.
The Financial Crises Inquiry Commission issued its final report at the end of January. The commission split along party lines with the Republicans offering two dissenting opinions.
The dissenting reports do not dispute the facts of the crises. The key points of dissent boil down to how to answer these two questions:
1. Could knowledgeable people have foreseen the financial crises?
2. Could regulators have played an active role in heading off the crises or limiting its damage?
The Democratic members answer “YES”; the Republicans answer “NO”.
(The second dissent pins most of the blame on the government itself not for lax regulation but for its jiggering of the free market with government incentives for home ownership).
The Republican dissent casts doubt on the efficacy of regulation, i.e. Regulation only slows the economy and can have unforeseen consequences. No one saw this coming.
“Pro-Business” legislators tend to have a reflexive response, “Get the government as far away as possible and the free market will function best”. But are these pro-business politicians defending 0% - down, liar loans? That is the equivalent of advocating an unlimited speed limit on Highway 1 along the coast of Big Sur. People drove off the cliff? Really? No one saw that coming.
Support of free Capital Markets does not mean “no law” and does not mean “no policeman”
I am a great believer in free markets. As a young man (with hair), I was a big fan of Alfred Kahn and was able to meet with him in 1978 when he was deregulating the airline industry through the Civil Aeronautics Board. He is still a hero of mine. But, as a business person I quickly learned that market participants often conspire to keep their market from being anything but free and fair.
I respectfully dissent from the dissenting opinions.For some reason we feel that regulators must stay far away from financial markets. I disagree. If any other industry sold products known to be dangerous, that cost the public their fortunes, jobs and dreams – people would demand to see indictments and prosecutions and, if not, we would see public outrage and new laws. Yet, at this time, three years after Lehman’s demise – VERY LITTLE NEW REGULATION IS IN PLACE! The too-big-to-fail banks are even bigger.
The wisdom of our forefathers that separated depository institutions and investment banks was proven to be correct, yet in order to save the Investment Banks our government merged the two industries. “Financial Reform” has been kicked down the road by Congress to the regulatory arena – an arena dominated by the lobbyist of the Big Banks and Wall Street.
Many Cultural Myths about “free” financial markets need to be deflated...
“The Free Market Knows Best.” In our minds the free market is a buyer and seller each knowing the product, facing each other haggling over price: If a market is this direct and open, it works. To try to regulate it would allow either side to attempt to game the system. But, when the market is controlled by a re-packager and re-labeler of the product, who keeps buyer and seller apart so risks are hidden, watch out! IT IS NOT A FREE MARKET. It is a license to disorient and game both buyer and seller.
“In Time the Just Will Prevail.” The Wall Street vendors of CDO and Subprime-backed securities knew they were selling unsafe, if not poisonous, investments. The investment banks that survived were those who kept the least inventory or who bought more of the antidote (credit default swaps) than the companies that went toes up. The most cynical investment banks survived.
Why was AIG bailed out in the blink of an eye? They sold the antidote! Credit default swaps against these toxic pools of mortgage bonds.
Goldman Sachs, the clear winner in this debacle, designed and sold several CDO’s, in fact, 3 are within the top 5 highest default ratios. Goldman established a book-making operation taking bets on whether these products would default. They convinced their own clients to buy positions betting the bonds would perform. Goldman then reaped huge profits betting against their own bonds. Given how the mortgage pools were picked, a sure outcome. The SEC $500 million fine is a minor slap on the wrist given the magnitude of the profits made. (Goldman bet against the housing bubble, $21 Billion on Credit Default Swaps with AIG alone. We taxpayers made good on Goldman’s bet with AIG.)
When purveyors of dried milk added melamine and knowingly sold dangerous products to the people of China and the world – they paid the ultimate price – summary execution. And what happened to those who knowingly polluted our financial markets.
“These were Sophisticated Buyers Who Knew the Risks.” Who runs the investment desk at a company’s pension plan, union or government retirement fund? Generally not a sophisticated buyer. In the face of a commission-incentivized Wall Street Investment Banker that pension investor is cannon-fodder
“Only Fat Cats are harmed by Wall Street.” We know today, this is not true. We are all victims. This is everyman’s retirement money. Dreams melted into despair. We will each be working 5 to 10 years longer because our Government let this happen.
“All it takes is Full Disclosure.” So you read those inserts with your prescription medicine in 4 point type? They’re about the same. Wall Street lawyers are artists of obfuscation. With hundreds of pages of red herrings no wonder it is so hard to sniff out the real deal.
“The rating agencies are watching the store.” This myth needs no further deflation.
“The World of Finance is too complicated to regulate.” I’ve said before, nuclear power is complicated and we regulate that. Why? Because it can blow up in OUR FACES!
But finance is not that complicated. Ask a kindergartner:
What is a loan? If you lend a classmate a dollar, you expect him to pay it back.
What is loan underwriting? If that classmate is unlikely to pay it back, do not lend him the dollar.
Explain a credit default swap to a kindergartner? You offer a quarter to the friend of the kid to whom you lent the dollar, if he guarantees his friend will pay you back.
A derivatives’ market? You go to your fellow kindergartners and take bets on whether the borrower-classmate will or won’t pay his debt.
