The groups described below have inflicted a greater financial damage on our nation than Al Queda could ever have hoped to.
The sheer unchecked greed of Wall Street and the failure of government to recognize and halt excessive credit availability have taken America to the financial edge. Last week (beginning Sept. 15th, 2008) we as a nation experienced the unraveling of our financial system at the hands of those who remain unable to control their greed. We all know how we got here, as those more qualified and smarter than I have written (http://www.msnbc.msn.com/id/26837854/page/2/ for a good quick summary). The people responsible:
Homebuyers who thought that they would get a free ride into home ownership and refused to educate themselves about their true financial situation are at the source of the meltdown. I am not sure that I understand how a person who is making one of the most significant financial decision of their lives does not plan for a relatively likely scenario of real estate price declines. I place the most blame with this group because without them, the rest in this list would have had nothing to do.
Policies approved by both parties that allow Freddie and Fannie to leverage themselves to unimaginable levels. Interest rates that were kept at ridiculously low levels invited imbalances in the market. A lack of leadership in government to confront excesses credit availability due to excessive leverage, complex derivative products, Hedge Funds etc. Our representatives act in their own interest and not in the interest of our nation (I am talking about all representatives from all parties).
Lack of oversight of investment banks who have also been allowed to leverage up to 40X+ assets. What are these people thinking? This is nothing short of negligence. One tiny hiccup in the market and the whole house of cards will come down. You don’t need sophisticated models to figure this out, you just need a napkin and a pen.
Nothing short of greed here! Putting people in mortgages that they obviously cannot afford. There are many mortgage lenders that need to be held legally accountable.
Most Real Estate Appraisers do their job and allow the market to dictate the price. I cannot find fault in that. However, there appears to be significant number of appraisers who purposefully over estimated their appraisals and for those, there needs to be legal accountability.
I am not exactly sure what this group does but I can assure you it is not their job. These people took for example 100 sub prime mortgages, sliced them into groups and said that up to 80% were of the highest quality and investment grade. You would have to be a moron to think that 100 sub prime mortgages are not correlated. “Oh” they said “but the historical default rates on these prove that 80% is reasonable.” If that is your answer then you should be fired. If you look at default rates while real estate is rising, then invest away but to evaluate the true risk, try looking at a period of declining real estate and better yet when a real estate bubble has bust then the 80% should be more like 20%. These rating agencies were plain wrong and they need to be held financially accountable.
A collection of our brightest minds! These people are definitely smart, no question about that. So how could they let something like this happen? Simple! They are so focused on making money for themselves that they did not take the time to ask the question, What if. It is the first question of risk analysis and these people didn’t ask it. A first year at Wharton would have answered the question correctly but would anything have changed if Wall Street had asked the question. Probably not. When you pay someone 5 times their base pay in bonus based on current year’s performance, there is incredible incentive to “swing for the fences.” If you hit the home run, you make a fortune. If you miss, you leave and join another firm to try again.
- Banks and Financial Institutions:
Unfortunately for this group and for us, they were the last ones holding the bag in this giant pyramid scheme. They were led to the CDO investments and jumped in without fully understanding the underlying instruments and their correlations. A rule of thumb for investing, if you do not understand the instrument and how different market scenarios will affect your investment, don’t invest. Because of their lack of understanding, we face a potential run on the bank. Last week depositors feared a meltdown in the money market mutual fund area. The run began but was swiftly stopped when government stepped in and backed the industry with a guarantee. Banks got extremely nervous about a potential run on their deposits given their $100,000 cap of FDIC insurance per depositor vs no cap placed on money market mutual fund deposits. The government quickly retraced and said only money market funds deposits prior to last week were guaranteed.
Am I angry? HELL YES!. A lot of these people made a lot of money over the last 8 years and now we, the taxpayers are being asked to pay a hefty price to bail them out. Will we pay? Yes because they have put us in a hole that can get a heck of a lot deeper if we don’t. But don’t think this is over. There is a lot more pain to come due to the fixes we are putting in place today.
My next post will discuss the potential impact of the Government bailout. Future entries beyond that will attempt to provide investment strategies to protect yourself.
I welcome comments and questions so don’t be shy. Please post comments to my blog so that I can read and respond to them.