Monday, October 13, 2008

Economy Honor / Dishonor Rolls

(See linked Huffington Post articles below for video and more.)

Economic Honor Roll:

Now that a full-scale economic crisis is upon us, many are left asking the complicated but necessary question of how did we get here. While there are numerous individuals and institutions who deserve their share of the blame, it is also important to recognize those issued warnings about the fragility of the financial system and sounded the alarm about an impending collapse before it all came crashing down.

Below is the beginning of our look at some of the figures--politicians, economists, pundits--whose observations about our financial situation have come to seem all too prescient. Please check back as more names are added to our list and by all means let us know who else deserves credit for having seen our current meltdown coming.

Nouriel Roubini, NYU professor of economics: from "The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster" (subscription req'd), February 5, 2008

A near global economic recession will ensue as the financial and credit losses and the credit crunch spread around the world. Panic, fire sales, cascading fall in asset prices will exacerbate the financial and real economic distress as a number of large and systemically important financial institutions go bankrupt. A 1987 style stock market crash could occur leading to further panic and severe financial and economic distress.

In this meltdown scenario US and global financial markets will experience their most severe crisis in the last quarter of a century.

Warren Buffett, BBC News, "Buffett Warns On Investment 'Time Bomb,'" March 4, 2003

Derivatives generate reported earnings that are often wildly overstated and based on estimates whose inaccuracy may not be exposed for many years.[...]

Large amounts of risk have becomes concentrated in the hands of relatively few derivatives dealers ... which can trigger serious systematic problems.

Nassim Nicholas Taleb, from his book The Black Swan The Impact of the Highly Improbable, April 2007

Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks - when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crises less likely, but when they happen they are more global in scale and hit us very hard. [...]

The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deemed these events 'unlikely'.

Byron Dorgan, Senator (D-ND): New York Times, "Washington's Invisible Hand," September 26, 2008

Dorgan's comment on McCain adviser Phil Gramm's deregulation efforts back in 1999:

I think we will look back in 10 years' time and say we should not have done this, but we did because we forgot the lessons of the past and that that which is true in the 1930s is true in 2010.

Joseph Stiglitz, Nobel Prize-winning economist: Washington Post, "The Iraq War Will Cost Us $3 Trillion, and Much More," March 9, 2008

We face an economic downturn that's likely to be the worst in more than a quarter-century. [snip] The economy's weaknesses were concealed by the Federal Reserve, which pumped in liquidity, and by regulators that looked away as loans were handed out well beyond borrowers' ability to repay them. Meanwhile, banks and credit-rating agencies pretended that financial alchemy could convert bad mortgages into AAA assets, and the Fed looked the other way as the U.S. household-savings rate plummeted to zero.

It's a bleak picture. The total loss from this economic downturn -- measured by the disparity between the economy's actual output and its potential output -- is likely to be the greatest since the Great Depression.

Paul Krugman, New York Times columnist Krugman has been warning about the dangers of the housing bubble for years, and the terrible toll it could take on the economy when it pops.

Here is a Krugman warning from August 29, 2005:

These days Mr. Greenspan expresses concern about the financial risks created by "the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages." But last year he encouraged families to take on those very risks, touting the advantages of adjustable-rate mortgages and declaring that "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.

If Mr. Greenspan had said two years ago what he's saying now, people might have borrowed less and bought more wisely. But he didn't, and now it's too late. There are signs that the housing market either has peaked already or soon will. And it will be up to Mr. Greenspan's successor to manage the bubble's aftermath.

How bad will that aftermath be? The U.S. economy is currently suffering from twin imbalances. On one side, domestic spending is swollen by the housing bubble, which has led both to a huge surge in construction and to high consumer spending, as people extract equity from their homes. On the other side, we have a huge trade deficit, which we cover by selling bonds to foreigners. As I like to say, these days Americans make a living by selling each other houses, paid for with money borrowed from China.

Economic Dishonor Roll:

Just like HuffPost's honor-roll of those who predicted and even warned against actions that have landed us in today's economic crisis, we have a dishonor roll chronicling those who helped create the situation.

Below is the beginning of our look at some of those figures--politicians, economists, pundits - whose recklessness and own greed have created the situation we're in today. Please check back as more names are added to our list and by all means let us know who else deserves to be on our dishonor role.

Alan Greenspan

The New York Times took a hard look at former Federal Reserve Chairman Alan Greenspan's legacy in Thursday's paper, leading with this rather statement of Greenspan's from 2004: "Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient."

Stronger regulation of derivatives would have done much to stem the current financial crisis, but Greenspan argued against such measures:

"What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn't be taking it to those who are willing to and are capable of doing so," Mr. Greenspan told the Senate Banking Committee in 2003. "We think it would be a mistake" to more deeply regulate the contracts, he added.

Phil Gramm

Gramm, McCain's chief economic adviser, helped craft the Gramm-Leach-Bliley act, "a bank deregulation bill that swept away a Depression-era law known as Glass-Steagall" as the Times writes. The Times also notes of Gramm:

For more than two decades in Congress he argued that the forces of the market had to be freed from government interference. Just a year after the passage of Gramm- Leach-Bliley, he was largely responsible for another bill -- the Commodity Futures Modernization Act -- that clearly did contribute to the current crisis. That law unleashed the derivatives market and paved the way for banks to become more aggressive about investing in mortgages. As recently as this summer, he was still saying that the biggest problem facing the American economy was excessive regulation.

Chris Cox

Currently head of the Securities and Exchange Commission, Cox helped put greater deregulation into effect, and as of last March, was saying the following:

"We have a good deal of comfort about the capital cushions at these firms at the moment."

Henry Paulson

Paulson, currently the Secretary of the Treasury, is leading the government's efforts to rescue the economy, but he himself was a major proponent of rolling back what he called "excessive regulation" and reducing the power of financial regulatory agencies.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.

Joe Cassano

Cassano, the executive of AIG, the insurance giant which received an $38 billion bailout loan from the federal government, is identified by CNN as number 10 in their top 10 list of people behind the current financial crisis. AIG, under Cassano, gambled huge amounts of money on mortgages that ultimately went bad. AIG boasted that it had once pioneered some of the exotic investments that are now bring Wall Street to it's knees.

Richard Fuld

Fuld, the former CEO of Lehman Brothers (the storied firm went bankrupt during the current crisis), is pegged by CNN as the 9th in their top 10 list of culprits to blame for the economic crisis. CNN reports that Fuld drove the company deep into the subprime market, and instead of scaling back the firm's investments when the market began to go south, Fuld doubled down and ultimately drove the company off the subprime cliff.

Martin Sullivan and Robert Willumstad

Martin and Willumstad were both CEOs of AIG during a time when documents show that the company knew of potentially serious problems in evaluating derivatives contracts:

Top officials at American International Group Inc. knew of potential problems in valuing derivative contracts long before these risky transactions caused the insurer's shareholders severe pain, according to documents released by congressional investigators.

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