It is not that complicated. We need some common sense laws. And we need the government to police these laws.
Summary of the conclusions of the Financial Crisis Inquiry Commission:
http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_conclusions.pdf
Dissent Joined by Keith Hennessey, Douglas Holtz-Eakin, and Bill Thomas: http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_hennessey_holtz-eakin_thomas_dissent.pdf
Dissent by Peter J. Wallison: http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_wallison_dissent.pdf
For a lighter version the meltdown download my cartoon parable about the financial crises,” Mad Meat!”: http://www.scribd.com/doc/40224496/MAD-MEAT-September-2010
February 2, 2011
Scene and heard at CRE Finance Council Conference in Washington DC
View from the (departure lounge) bench
Stranded overnight at Dulles Airport in a snowstorm may not have been the ideal end to the CREF Finance Council January conference, but it left me plenty of time to contemplate the (other) memorable moments from this year’s January CREFC Conference. Here's my summary of the event. For a selection of slides from the event click here.
Rational Exuberance?
The mood at the CREFC January 2011 event was near giddy. CREFC’s events are attended heavily by Wall Street-oriented players; CMBS conduits, issuers, rating agencies, securities lawyers and bond investors. I've said it before... what a difference a year makes. Michael Heagerty, Newmark’s CFO, described the mood at last year’s conference as desperate to suicidal; in January 2010 conference speakers were predicting health would not return to the CMBS new issue-market for many years, if ever. This year’s CREFC participants seemed to be shifting their outlook from relief at having survived to fully-pumped and ready for action.
2011 Likely Lending Volumes
Banks: Larger banks have worked through or written down much of their CRE loan problems and are coming in to 2011 pushing for resolution of distressed loans now that the real estate markets are seen to have stabilized. As a result, banks are making noises about making new commercial real estate loans in 2011, maybe even making a construction loan here and there.
Life Companies: The life companies as an industry will increase volumes moderately in 2011 over 2010 levels of roughly $30 billion. Life Companies generally increased their production targets for the coming year, but will face a lot more competition in 2011.
Wall Street: CMBS loan production may exceed life company volumes in 2011. In 2010 the industry did about $11.6 billion of new CMBS issuance. However, in the first quarter of 2011 $11.3 +/- billion of CMBS are scheduled to come to market. Various industry estimates for the 2011 full year range from $30 to $60 billion of new CMBS issuance.
2011 Rates and Spreads
Rates: The conference saw a fairly universal prediction that long term interest rates will increase as the economy strengthens. If you want low rates, root for a double-dip recession. Some speakers felt that with a full-paced recovery we could see a 5.5% yield on the 10-year T-Bill within a year.
Spreads: Spreads are already down but might have 20 to 25 BP left to tighten. Many CMBS investors have AAA bonds that were valued not long ago at 70 cents on the dollar, now find these same CMB Securities are valued at 105 cents on the dollar. The managers in an investor’s CMBS department look like heroes even if they did nothing all year. Investors are hungry for new issues and the 20 or so conduits that are now in the market are chasing the few good loans in the market. The issuers are holding firm at making 4% to 5% in profit on each new issue brought to market. So spreads will only tighten if the bond buyers are more comfortable and strongly bid for the bonds.
Hot topic - CMBS 2.0 vs. a rebooting of CMBS 1.2
There was much talk at the conference about the attempt to totally re-write the rules of engagement for CMBS under Dodd-Frank, an effort labeled CMBS 2.0. Many felt that the crafting of new regulations is turning into a jump-ball where Big Banks have an unfair advantage. The players at either end of the CMBS process, at the front borrowers and mortgage bankers and at the back bond investors and B Piece buyers, feel strong-armed by the dominant issuers of CMBS.
Each of the Big Four Banks (Chase, Wells, Citibank and BofA) plus Goldman Sachs and Morgan Stanley has more lobbyists in DC than any single trade association. These banks are pushing for and likely to get new rules that will limit competition, protect their securitization profits and maximize their control of the process. For example, the CMBS bond investors question the banks pushing for a vertical slice retention policy (a slice of each level of security from AAA to first-loss) to meet the 5% risk retention required by Dodd-Frank. As an alternative, the bond-investors are calling for a return to the olden days of CMBS, say the 1999 to 2003 playbook - what people are calling CMBS 1.2, when there were strong B-Piece buyers who actually held the first-loss risk in the mortgage pools and actively kicked-out bad loans from the pools.
The banks have the balance sheet to meet the 5% retention requirements, which today basically means leaving in their securitization profits. With a vertical slice the Big Bank’s retained profits will not be at risk – if the first loss piece is say 4% of the pool, 5% of that 4% is only 0.2% - a negligible amount of the Big Bank’s securitization profits.
Other Dodd-Frank regulations favoring the Big Banks: (a) Loan buy-back requirements in the proposed loan originator’s reps and warranties. (b) Planned Regulation AB changes making it hard for loan servicers with smaller balance sheets to stay in the game.
