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The Wall Street Picture, Cropped in a Few Places
on November 8, 2010
I'm a long-time reader (addict?) of The Big Picture and bought this book when it first came out. Unfortunately (time constraints being what they are) I only had a chance to read it this summer and time to review it now.
I'll start with a brief chapter summary of the book (paraphrasing).
[Chpt 0] Revised Edition. Six bogus principles: 1) Efficient Market; 2) Self-interest prevents recklessness; 3) Markets can self-regulate; 4) Deregulation is always good; 5) Consumers are rational; 6) Compensation is properly aligned. These must be discarded.
Areas we must reform: Campaign finance; Derivatives; Repeal 2004 leverage exemption; Encourage shorting; Remove bank regulation from the Fed; Create a single regulator; Restore Glass-Steagall; Break up "too big to fails"; Hold senior management responsible; Regulate non-bank lenders; Allow full clawbacks; Overturn federal preemption; Educate consumers; Allow SEC whistle-blowers.
[Chpt 1] Intro: $14T mess, lots of bailouts after Lockheed.
[Chpt 2] Need for a single currency. Establishment of Fed and growth of Fed power.
[Chpt 3] (1860 - 1942) Early history of US growth. Govt funds infrastructure projects. Consumers choose winners and losers. Current market crash not as bad as Great Depression. History of home ownership programs (HOLC). Bailout versus Rescue. Timeline of New Deal programs.
[Chpt 4] (1971 - 1995) Corporate welfare is born: Lockheed! Amtrak! Chrysler! Nixon takes US off gold standard, dollar's value falls through the floor. Lesson 1: Short-term pain avoidance yields major long-term future pain. Lesson 2: The organizations that hate the free market the most are large, well-established corporations.
[Chpt 5] (1987 - 1995) Stock Market Bailouts. Black Monday. Fed hell-bent on supporting asset prices (where's the charter for that?) instead of addressing inflation. Wall Street: "Greenspan's got our back!"
[Chpt 6] (1996 - 1999) Irrational Exuberance. More Greenspan asset price tricks: "bubbles cannot be preempted cheaply." LTCM starts imploding and Greenspan, Rubin, and Summers rescue it. Mistake: Greenspan should have stuck to his (supposed) laissez-fair principles and let LTCM fail. That would have taught everyone a valuable lesson. Again: "Greenspan's got our backs!"
[Chpt 7] (2000 - 2003) Tech Wreck. Greenspan says there's a bubble in 1996, but takes no action. Instead, Fed injects $50B liquidity in late 1999 and NASDAQ doubles. Bubble burst and Greenspan cuts rates in desperate attempt to shore up asset prices. 9/11 was final confirmation of Greenspan policy. Not good: ultra-low rates can cause many problems.
[Chpt 8] Backwards, Rate-Driven Economy. 2002 - 2007 housing cycle fueled by low rates and exotic instruments. Job creation very weak. Stagnant wages => House-as-ATM. Stock buy-backs the new rage. Mtgs: ability to pay succumbs to ability to securitize.
[Chpt 9] Scramble for Yield. Low Fed rates generate mad rush for "safety" of MBS yields. Huge growth in MBSs, CMOs, CDOs, CDSs. Rating agency payola.
[Chpt 10] Subprime Machinery. Abdication of all lending standards begins in early 2000s, driven by Wall St demand. Sleazy mortgage lenders with 90-day warranties were paid by loan volume, not quality. Fraud in appraisals, referrals, applications, mortgages, lending, and builder incentives. Bizarre "innovative" loans. Regulation was virtually non-existent. Washington helped in myriad ways.
[Chpt 11] Radical Deregulation, Nonfeasance. Reagan started deregulation, and it snowballed. Compensation systems encouraged short-term profits. Glass-Steagall, CFMA, Gramm nepotism, Enron. Self-regulating markets don't work. The "Bear Stearns Rule:" 2004 leverage exemption.
[Chpt 12] Unintended Consequences. Clear Channel: cannibalizes own market! Securities Litigation Reform Act of 1995: accounting fraud explodes! Boskin Commission: lying about CPI. Bear bailout encourages Lehman arrogance? CFMA triggers AIG. Lockheed -> Chrysler -> SUVs!
[Chpt 13] Moral Hazard. Greenspan and LTCM. Chrysler: encouraged Big 3 to lobby rather than innovate. Table of "Smart Money" disasters. Housing Collapse Anatomy graphic.
[Chpt 14] Suicide by Democracy. Bear implodes, JPM picks up pieces. Random, knee-jerk reactions from Treasury. Bush went AWOL. Nice Bailout Tally table.
