. Mortgage banks-United States. I. Title.

HG2040.5.U5G543 2010

332.1’ 7530973-dc22 2009048428

Introduction

The Great Credit Bubble

Where did the money come from? Where did it go? How was this allowed to happen? Who is to blame? These are the key questions surrounding the credit crunch that has engulfed the “global financial” system.

The answer, in part, is that there wasn’t anywhere near as much money as there seemed to be. And because it didn’t exist in the first place, the money hasn’t gone anywhere. It was all an illusion, although the economic consequences of its disappearance turned out to be very real indeed.

As to how it was allowed to happen and who is to blame, in a sense the honest reply is that we all allowed it to happen, and we’re all to blame, either as active accomplices or complicit bystanders. Society as a whole made a collective, unconscious decision to allow the banking system to grow unchecked because the tangible benefits that seemed to accrue from unbridled capitalism outweighed the intangible hazards that might accompany this dangerous test of capitalism’s limits.

Consider an analogous bit of history. In nineteenth-century Britain, physicians finally began to understand human physiology, working out the body’s geography by mapping veins and arteries, dissecting eyes and hearts, and manipulating bones and joints. The new knowledge promised to usher in a period of unprecedented medical advancement.

Religious beliefs and general distaste, however, meant that few people would send the corpses of deceased relatives to the gurneys of surgeons with eager scalpels. After all, how could a dismembered body pass through the gates of heaven? Surgeons instead dissected the bodies of executed criminals, who lost dominion over their body parts’ destination upon conviction.

But—even fueled by the era’s commonplace executions—supply was insufficient to meet demand. A shadowy secondary market in cadavers developed; those who died in a hospital and weren’t quickly claimed by their loved ones moved from mortuaries to teaching hospitals, sold by undertakers and bought by physicians. Even those claimed by family and properly buried could be dug up and sold to satiate the needs of the anatomists.

The authorities—both legal and medical—turned a blind eye to the practice of grave robbing, while the general public remained ignorant about how doctors were getting smarter. For society as a whole, it was a win-win situation—until a pair of entrepreneurs called William Burke and William Hare decided to circumvent the waiting time demanded by nature, started murdering for profit, and brought the whole grisly, underhanded process into the open.

A similar conspiracy of vested interests caused the credit crunch. Any banker, trader, investor, or economist asked to invent the perfect financial market environment for creating global wealth beyond the wildest dreams of avarice would have come up with a list of conditions similar to those that prevailed for a decade.

Like those of Burke and Hare, these good times have ended with an almighty bang, not a whimper, wiping out the nest eggs of millions of workers by destroying stock market values around the world, undermining ordinary savers’ confidence in the safety of the banking system, and exposing deep fault lines in the philosophy of capitalism. The financial community, through a deadly combination of greed and hubris, fouled its own sandpit. The era of munificent money-making conditions—regulation and oversight so gentle as to be almost invisible, ever-faster data and information flows, freely available credit at super-low interest rates, unprecedented access to investors all around the world, and oil-enriched buyers of any investment yielding north of zero—is over.

The global financial authorities—the elected politicians who decree the legal framework within which finance operates; the unelected central banks charged with tending the economy; the regulators responsible for creating and enforcing safety rules; the money managers entrusted with nurturing the future incomes of widows, orphans, and hordes of other savers; and the people paying themselves millions of dollars to run the investment banks—all looked the other way. They operated under the belief that the monetary benefits accruing to society from incessant, unprecedented, and essentially unregulated growth in the securities industry more than outweighed any of the attendant risks.

In the United States the rising economic tide was seen to lift all boats, underlining the political triumph of capitalism over socialism and communism. In Europe, increased prosperity helped cement the decades-old dream of a common currency, binding nations closely enough to nullify the nagging conflicts that gave rise to two world wars, with the United Kingdom playing a supporting role as the unofficial treasurer to its continental, euro-embracing neighbors, even as it clung stubbornly to its own currency. And across swathes of Asia, globalization and growing international trade helped fund the transition from agrarian to manufacturing economies, with governments offering compensatory affluence to avert discussions about democracy and voting systems, thereby blunting the risk of social unrest.