Competitive Landscape
JP Morgan/Chase had a 50%+ market share of the CMBS new issue volume in 2010. Nothing speaks louder about the loss of competition than a single player achieving a 50%+ market share. The Big Four US Banks, a few European Banks plus Goldman Sachs and Morgan Stanley will dominate the new CMBS world. Many of the 20+ conduits who say they are in the market are really planning to feed loans into pools led by these few big players.
So is exuberance warranted? Does a middle seat in Economy look great after a night on a bench at Dulles Airport? You betcha.
Stranded overnight at Dulles Airport in a snowstorm may not have been the ideal end to the CREF Finance Council January conference, but it left me plenty of time to contemplate the (other) memorable moments from this year’s January CREFC Conference. Here's my summary of the event. For a selection of slides from the event click here.
Rational Exuberance?
The mood at the CREFC January 2011 event was near giddy. CREFC’s events are attended heavily by Wall Street-oriented players; CMBS conduits, issuers, rating agencies, securities lawyers and bond investors. I've said it before... what a difference a year makes. Michael Heagerty, Newmark’s CFO, described the mood at last year’s conference as desperate to suicidal; in January 2010 conference speakers were predicting health would not return to the CMBS new issue-market for many years, if ever. This year’s CREFC participants seemed to be shifting their outlook from relief at having survived to fully-pumped and ready for action.
2011 Likely Lending Volumes
Banks: Larger banks have worked through or written down much of their CRE loan problems and are coming in to 2011 pushing for resolution of distressed loans now that the real estate markets are seen to have stabilized. As a result, banks are making noises about making new commercial real estate loans in 2011, maybe even making a construction loan here and there.
Life Companies: The life companies as an industry will increase volumes moderately in 2011 over 2010 levels of roughly $30 billion. Life Companies generally increased their production targets for the coming year, but will face a lot more competition in 2011.
Wall Street: CMBS loan production may exceed life company volumes in 2011. In 2010 the industry did about $11.6 billion of new CMBS issuance. However, in the first quarter of 2011 $11.3 +/- billion of CMBS are scheduled to come to market. Various industry estimates for the 2011 full year range from $30 to $60 billion of new CMBS issuance.
2011 Rates and Spreads
Rates: The conference saw a fairly universal prediction that long term interest rates will increase as the economy strengthens. If you want low rates, root for a double-dip recession. Some speakers felt that with a full-paced recovery we could see a 5.5% yield on the 10-year T-Bill within a year.
Spreads: Spreads are already down but might have 20 to 25 BP left to tighten. Many CMBS investors have AAA bonds that were valued not long ago at 70 cents on the dollar, now find these same CMB Securities are valued at 105 cents on the dollar. The managers in an investor’s CMBS department look like heroes even if they did nothing all year. Investors are hungry for new issues and the 20 or so conduits that are now in the market are chasing the few good loans in the market. The issuers are holding firm at making 4% to 5% in profit on each new issue brought to market. So spreads will only tighten if the bond buyers are more comfortable and strongly bid for the bonds.
Hot topic - CMBS 2.0 vs. a rebooting of CMBS 1.2
There was much talk at the conference about the attempt to totally re-write the rules of engagement for CMBS under Dodd-Frank, an effort labeled CMBS 2.0. Many felt that the crafting of new regulations is turning into a jump-ball where Big Banks have an unfair advantage. The players at either end of the CMBS process, at the front borrowers and mortgage bankers and at the back bond investors and B Piece buyers, feel strong-armed by the dominant issuers of CMBS.
Each of the Big Four Banks (Chase, Wells, Citibank and BofA) plus Goldman Sachs and Morgan Stanley has more lobbyists in DC than any single trade association. These banks are pushing for and likely to get new rules that will limit competition, protect their securitization profits and maximize their control of the process. For example, the CMBS bond investors question the banks pushing for a vertical slice retention policy (a slice of each level of security from AAA to first-loss) to meet the 5% risk retention required by Dodd-Frank. As an alternative, the bond-investors are calling for a return to the olden days of CMBS, say the 1999 to 2003 playbook - what people are calling CMBS 1.2, when there were strong B-Piece buyers who actually held the first-loss risk in the mortgage pools and actively kicked-out bad loans from the pools.
The banks have the balance sheet to meet the 5% retention requirements, which today basically means leaving in their securitization profits. With a vertical slice the Big Bank’s retained profits will not be at risk – if the first loss piece is say 4% of the pool, 5% of that 4% is only 0.2% - a negligible amount of the Big Bank’s securitization profits.
Other Dodd-Frank regulations favoring the Big Banks: (a) Loan buy-back requirements in the proposed loan originator’s reps and warranties. (b) Planned Regulation AB changes making it hard for loan servicers with smaller balance sheets to stay in the game.
Competitive Landscape
JP Morgan/Chase had a 50%+ market share of the CMBS new issue volume in 2010. Nothing speaks louder about the loss of competition than a single player achieving a 50%+ market share. The Big Four US Banks, a few European Banks plus Goldman Sachs and Morgan Stanley will dominate the new CMBS world. Many of the 20+ conduits who say they are in the market are really planning to feed loans into pools led by these few big players.
So is exuberance warranted? Does a middle seat in Economy look great after a night on a bench at Dulles Airport? You betcha.
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