Like the rest, I read a few magazines too. In fact, I just finished a couple of good articles in The New Yorker, and I am in the middle of another. The subject of debt as the cause of the recent financial crisis has come up repeatedly in my readings about the financial and economic crisis. Yes, too much debt is no good, but even more important than too much debt is what I will call "dirty debt". What do I mean by dirty debt?
Let me start by saying that debt like fire, used correctly, is a good thing. A fire in a California forest is not the proper use of fire, nor is debt taken on by an individual, couple, family, partnership or corporation that is beyond sound judgement. Add to the equation motive of lenders to grant unsound debt levels to borrowers, that can not be sustained, and you have the recipe for financial disaster. Where and why was there a motive?
The answer to the above question lies in the creation of another financial tool, in and of itself not bad, but eventually because of greed became the problem - the mortgage-backed bond. Bundling mortgages into bonds to be sold to investors around the world is a great idea. The problem came about when those doing the bundling realized that they could cheat a little and shop for the triple-A rating, which would give the bonds they were selling the highest bond rating given out by the credit rating agencies. The credit rating agencies soon realized that the growth in earning per share (EPS) of their corporation was tied directly to the growth of the structured finance bond market. Buying the triple-A rating, in my mind, sealed the fate of the mortgage-backed bond market and lead to the eventual meltdown in the mortgage-backed bond market.
The problem, as I see it, lies with the ease in which the credit rating agencies were able to game the system for their profit, and leave everyone else, investors in the mortgage-backed bonds, holding the bag. Debt used properly is a good thing, just as fire used correctly warms our homes in the winter and cooks our food.
Whether the Fed or Congress understands this simple fact is unknown to me, but until they "get it" we are going to be going down the same road in the very near future.
Stay tuned.
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2 comments:
What I would like to know is - who held all of those Credit Default swaps? Because whoever did, whatever group did, has made Billions upon Billions of dollars. What people don't understand is that not all of that wealth that disappeared through this financial crisis, evaporated. A SUBSTANTIAL portion of it was taken off the table - in other words - it went into people's pockets.
Lou, you are absolutely right, it did go into people's pockets.
AIG, the big insurance company that the U.S, Government bailed out, had a unit in London that sold these credit default swaps to buyers and they pocketed the premiums from those sales. Goldman Sachs bought those credit default swaps and when the Government bailed out AIG, AIG was able to pay Goldman $12 Billion dollars. If the Government hadn't bailed out AIG, Goldman would have lost on their investment in those credit default swaps that they purchased from AIG. Hank Paulson, Secretary of the Treasury, was a former CEO of Goldman Sachs, but I don't think that had anything to do with the Government's decision to bail out AIG. AIG was too big to fail. There still are several former Goldman people working for the Obama administration, but that does not mean they can not see the level playing field, even if it is out the window from their offices.
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