In the Sunday Business section of The New York Times, they are still discussing who is to blame and how and what went wrong in the recent credit meltdown. After I finished reading a couple of articles, I looked over at Chubbs, my cat, sitting in the chair beside me. She had that look on her face that said it all. Yes Chubbs, I wrote about the lack of regulation, the incentives, the greed to take risk, and then take even greater and greater risk, the short fall of the rating agencies to do their job, and how there was not enough shoes on the ground to do the regulatory job right. I did write about all that weeks ago in earlier postings. So, I looked over at Chubbs and told her to first let me reheat my cup of coffee, and then I would tell her a story.
Years ago when I was a young bond portfolio manager/bond trader at Central Trust Bank in downtown Cincinnati, I got to see how decisions at the top were made. Interestingly enough, regardless of how high up the men are that make the decisions, they are always sure to have a scapegoat to take the fall if and when the decision goes bad. That is how things work in organizations that are more than a few people.
I had joined the bank in April, 1977, and took my place in the bank’s bond department where I had access to the munifax wire and all the info that came over the wire daily. In those days, there was the ever present Wall Street Journal and The Blue List of municipal offerings. The Blue List was published daily Monday through Friday and was mailed Special Delivery every day to the various bond departments and broker dealers in the city. These were our tools in 1977. My job was to buy and sell municipal bonds for the trust department and manage a common trust fund of municipal bonds for personal trust clients in the trust department. Although my desk was in the bank’s bond department where the bank’s bond portfolio was managed, I met with members of the trust department’s fixed income committee every few weeks. The chief investment officer of the trust department ran the fixed income committee meetings and set the policy. Furthermore, he had no use for anyone that could enlighten him on the fixed income markets for he received his knowledge from a higher power or perhaps directly from god. The bottom line was that he was dead wrong on the direction of interest rates in 1977 and eventually the trust department paid dearly for his mistakes.
I was young and naive, and thought that with my knowledge of the movement of interest rates, monetary theory and monetary policy as it was being practiced during the Carter administration, that I had a duty to share my knowledge with the trust department. After all, they were paying me $21,000 a year and I had the title of Bond Investment Officer. By November 1977, the “party line” in the trust department was that interest rates were headed lower even though they had been moving higher each month. Each month a man named Joe, who responsible for taxable fixed income would give the standard party line in the trust department's monthly investment meeting. This particular month, I decided that I was going to make a point of enlightening everyone in that big conference room sitting around the huge table, that there was another point of view out there.
When it was my turn to speak about the municipal bond market, I started out by saying I disagreed with everything that Joe had said. That got everyone’s attention, particularly the chief investment officer’s, who wanted his view of the market to be the only view expressed at the meeting. After I finished my presentation on why interest rates were going higher not lower, there was only one person that asked me a question and that was the head of the trust department. He was genuinely interested in my opinion and he knew that the bank’s bond department shared my opinion on the future direction of the yield curve. No one in that entire trust department said a word. I had a short debate for a few minutes with the chief investment officer about where interest rates were headed. Finally I shut up after the CIO said, “what are they (investors) going to do, buy gold?” At that point, I realized that the CIO did not have a clue as to what forces influenced the movement of long term interest rates. I might as well have been speaking Hebrew, he had no idea what factors influenced long term interest rates.
A few months later, in early 1978, the CIO was fired. A large corporate pension fund, with ties to the bank, fired the trust department for the losses it suffered in the bond market. But, in the true fashion of a big organization, the number two man in the trust department was also fired. Before the CIO left the bank, he called me into his office for a talk. I thought he was going to give me a hard time, but he just wanted to ask me some questions about municipal bonds that were so elementary that I could not believe my ears. The question was, “do municipal bond issues have serial maturities?” I could have fallen off my chair. Here was a man who had talked his way into a position that he had no business filling, no wonder he was eventually fired. He was a nice guy who knew how to dress, but he did not have the knowledge to be the CIO of any trust department. I would run into this situation again and again in varying degrees in trust departments in which I would work over the years.
The old story that it is not what you know, but who you know is alive and well. It will never go away. The mistakes, errors, greed and lack of regulation on Wall Street is no different. Letting the large firms regulate themselves is just plain stupid. In Las Vegas where people gamble big stakes, doesn’t the house decide how much can be put on a bet? Of course it does, that’s what risk management is. The gambler doesn’t set house rules, the house sets house rules. The same should apply for Wall Street. If the Fed and the government are going to be the lenders of last resort, are they not the house? And, does it not follow that as the house, they should set house rules for the size and kind of bet. I am not against hedge funds or derivatives, each has a place in managing risk. But, unless there are some house rules, set by the house, we will continue to have meltdowns in the future. Greed is a powerful motivator. A chance to grab the brass ring is too great a temptation to curb reckless behavior. Unless the government gets serious about regulation, oversight and auditing, we will continue to have what is now being referred to as “the privatization of profits and the socialization of losses.” Stay tuned.
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2 comments:
Good Morning, Fred. I told you so's are fine, but how about outlining a legislation package that would actually work to stabilize the markets and provide the appropriate oversight.
There are more knowledgeable people out there that are professionals at writing legislation. It has been written by the best we have in the field. The problem is getting the legislation passed. The foxes veto the tighter specs on the chicken coop. They, Wall Street investment houses and the big banks, have the money and influence to keep it "regs lite" and under staffed. The politicians know this, but as I have said before, "money talks and bullshit walks." One of these days, they, Wall Street, will go to the well once too often and the people will say enough is enough. No more privatization of profits and the socialization of losses. This isn't cancer where they really don't have a cure. The Fed, Congress and Wall Street know what needs to be done, they just don't want to do it. Some day there may be a revolution of sorts, and then everyone will say they get it. Too bad things will have to get really bad before the proper corrective action is taken.
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