Watching the Bailout unfold in Washington this week, five things are apparent to me:
1. We are extraordinarily lucky to have Hank Paulson and Ben Bernanke as economic leaders at this moment in history. Both have studied the credit crises in the great depression, the Swedish and Japanese bank failures, and both are now proposing the only remedy that will save this economy from a significant recession.
I think the Fed has been slow to recognize the severity of this crisis and wasted several months before making needed regulatory reforms on underwriting guidelines. They had data that showed the impact of poor loan underwriting in October 2007 and waited until June of 2008 to revise the rules. That delay means the mortgage markets are still facing the long tail effect of toxic loan content stretching into the first quarter of 2008. Had the Fed acted sooner, the tail could have been shorter.
This aside, Ben and Hank have exactly the right historical experience for the crisis as it stands today.
2. President Bush's lack of economic understanding in this crisis is terrifying. His speech to the nation on Wednesday was a weird mix of outright denial, fiscal fantasy, and desperation. He used words like "panic" and "recession," and omitted words like "accountabilty" and "responsibility."
We didn't have low interest rates for five years because of foreign investment. We had low interest rates because he told the nation to "Go Shopping" after 9/11 and the Fed dropped rates to 1%.
3. Congress doesn't understand the economy either. Democrats and Republicans were complicit with the administration for years in really poor fiscal stewardship. They allowed the Housing Bubble to grow. They removed prudent loan underwriting guidelines to serve political agendas. They voted for runaway spending, tax cuts, and de-regulation.
4. We will have a recession whether the bailout is approved or not. When the government buys $700B of bad debt at a discount, banks have to write off that discount as losses. That leaves them with less capital, and therefore fewer dollars to loan out. The economy will contract.
But the economy will collapse without the bailout.
5. Math has no party affiliation. If you spend more than you earn, you have nothing left when you need it. The doubling of national debt under this presidency illustrates the failure of macro-economic risk measurement. An administration that casually says "Deficits don't matter," demonstrates that they do not measure the economic risks of deficit spending.
The world is now witnessing the result of those bad decisions. This country has to borrow to bail out, and guess who owns that debt? I laugh when I hear energy nationalists fret about buying so much oil from foreign governments who may not have our best interests at heart. Here's a little tip for you: those foreigners already own $11T of our national debt, which is 20 times more than we pay them for their oil.
Deficits do matter. America can't remain a super-power without a better grasp of math.[Read More]
Adler on Data Governance
From archive: September 2008 X
DataGovernor 120000GKJR 4,043 Views
Letting the bottom fall out of the economy is a worse idea, but quickly passing a colossal $700B+ economic bailout package as currently drafted is also a big mistake.
A few quick reasons why:
1. No one knows exactly how large the bailout package will ultimately be. $700B?Don't believe anyone who tells you they know what it will cost. And this administration has historic problems with math. They originally calculated the cost of the Iraq War at $50B, and we know now it's closer to $1T. Whatever they predict now, make sure to multiply it times 2 or 3 to be safe.
2. This is the administration that relaxed regulations and got us into this mess, and now they want emergency powers to assume $700B - $2T of toxic debt and put it on the US Government balance sheet. The last time they wanted emergency powers, we got The Patriot Act.
3. The current proposal from Hank Paulsen concentrates all power over this extraordinary bailout into the sole hands of the Secretary of the Treasury, with minimal oversight from Congress. It doesn't require even a report to Congress on the status of the bad debt and program function until three months after the start of the program - read, post election.
Now I don't think Congress knows much about how the US economy functions, but they have good staff and the GAO reports to Congress. Giving this much power to a power-hungry and secretive Administration just seems to me to be a bad idea.
I'd recommend a few Data Governance additions to the current legislative proposal:
1. Audit & Reporting - The assumption of whatever trillion dollars of toxic mortgage content should be done with full market transparency. The administration should be required by law to publish each mortgage transaction to a public trust website where everyone can see all the details of each transaction. The GAO should be required to audit the process on a quarterly basis, and Treasury should be reporting on progress to Congress bi-yearly.
2. Governance - A bi-partisan commission of Senate and House members should provide policy oversight on the program, with the Secretary of the Treasury acting as Chairman of the Board.
3. Stewardship - A special office within Treasury should be setup to manage the operation of the program, accepting policy leadership from the Governance Committee.
4. Data Quality and Provenance - These toxic mortgages are extremely complex to understand en masse, but individually each has a story to tell about underwriting incompetence, business negligence, homeowner fraud or ignorance. Those stories should be told because this unraveling of what went wrong is potentially the largest database of credit losses in the world. Each case should be researched and the debt narratives preserved.
5. Risk Calculation - The aggregate losses here should be profiled in a database and preserved as an historic repository of credit risk and loss - available to every lending institution in America to benchmark and calculate their own risks.
6. Value Creation - each MBS and CDO purchased at below-market rates should be monitored to determine how much ROI they return when market conditions return to normal. The American people have a right to learn that information, and Congress has a right to determine how those proceeds should be used - hopefully to pay down the US National Debt which will soar well above $11T thanks to this bailout!
These Six Things are not in the current legislation Hank Paulson sent to Congress today, but I do hope someone from Chris Dodd's or Barney Frank's committees are reading my blog and take note.
If we don't take this opportunity to make this bailout process transparent, we will have another mess to clean up later. Human beings are like that - they don't behave correctly when there is no accountability. That's exactly the lesson learned from this crisis - so why would Treasury repeat that mistake in this bad bailout legislation?!
Answer: because people never think it will happen to them.
DataGovernor 120000GKJR 3,075 Views
The stunning market downturn this week has revealed the breathtaking lack of Enterprise Risk Management in Banks, Brokers, and Washington.
Let me be clear; Risk Taking is not the same as Risk Management.
We've had 7 years of extraordinary risk taking in our mortgage markets, financial markets, tax policies, and war policies. No one, in Banking or Government, can say with any confidence what their risk profile is, calculate probability of loss, or forecast future exposures.
This makes all claims of Enterprise Risk Management one of the most stellar myths in modern business. Anyone telling you they are doing it is either lying or a rare breed indeed.
I do hope that someone is recording the history of losses at the institutions failing and surviving every day. Because the historical study of that record of loss - and new regulations mandating real Enterprise Risk Management and loss capitalization - is the only thing that will prevent them from happening again.[Read More]
DataGovernor 120000GKJR 3,081 Views
"USSR Nationalizes World's Largest Insurance Company" - A headline like that in Pravda in the 1950's might not have been that unusual. The Soviet Union was always bragging about having the world's largest buildings, rocket ships, and industrial organizations.
But the same story in today's NY Times about the anti-regulation Bush Administration taking an 80% interest in AIG, today's largest insurance company worth $1T, for a mere $80B, and replacing its entire management team is simply breathtaking.
In the past six months the US government has been a broker to a leveraged buyout (Bear Sterns), become the world's largest mortgage issuer through the nationalization of Fannie Mae and Freddie Mac, and an M&A advisor to Bank of America and Merrill Lynch.
Now its in the commercial insurance business!
No doubt automakers in Detroit have AIG-envy today.[Read More]
DataGovernor 120000GKJR 2,926 Views
On Monday, October 19, 1987, the NYSE Dow Jones Industrial Average tumbled 508 points. That was 22% of the DOW then, and while today's DOW losses of 504 points are less than 5% it is nevertheless a major market correction.
Back in 1989, I was a professional liability insurance underwriter at Continental Insurance on Maiden Lane and my best friend worked at Goldman Sachs in their Mortgage Backed Securities division. We spent the day on the phone calling each other as the DOW sank to new levels. We were both History Majors in college and we knew then that we were participating in a history-making event. At the close of the trading day, we rushed to Fraunces Tavern and ordered dinner while news crews circled interviewing everyone about the day's stunning losses. Several journalists asked us for interviews and we declined.
I've never forgotten that day. It took two years for the stock market to recover to the level at the opening bell. And today, September 15, 2008, as we watch Wall Street vanguards Merrill Lynch and Lehman Brothers crumble under a massive de-leveraging that is shaking the foundations of the post-WWII economic order, I see again we are in the midst of an important historical moment.
DataGovernor 120000GKJR 2,971 Views
The global financial crisis that began last summer with the first write-downs of credit losses is now entering its second phase. Prior to today's news that Lehman Brothers is entering Chapter 11 bankruptcy protection and the sale of Merrill Lynch to Bank of America, this crisis had already cost the global banking system $504B in losses and $364B in new capital infusions. Just two weeks ago, many nitwits on Wall Street were predicting that the bottom had been reached and financial stocks were rallying.
Sadly, we are just half-way through this crisis, with another $500B in write-downs to go. There is a massive de-leveraging - repricing - of risk going on in the markets that makes this financial crisis particularly toxic.
Two weeks ago, the Treasury Department took over Fannie Mae and Freddie Mac and fired their CEO's (who should have been fired a long time ago). This step stopped those institutions from massive writedowns of their own assets to raise capital and remain solvent. But the takeover has not solved the problem of how to return the American mortgage system to health.
Health in the mortgage market is directly linked to health in the Wall Street financial markets. There is a supply chain of bad debt linked to high delinquency and foreclosure rates in mortgages from 2005 to the 1st quarter of 2008. Many of those loans had very high fraud rates and the tail of on those bad loans will extend deep into 2009.
The American financial system will return to health when these losses are absolved from balance sheets. That in turn will impact the solvency of many financial institutions, which will in turn impact the value of assets across our economy - including the NY Metro Area real estate market, which will soon feel the impact of significant job cuts on Wall Street.
We are a year into this crisis. The Fed has cut interest rates down to 2%, and will probably continue to cut them to pump liquidity into the markets.
I believe this crisis will hit bottom after the election, when Washington begins putting in place the pieces of the new American Financial System with the following components:
1. The demonopolization of Fannie Mae and Freddie Mac.2. A covered bond system of risk pass-through and mortgage securitization.3. A new mortgage regulator that sets American mortgage underwriting guidelines, monitored by the GAO and Congress.4. The end of the mortgage broker system in America.5. A radical reshaping of credit scoring and the end of private credit rating agencies without oversight.6. New banking and financial market risk calculation and reporting standards that help federal regulators benchmark aggregate risk in the economy.7. New financial disclosure laws that require unheard of levels of financial market transparency that allow risk and returns to be priced in real-time.8. Changes in banking, broker, and insurance laws that dramatically alter the terms of The Financial Services Modernization Act of 1999.
When you see some of this announced in the media, you will know that the economy has hit bottom and we can begin looking for the next Bull Market. But that day is some months, and many bank failures, away.
Without transparency and information, markets price on speculation and emotion. Our markets - mortgage and financial both - need an information revolution to price on facts instead of fear, and data governance will play a pivotal role in that process.[Read More]