Monday, December 13, 2010
A New Generation None The Wiser: Is That What We Are Waiting For?
Where do I start to give you a holistic approach to money, investment banking, monetary policy and inflation? Paper money, like a casino's chips, rely on confidence. Confidence is the thread that connects everything together and without it, the system falls apart. When confidence leaves, panic fills the void, and a financial meltdown occurs.
For many months, I wrote about the bond market, in particular the mortgage-backed bonds, and the credit rating agencies, that in my opinion, set in motion the great damage that was done to the whole structured finance market.
The credit rating agencies that passed out their highest credit rating, the triple-A rating, to mortgages that were securitized into mortgage-backed bonds by the investment bankers, and then sold to investors, both public and private portfolios around the world were bogus triple-As. As long as there was confidence in the credit ratings, the mortgage-backed bond market performed well. However, once it became general knowledge among market participants that the investment bankers were betting against the very mortgage-backed bonds that they put together for sale around the world, known as credit default swaps, the game was over and the mortgage-backed bond market meltdown ensued.
People in government, on TV and in coffee shops around the country debate what it is going to take to get the economy moving again. I can tell you why I think there is still a defect in the way the capital markets operate and for me, that is why our economy, while there is much cash on the sidelines, is not growing at a faster pace.
There continues to be trillions of dollars sitting in private, public and sovereign portfolios around the world waiting to be invested in fixed-income assets. Fixed-income assets is just another name for bonds and notes. But, the lack of confidence, the word that I started with at the beginning of this talk, in my opinion, is still the main obstacle. Without confidence in the credit rating agencies the system is broken.
I suggested that the Federal Reserve Bank take a role in passing on the efficacy of what constitutes a triple-A rating, in that the Fed specifies that banks must hold triple-A paper in reserves. Again, I go back to confidence in the system, without it the movement of capital from the investor to the borrower is stymied.
But, there are those that like the game the way it is. Shooting fish in a barrel is not sport in my book and it should not be sport in anyone else's book either. We need a level playing field where the investor has a chance and the tables are not rigged in favor of the investment bankers. When this becomes clear, the game will be changed and the economy's growth rate will speed up. Or, we can wait for a new generation of players that will not have seen the last meltdown and be none the wiser.