The list of credit crunch perpetrators is long. Realtors appraised houses at fictitious levels. Lenders granted mortgages to people who couldn’t pay. Aspiring homeowners bought properties that they couldn’t afford, taking on debt burdens they couldn’t support. Frankenstein bankers cobbled together nasty parts of different markets, creating instruments they couldn’t value or control. Credit-rating companies stamped their highest seals of approval on nearly anything and everything that crossed their desks. Traders invented prices they couldn’t justify. Investors bought securities they didn’t understand. And there are thousands and thousands of fleas on the financial dog; armies of lawyers and accountants earned their livings during the past decade by pretending to scrutinize deals while getting paid for rubber-stamping transactions.

The people in the world of high finance aren’t stupid. For at least a decade, the finest graduates of universities all over the globe have been drawn to Wall Street and its counterparts in the world’s biggest cities. Little wonder, then, that market regulators struggled to either find or retain talented staff, when the rewards for jumping the fence and becoming a poacher rather than a gamekeeper were so rich. Investment banks and hedge funds became employment black holes, sucking in talent to the detriment of arguably more productive, clearly less lucrative, disciplines such as engineering and science.

The credit crunch wasn’t caused so much by a confederacy of dunces as by a silent conspiracy of the well rewarded. And most of the participants aren’t fraudsters (albeit with some notable exceptions), nor are they evil or malicious. But everyone involved collectively suspended disbelief, a mass self-induced myopia to the possibility that anything could go wrong, because the financial rewards for playing along were so compelling.

One of the simplest tricks in finance involves borrowing money at a low rate of interest, reinvesting it at a higher rate, and pocketing the difference. The easiest way to achieve this is to take out a short-term loan which, because it will be repaid quickly, typically offers a low interest rate. Then invest the proceeds in some longer-term investment, which offers a higher payout because it locks away the money for a longer period.

When the initial loan falls due, the investor simply takes out a second loan to repay the first, then a third loan to repay the second, and so on until the longer-term investment project pays off and all debts are covered, plus a nice profit. Banks have always done this, taking in deposits from customers who get a low interest rate and instant access to their money, then lending that cash at higher rates to governments building tarmac roads and erecting bridges, and to companies building factories and buying equipment. The difference between rates is called the spread, and it’s a fundamental bank profit driver.

The credit crunch revealed that the financial community had made similar spread bets billions of times over, relying on short-term loans to make wildly speculative purchases of an array of increasingly complicated derivatives securities. The system didn’t have an alternative source of financing when short-term loans started to dry up amid concerns about liquidity and solvency, leaving investors with no way to cover their bets when derivative market investments lost value.

Since its inception, the derivatives market has echoed the fairground hawker’s call to “scream if you want to go faster.” Every time Microsoft Corporation upgrades its Excel spreadsheet software to accommodate more cells, rows, and columns, the structured finance world grafts yet more layers of complexity onto its inventions. Once investment banks found ways to decouple derivatives from underlying markets, constraints on how much product they could create and how big the bets could become disappeared, creating a new universe of virtual money.

Regulation failed to keep pace with those changes. None of the global economy’s health and safety inspectors showed up for work during the past decade. No one wanted to be responsible for slowing the output of the financial factory with pesky citations for violating the rules, let alone threaten parts of it with closure.

Central banks said it wasn’t their role to second guess when a bubble might be swelling and not their place to do anything except clean up the mess a puncture might cause. Regulators left some areas, such as the over-the-counter derivatives that aren’t listed on any exchange, to their own devices. Others became the province of credit-rating companies, which made money in defiance of the inherent conflict of interest.

