Eric Von Berg - Newmark Realty Capital - 595 Market Street, Suite 2550, San Francisco, CA 94105 - for loan quote: 415 956 9922

February 21, 2011

Rebuttal to the Rebuttals to the Financial Crises Inquiry Commission Final Report

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:
Dissent Joined by Keith Hennessey, Douglas Holtz-Eakin, and Bill Thomas:
Dissent by Peter J. Wallison:

For a lighter version the meltdown download my cartoon parable about the financial crises,” Mad Meat!”: