Wednesday, October 6, 2010

There Is Plenty of Cash on The Sidelines


Yesterday I heard from a friend on the west coast that I went to high school and college. He could not make it in for our 50th high school reunion, but called to say he enjoyed the pictures I posted on Facebook. I told him some of the guys that were there that we were at UC with in the early 1960s.

Then we talked about the economy. He has his own software company that writes financial software for many of the largest Wall Street firms. He is somewhat retired and working with a foundation to bring meds to people that have little or no money. We have talked about the role of the credit rating agencies in conversations before, but this time I mentioned PREDATOR'S BALL by Connie Bruck. He had read it 20 years ago he said, about the same time I read the book.

This book is about the junk bond era and the insider trading that went on in the 1980s. How does this relate to the credit rating agencies? Well, back then everyone was looking for an edge as they are today, and insider information was that edge. When the Feds came down on insider trading, those on Wall Street moved on to another "edge" if they could find one. In the 1990s, the growth of mortgage-backed bonds became the big game on Wall Street. Knowing that not every bundle of mortgages was worth a triple-A rating, the investment bankers shopped the rating with the major credit rating agencies. These so called agencies are nothing more than for profit corporations with shareholders and CEOs that answer to a board of directors.

We both agreed that until the conflict the bankers have with the credit rating agencies disappears the economy is going to continue to falter. Then he said perhaps the Federal Government should take a hand in deciding what is triple-A. I told him I had suggested that because the Fed requires banks to hold so much triple-A paper that they should pass on both triple-A and double -A bonds to make sure the ratings are not bogus. Wall Street would rather that our domestic economy suffer than let the government do the right thing to fix the conflict of interest, and the politicians go right along with it.

There is plenty of cash sitting on the sidelines waiting to be invested. If mortgage-backed bond investors could trust the ratings, the housing industry could possibly get back up on its feet. But, it is not just mortgaged-backed bonds that would benefit from an honest credit rating system. There would be buyers for several types of securitized debt issues too.

The politicians take their orders from Wall Street and Wall Street doesn't want to give up its edge to making money.

stay tuned.

5 comments:

LceeL said...

You know, when it all gets cooked down to its essence, it's gamblers and speculators. I do NOT understand why, in a country that supposedly built itself on the notion of hard work and honesty, that we allow ourselves - our economy - to be driven by the guesses and whims of gamblers.

moneythoughts said...

Lou, there have always been gamblers, and that makes the economy grow, but those that don't play by the rules has always been a problem. Hard work and making money honestly is what most of us do, but there will always be those that break the rules, and for this reason we need a better oversight and more transparency.

winslow said...

With the stranglehold that Wall Street has over decision-making and also the philosophy of the Republican Party of smaller government control, I don't see how this will ever change.

Take the above comments along with high-speed trading by hedge funds in the market, and the prognosis for the future is not good.

Robert said...

It may be a while before housing rebounds as prices are still quite high relative to most wages. Prices have dropped, but it is likely that there is room to drop farther. Of course this varies from region to region.

As corrupt as the credit rating agencies are, I think they were also blindsided by the housing bubble where housing looked like a good investment back around 2005. They were following along in the herd mentality.

Part of that bubble was driven by low interest rates.

I think low interest rates are one of the many factors that have thrown the economy out of balance. When interest rates are that low, it destroys incentive for people to save money in the bank. No wonder savings has been down.

During the bubble, the incentive was for people to use their home equity as their savings.

It's a bad situation if home equity becomes the only road to savings. For instance, renters get left out. Other investments, like stocks are available as well, but tend to be risky; especially as one can't trust rating agencies.

Rating agencies and a lot of other folks have been blindsided by the weired international trade situation which contributed to the low interest rates.

For years, the US has had huge trade imbalances; importing products and energy. This tends to put downward pressure on wages as export industries die. At the same time, plenty of money has flowed back into the US from overseas investors. This has allowed us to borrow our way into prosperity with both government and private borrowing. The money is available to inflate bubbles.

moneythoughts said...

Robert, I can see your point of view on a few things, but not the credit rating agencies. They knew exactly what they were doing. There would not have been a housing bubble if the credit rating agencies hadn't given their triple-A ratings to junk mortgage-back bonds. They knew that this was an area of growth and they being publicly traded corporations needed to grow their earnings per share. CEOs of the three big rating agencies would have been fired if they hadn't gone after their share of this business.

In a much early post, I said the credit rating agencies were the the needle vowel that blows up a ball. Without the needle vowel no air enters the sphere.

The underwriters shopped the ratings and the CRAs knew they would lose business if they didn't play ball with the investment bankers.

There were other problems in the capital markets, but this conflict of interest, in my opinion, had a lot to do with the bond market meltdown of mortgage-backed bonds. The triple-A paper was sold around the world and I think lead to the liar loans. The demand for mortgage-backed bonds was great because other better instruments, like treasuries, were paying so little in interest.

That is the way I see it.