[Chpt 15] Bear. Heavy fixed-income focus, heavy leverage. Crisis of confidence and competence. Cayne, Schwartz, and Spector. Lehman: mark-to-make-believe. Feds think Bear is the only bailout they should make; Lehman expects otherwise. Bear Lessons: Go Big; Go First; Threaten Counterparties; Risk the Economy; Incompetence, Not Arrogance; Balance Sheets Matter; Unintended Consequences.
[Chpt 16] Dot-Com Envy. Overcompensation originated in dot-com days. If startups could do it, so could Wall St execs. Just lever up! Problem: they were betting with pension money. Mutual funds dropped the ball on oversight. Good table on executive pay.
[Chpt 17] Year of Bailout, part 1: AIG. Financial Products managers kept 32% of up-front profits on $3.26B (2005) in revenue. Massive risk (Bloomberg: $587B). More "mark-to-make-believe." Real reason for AIG, Freddie, and Fannie nationalization: to protect counterparties.
[Chpt 18] Year of Bailout, part 2: Too Big to Succeed. Citi a victim of Glass-Steagall greed; used accounting gimmicks (SIVs) to move troubled assets off its books; ballooned into a monster. Despite gross incompetence, Treasury delivers sweetheart deal. BofA buys Countrywide (oops), and then overpays for Merrill. TARP is a one-page receipt for $700B from headless chicken Paulson, but is merely a coverup to hide Citi's bankruptcy. PPIP a bad joke and Congressional end-around.
[Chpt 19] Casting Blame. Long list of culprits with Greenspan/Fed, Gramm, and Ratings Agencies at the top. Rubin opposed Brooksley Born on CDS regs, along with Greenspan and Summers.
[Chpt 20] Misplaced Fault. Mtg Interest Deduction. Naked Shorts. CRA. Fannie & Freddie.
[Chpt 21] Foreclosure Virtue. The market needs to correct but the govt is preventing this. Foreclosures need to happen.
[Chpt 22] Casino Capitalism. Follow the Swedes, not the Japanese. Nationalize the losers.
[Chpt PS] Advice to Obama. Education! Ideas from other Wall St vets.
Here's what I think is missing. Somewhere on these Amazon review pages Ritholtz says that there are three "But For" causes of the crisis, one of which is the ratings agencies. (I.e. "But For" these three, the crisis would not have occurred.) I couldn't agree more. These government-granted monopolists made out like bandits as they passed off toxic waste to pension fund managers as holy water. The ratings agencies abused their privileged status and shirked their responsibility to provide accurate ratings -- all in the name of short-term profits.
Yet in this 300 page book, Ritholtz devotes all of five pages (total) to covering the rating agencies!
I think readers would have appreciated learning how the NRSRO nightmare came about, and how their business model changed around the time the NRSRO designation was established. In particular, I think that not mentioning the fact that Securities Act Rule 436 protected the rating agencies from liability is a large hole in the book.
Another hole: why is there no coverage of the foreign bailouts of the 90s? Wasn't Goldman a leading underwriter of Mexican equities and bonds in the early 90s? And what Wall Street banks welcomed the Asian bailout? Or the Russian or Brazil bailouts? These are excellent examples of Wall Street learning that they can pocket profits while socializing risks.
Also, readers who are looking for the complete "Big Picture" on the housing meltdown will need to keep reading. The holes mentioned above notwithstanding, Ritholtz covers the Wall Street angle exceptionally well. What you won't get is an account of how lending standards became so relaxed; the role politicians and bureaucrats played (except for a couple of Phil Gramm bills); the overall market hype that was in play at the time; and all the amazing stories of fraud at every level in the housing chain.
In particular, Ritholtz seems to reject any notion that there's an ideology that says "Housing Is an American Right." Yet I think it is this ideology that was the catalyst for the development of "innovative mortgage products" and provided the pressure on regulatory agencies to relax standards so banks could make more loans. In my mind, this ideology shares responsibility for the boom with the "Markets Can Self-Regulate" ideology: they both work to corrupt oversight of the market.
Finally, there's an awesome quote by Thomas Jefferson on page 15:
"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered."
which Snopes says is bogus.
In spite of all this, I enjoyed reading this book. It provides a highly accessible description of the history of direct government support of the markets, the mistakes of Greenspan and the Fed, the market environment leading up to the crisis, and the major Wall Street players' mistakes. Especially good are the closing chapters 21 and 22, where Ritholtz discusses the virtues of foreclosure and nationalization. There's also an excellent "What If Chrysler Went Bankrupt" section in chapter 4 that should be mandatory reading for all poly sci majors.
Hopefully there will be an updated version that might address some of the issues above (and skewer the so-called reform bill?). In the meantime, if you haven't checked out The Big Picture blog, you're missing out.