All these market overseers convinced themselves that credit derivatives were a neat way to slice and dice markets into separate components with greater or lesser chances of losing money, which could then be distributed more evenly and safely through the financial system to those with the appropriate risk appetite. Market overseers, though, missed the trick: the derivatives desks at major banks invented bets that had never existed before, creating risk out of thin air rather than simply refining and redistributing existing exposures.

While the current crisis is unprecedented in its scale, it is untrue to say that nobody saw it coming. Plenty of market commentators screamed from the rooftops about the trouble ahead, warning that the clothing worn by the emperors of finance was threadbare at best and likely to unravel in a storm. Shouting that the king was in the nude was a thankless and futile exercise, though, while market liquidity was flowing freely; as billionaire investor Warren Buffett said, it is only when the tide goes out that the world learns who has been swimming naked. None of the participants had any incentive to check whether their Speedos were slipping during the boom times.

Capitalism will always overreach itself, which goes a long way toward explaining why it is such a successful economic motivator. It rewards those who put their reputations and money on the line. Typically, the bigger the gamble, the bigger the potential gain. But even laissez-faire capitalism should punish mistakes, and that essential constraint disappeared during the go-go years.

It is almost impossible for the average person to comprehend just how much money finance professionals paid themselves during the boom times. In the investment banking world, a base salary of $100,000 is walking-around money, the loose change used to pay for incidentals. The real prize comes in the bonus. While mere mortals focus on the left-hand side of their pay slips, hoping to turn $35,000 into $37,000 or $64,000 into $69,000, the masters of the financial universe are much more interested in the right-hand side of the number, trying to add the zeroes that augment $100,000 with a bonus of $1,000,000 or $10,000,000.

No wonder investment bank brass spent zero time trying to understand how their employees were actually generating quarterly profit numbers. Asking questions about what kinds of risks employees were running might have produced unwelcome answers, imperiling those lovely bonus payments.

U.S. President Barack Obama was spot on when he called those payments “the height of irresponsibility. It is shameful.” In his subsequent request, though, for “the folks on Wall Street who are asking for help to show some restraint and show some discipline and show some sense of responsibility,” he may as well have been speaking in tongues. Restraint, discipline, and responsibility have not been part of the financial world’s lexicon for years.

A January 2009 report by the New York State comptroller estimated that, even in the eye of the credit-crunch hurricane in 2008, Wall Street firms paid themselves $18.4 billion in bonuses while passing their begging bowls among U.S. taxpayers. John Thain, in his final year as head of Merrill Lynch before Bank of America bought that firm and jettisoned Thain, signed off on a $1.2 million office refurbishment package that included $87,000 for rugs and more than $35,000 for a commode on legs. (Thain ultimately agreed to repay costs out of his own pocket.)

The bankers alone aren’t to blame, of course, any more than the grave robbers of the nineteenth century were solely responsible for the medical profession’s sourcing strategies. As a whole, the financial community “behaved as if untethered by any moral or social accountability,” according to Tim Price, the investment director at PFP Wealth Management in London. “Just when capitalism seemed to have won the global battle for consumer hearts and minds, its venal banking sector had sown the seeds for its own destruction and replacement by a newly resurgent spirit of socialism and protectionism.”

In the latter part of the twentieth century, it was Milton Friedman, rather than John Maynard Keynes, who shaped the economic policies of Western governments. The twenty-first century will show that, while capitalism triumphed in the battle against socialism, it may not have won the war.

ONE

Bubbles Are for Bathtubs

The Real Estate Boom

Everything’s inflated, like a tire on a car. Well, the man came and took my Chevy back, I’m glad I hid my old guitar.

—BOB DYLAN, “MONEY BLUES”

IN 2005, JAMIE WESTENHISER, Playboy Enterprises’ Playmate of the Month for May of that year, announced that her disrobing days were over. With housing prices near her home in Fort Lauderdale, Florida, up 105 percent in the previous five years, the then-23-year-old model told the magazine she was quitting the skin game for a career in real estate. The Playboy Bunny swapped a profession specializing in artificially inflated assets for a career focused on, well, artificially inflated assets. Westenhiser made her move just as U.S. housing reached its least affordable level in the five years since the National Association of Realtors began tracking median home prices against incomes.

