Who's to Blame? Banks


Each day for five days, a different writer from TheStreet.com will make the case for why one of five prime culprits—the banks, Congress, irresponsible home buyers, the Federal Reserve or the rating agencies—is most to blame for the credit crisis and ensuing economic meltdown.

The now-famous (infamous?) Rick Santelli rant on CNBC a few weeks ago offered a prime example of how quickly Wall Street has overcome its sheepishness for extinguishing this edition of the global economic system.

For those of you fortunate enough to watch very little of the financial news network, the faux-populist Santelli rallied his Chicago Mercantile Exchange brethren (literally—I don't recall seeing a single female amid his mob) to shout down President Barack Obama's stimulus plan as a bailout for "losers" who risk losing homes they never were able to afford.

"How about we all stop paying our mortgages?" shouts one trader into Santelli's microphone during the tirade. "It's a moral hazard."

"This is America!" Santelli says, defending the congratulatory shouts of his pit buddies, who chuckled at their terminals, no doubt considering themselves modern-day coal miners, slogging through another bleak day before trudging home to comfort themselves with jugs of homemade corn wine.

As others have pointed out, "this" isn't America. In America, the median household income is barely above $50,000 a year. Real wages haven't moved for 30 years, one in four people say they have "no use for the Internet" and CNBC exists as a blur for people thumbing their remotes from the Discovery Channel to the Food Network.

The problem with the blame game is that it's mostly an academic issue—the economic system is too interdependent to ferret out just one villain, and any alleged improvements to come will likely be made at the margins and will have no role in preventing another boom and bust.

In fact, as far as the global financial framework goes, there's nothing wrong at all—everything has gone according to expectations. As economists were predicting earlier this decade, particularly economists John Eatwell and Lance Taylor in their 2001 book Global Finance at Risk, the dismantling of financial regulation over the past 30 years had no choice but to lead to an increase in speculation and mispriced risk.

Throw in the growth of derivatives and exotic financial instruments (overseen, by the way, by Clinton Treasury secretaries Robert Rubin and Lawrence Summers) and the repeal of the Glass-Steagall Act (Rubin again), which let banks become "financial supermarkets," expanding their involvement in the new products (see Citigroup (Stock Quote: C), with Rubin joining the board in 1999).

Of course, this entire arrangement rested on the interest of banks in correctly pricing their risk. I believe we've seen how that has gone, as banks like Citi, Bank of America (Stock Quote: BAC), JPMorgan Chase (Stock Quote: JPM), Goldman Sachs (Stock Quote: GS) and Morgan Stanley (Stock Quote: MS) have sold the federal government preferred equity stakes and hover near multi-year lows.

As the Bank for International Settlements put it such understated terms in its July 2008 annual report: "Recent innovations such as structured finance products were originally thought likely to produce a welcome spreading of risk-bearing. Instead, the way in which they were introduced materially reduced the quality of credit assessments in many markets and also led to a marked increase in opacity."

The staggering growth in money and credit certainly received pushes from Congress, the Alan Greenspan Fed, and the ratings agencies, but at the end of the day it was the banks' responsibility to use their new firepower without shooting themselves. They bet their companies, and they lost.

Yes, there were many homeowners that gamed the house-flipping system as home prices shot higher, and many people are in homes they should not have been allowed to "buy."

In his must-read piece a few months ago in Portfolio, Michael Lewis relates this anecdote from investor Steve Eisman, who gets a call from a former baby nurse:

"One day she calls me and says she and her sister own five townhouses in Queens. I said, 'How did that happen?'¿" It happened because after they bought the first one and its value rose, the lenders came and suggested they refinance and take out $250,000, which they used to buy another one. Then the price of that one rose too, and they repeated the experiment. "By the time they were done," Eisman says, "they owned five of them, the market was falling, and they couldn't make any of the payments."

No, these weren't intelligent transactions, but it takes two to sign a contract, and homeowners had nothing to do with chopping up mortgages into slices of lottery tickets that were ultimately backed by the very existence of the banks.

Financial institutions are so chagrined about the industry's past mismanagement that they continue to favor making it difficult for investors to learn about the status of loans on their books

As Bloomberg's Jonathan Weil pointed out on Thursday, Regions Financial reported in a Securities and Exchange Commission annual report footnote that the "fair value" of loans it was holding for investment was $79.9 billion, $15 billion less than the amount it disclosed on its balance sheet.

Banks know these loan values have been plunging, of course, but they choose instead to stick to the letter of the law and keep the numbers to themselves.


One would think, at long last, that banks would see it in their own best interest to provide shareholders with a more transparent and timely information stream—but, hey, this is America.

Tomorrow, Lauren Tara LaCapra blames Congress, Fannie Mae and Freddie Mac.

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