Monday, January 5, 2009
Two Articles to Read
There are two articles in the Sunday New York Times, January 4, 2009, that I would like to bring to the attention of people that read this blog. The first article is titled THE END OF THE FINANCIAL WORLD AS WE KNOW IT by Michael Lewis and David Einhorn, and is in the Week In Review section, pages 9 and 10. Those that are interested in more of the same about the mistakes that were made and what caused the financial crisis will find this short article of interest. At the end of the article they list several items that contributed to the financial meltdown and things they think should be done in the future. The second item is titled "End the official status of the rating agencies." I would like to re-print the short piece they wrote here. "Given their performance it's hard to believe credit rating agencies are still around. There's no question that the world is worse off for the existence of companies like Moody's and Standard & Poor's. There should be a rule against issuers paying for ratings. Either investors should pay for them privately or, if public ratings are deemed essential, they should be publicly provided."
Several weeks ago I wrote a piece that I titled the Federal Fixed-Income Rating Agency or FFIRA. In this piece, I called for a federal agency that would provide credit ratings, thus eliminating the "shopping" of ratings by the investment banking firms doing the underwriting of structured financings such as mortgage-backed bonds. I maintain that without the AAA-rating of all that mortgage-backed paper by the rating agencies, the real estate bubble could not have been inflated in the first place. Because interest rates were kept low by design of the Federal Reserve Bank's monetary policy, and the pressure to reach for higher yields that were not available from other types of debt instruments, the demand among investors around the world gave a great incentive for home borrowing requirements to be relaxed and lowered to fill the huge demand for mortgage-backed bonds from the underwriters and the portfolio managers. But, without the AAA-rating this whole train of events would have never reached a melting point.
The second article is in The New York Times Magazine, January 4, 2009, and is titled RISK MISMANAGEMENT by Joe Nocera. This article deals with risk management tools used by Wall Street to run banks and securities firms. The model for VaR, Value at Risk, is discussed and how it was misused. I am not a quant guy, so I will not make many comments about this article other than to say that garbage in garbage out has to apply even to VaR. This goes back to the ratings that were given to the structured finacing pieces of debt that were traded and positioned by the several trading desks on Wall Street. A final number at the end of the day, referred to as the 415 number because it was presented to the CEO of the bank or brokerage firm 15 minutes after 4pm, when the markets closed, and was suppose to be a number that the company could hang its hat on. Again, when the fire got too hot, everything started to melt and then Wall Street had the huge meltdown of 2008.
Both of these articles are well written and worth reading if you are interested in knowing a little more about what brought about the financial crisis of 2008. I think, most fair minded economists would agree that the financial crisis spilled over into and contributed to the economic crisis of 2007- 2008. It should be no surprise to anyone that has been reading my blog that the economic crisis was brought about by the sudden and steep jump in the price of oil. Gas prices rose to over $4 a gallon at a time when such a "tax increase" on the American consumer could be least absorbed. Had the President taken action to slow the sudden and swift increase in the price of gas and diesel in 2007 and 2008, the American consumer may have been better abled to maintain their home mortgage payments and the resulting unemployment, loss of jobs, may have been slowed from its rapid pace. But, that did not happen in 2007-2008, so we are now waiting for a stimulus package from the Obama Administration to put people back to work and hopefully reduce and/or stop the number of home foreclosures in the United States. We are now just two weeks away from a new administration, let us all hope and pray for its success.