The seeds of the global credit crunch were sowed in the housing market. It was fertile ground, nourished by a booming economy and watered by a misguided belief that the good times would never end and housing prices would never fall. All of the credit crunch villains played a role in inflating the real estate bubble, including ordinary people borrowing beyond their means to buy their dream properties or simply gamble for profit, market regulators averting their eyes from the growing pile of unsafe mortgages, and investment bankers who were able to weave ordinary home loans into complex financial products to be bought and sold all around the world.

FIGURE1.1U.S Home Ownership (Percentage of population)

Source: Bloomberg, U.S Census Bureau data

Suspending Disbelief

Houses and apartments, typically slow to build, sometimes hard to sell, and easily the most expensive purchases most people ever make, were once considered a long-term commitment. Buyers needed verifiable incomes and good credit scores to get mortgages. In this market, however, it became akin to sacrilege to admit that some consumers couldn’t handle a mortgage. Banks loved the possibility of writing and packaging more mortgages—and earning the attendant fees. Investors were eager to buy those mortgages. Politicians loved the idea of poorer constituents getting a foothold in the housing market, making for more stable communities—and potentially more winnable votes.

The housing market became a Ponzi scheme, where the cash from the new entrants was passed up the pyramid to give the illusion of rising profits. That worked when prices were rising, but proved disastrous when values started to subside, a slide that triggered the credit crunch. Banks lent money against a backdrop of rising housing values, so people felt as if they were better off. In truth, though, the churning market created little real wealth. The foundations of the housing boom crumbled easily because they were made of borrowed money.

To maintain the charade, the market needed a strong supply of new prospective homeowners—ideally, ones who would suspend any disbelief in forever-increasing home values. In the 1980s, about 64 percent of Americans owned their own homes, according to figures collected by the U.S. Census Bureau. As mortgages became more freely available, that percentage jumped to about 69 percent by the middle of 2004—a large jump, given how stable homeownership figures had been for decades, and one that probably incorporated the most marginally qualified buyers. It stuck there for the following three years, then slipped to 68 percent in 2007 and 2008 as the housing market collapsed.

Many of those latecomers would never have qualified for a mortgage under normal circumstances. But because the people at every link in the housing chain had a stake in keeping the music playing for as long as possible, the hindmost were welcomed into the homeowning fold, where membership qualifications grew more and more lax. These changing credit standards formed the “credit” side of the credit crunch.

Bubbles Are for Bathtubs

The financial bubble that grew up around the U.S. housing market also needed experienced buyers to suspend their powers of reason and adopt the belief that housing prices would continue ever upward. “Bubbles are for bathtubs,” was the marketing message at http://www.condoflip.com, a Web site exhorting Americans to jump on the get-rich bandwagon by “flipping” properties. Some bought and sold existing homes; others went so far as buying developer-planned condominiums, then selling them to the next speculator, at a profit, before construction crews even broke ground.

Poor stock market returns also stoked increased appetite for American real estate. The Nasdaq Composite Index lost almost half its value from March to December of 2000. A wave of accounting scandals followed that slump, engulfing companies such as Enron Corporation and WorldCom, and undermining investor confidence in the veracity of company earnings. From a peak of 5,132 points in March 2000, the Nasdaq index tumbled more than 70 percent in the next three years.

Many investors were disappointed by the stock market; to them, real estate looked like a better place to invest a nest egg. That helped explain why U.S. housing prices were climbing at an annual pace of 12.5 percent by the first quarter of 2005, according to the Office of Federal Housing Enterprise Oversight. The housing market had already seen an annualized gain of 11.9 percent in the previous three months and 13.4 percent in the third quarter of 2004.

For the housing pyramid to stay upright, every new owner had to believe that housing prices would continue to rise indefinitely. But the global housing market’s history shows very clearly that housing bubbles don’t deflate—they burst. There is plenty of evidence, too, to suggest that bursting real estate values can often wreak economic chaos.

Thomas Helbling, deputy chief of the world economic studies division at the International Monetary Fund in Washington, DC, scrutinized the housing market histories of fourteen industrialized nations for the period from 1970 to 2002, finding seventy-five home-price cycles. Bull housing markets typically lasted a bit less than three years, he found, with prices climbing by a cumulative, inflation-adjusted 11 percent. Bear housing markets were about one year long and decreased prices by about 6 percent, his study found.

In more extreme times, which Helbling felt defined 25 percent of the cycles, boom times lasted for about four years and brought an average increase in housing values of 32 percent. Housing market busts also persisted for about four years, with prices declining by an average of 27 percent. Helbling presented his findings at the IMF’s October 2003 conference on Real Estate Indicators and Financial Stability.

There was no question that what was happening in the U.S. counted as an extreme boom, according to Helbling’s measurements. The average price of a U.S. single-family home more than doubled between the beginning of 1989 and June 2003, climbing to $229,000 from $113,000, according to figures compiled by the National Association of Realtors. Housing prices then gained an additional 20 percent, peaking at an average of $278,000 by June 2007. According to Helbling’s analysis, real estate professionals should by then have been braced for a four-year bust, one that would erase housing values by about a quarter.

The housing market, moreover, was deeply integrated with the wider economy, and historical evidence shows the power of slumping property values to wreck the economy. “Housing price busts in industrial countries were associated with substantial negative output gaps, as real gross domestic product growth decreases noticeably,” Helbling wrote in his study. “On average, the output level three years after the beginning of a housing price bust was about 8 percent below the level that would have prevailed with the average growth rate during the three years up to the bust.” In other words, allowing housing prices to climb unchecked is a risky route to a prosperity that typically proves short-lived and results in a ferocious hangover.

Some commentators began to get nervous about how the most recent bubble’s endgame might look. In 2005, Yale University economist Robert J. Shiller updated his prescient 2000 stock market book Irrational Exuberance, adding a new section on the housing market. He told the New York Times in August of that year that U.S. housing prices might decline by as much as 40 percent in the next generation. Shiller dug into price data back to the late 1800s to conclude that a period of declining prices followed every boom.

David Rosenberg, then chief economist for North America at Merrill Lynch in New York, concluded in an August 2005 research report that U.S. houses for first-time buyers were at their least affordable since the third quarter of 1989, when rising energy prices and higher Federal Reserve interest rates had last coincided with a bursting bubble. History, moreover, taught a hard lesson about what might come next. In his report he wrote that, in 1989, “new home sales plunged 20 percent in the ensuing year as demand responded to the affordability erosion.”

But these comments had little effect on central bank attitudes toward asset bubbles. Central bank philosophy remained strictly agnostic. Policy makers would deal with the aftershocks, if any, caused by bursting bubbles, but they would not target asset prices. They hadn’t tried to talk investors out of driving equity prices to untenable levels earlier in the decade, after all; Federal Reserve then-chairman Alan Greenspan declined to repeat his December 1996 comment that “irrational exuberance” (the origin of Shiller’s book title) might be a shaky foundation on which to build such gains.

Central bankers were not about to risk a backlash by trying to restrain real estate values, and so the most recent boom drew few official warnings. The nearest was a milquetoast comment from Greenspan in July 2005, who said he saw “signs of froth in some local markets.” Housing prices continued to rise unchecked.

Houses as ATMs

Rising prices let consumers use their homes as gigantic cash machines, buying Chevrolet behemoths, wall-dominating high-definition plasma television screens, and every shiny toy Apple waved under their gadgetguzzling snouts. Savings accounts became as unfashionable as mullet haircuts as homeowners piled on debt, assuming that real estate prices would keep rising, allowing home equity to support the lifestyles to which they were quickly growing accustomed.