Obama, Populism, and the Financial Crisis Redux

My best friend works on Wall Street. He's been working to teach me about the Street, and in the process we have engaged in a terrific debate about US politics, economics, and the current state of affairs. The following is the major portion of an email I sent him today. Will not try to explain what he wrote that I was responding to. I trust it will be self-explanatory. He did start out in a recent email me to advise me that Wall Street is not a monolith, that there are segments that have differing perspectives and interests: particularly the Bank segment (BOA, JPMChase, Citi, Goldman, etc.) and the non-Bank segments (boutique banks, asset managers, investors, etc.). You could count on these segments differing on topics like TARP, the stimulus, etc. With that short intro, here's the post:



Populism is certainly a divide and conquer approach and might well affect attitudes that affect the markets. So if markets are strong for an extended period of time (March 2009-Spring 2011), wouldn't that indicate that "populism" is absent? Obama was much more "populist" during the "bonus crisis" in 2009 then he is now. And who discouraged Dems from pursuing the "bonus tax"? Do you really think Obama is a populist? I don't.

You criticize Buffett for stepping up and saying the wealthy should pay more in taxes, because he has already made his money. I, for my part, admire him. He's willing to say that the sacrifice must be shared, and that current and proposed Republican tax policy asks nothing of the wealthy. What has been completely absent from the scene is anyone from any side of Wall Street stepping up and saying "We screwed up...all of us...and here's how I/we contributed to the mess..." When I see any part of Wall Street stepping up in op-eds and accepting some responsibility for what this country went through, I will jump on Obama for "populist" comments. In the meantime, I will let him hammer at will.

Re the banks: you have pointed out elsewhere that the Fed successfully used "extend and pretend" in the past to help recapitalize the banks, providing low interest rates that made it easy to make money and rebuild balance sheets. Key difference: then (1990s') we had some uplifting inflation. Now we have deflationary pressure. It won't work this time. Probably before next summer, and most likely catalyzed by some bank or sovereign failure in Europe, we will have a banking crisis in the US. If so, and my probability is over 60%, we will have a second chance to restructure the banks. BOA will surely be the canary in the coal mine, the first to expire. I know what megabank Wall Street will say: "Save me. You can't live without me. And don't even think about restructuring me. It's too dangerous." What will non-bank Wall Street say? Romney should pray daily for this eventuality. It's his ticket to the nomination.

When before, I said I was surprised the chain of title mess didn't seem to register with you, what I meant was I didn't understand why this didn't make you mad. I knew you were aware of it, as you are hugely well read and informed. It makes me furious. You simply cannot have probably millions of mortgages in trusts that have incomplete documentation without system-wide gross negligence, malfeasance and probably fraud. When I first encountered these issues two years ago, I said to myself: "This is impossible. It means every investment banker, every supporting lawyer and accountant, every trust banker, every bank servicer must have worked together and supported a process of seccuritization that at the very best was combined gross negligence, and more likely represented broad scale fraud." Why would they do it? Arrogance is my answer. Treating the investors well, punctiliously following the requirements of the PSA's, didn't matter very much. The investor money was coming or in. Reps and warranty cases are enormously hard to pursue - you (as Brian Moynihan threatened) have to fight them case by case, loan by loan, mortgage by mortgage. Everybody ALWAYS settles early. And chain of title??? You think individual homeowners, those idiot and deadbeat borrowers can take us on? We'll kill them. Trust me, amigo: what I write above is what happened. You can question my preferences, my perceptions, my politics. But you cannot question my facts. And since I know my facts are right, you ought to be upset, because these arrogant idiots are threatening the honor and dignity of your chosen and noble profession.

Two more examples of arrogance, deception and most likely, fraud:

Am sure you know that Clayton Holdings did about 70% of the MBS pre-bond sale due diligence. Am also sure you know that Clayton's former President testified before Congress that over a very broad series of issues, Clayton found that 47% of the sampled mortgages did not meet the reps and warranties in the MBS bond prospectuses. Was anything done about it? Mostly no, except to go back to the mortgage poolers and negotiate a discount. And who got the discount? The investors? Of course not. The banks. Were investors informed of either the size of their portfolio that was outside of reps and warranties, or that the sponsor bank had negotiated a discount on the mortgage pool acquisition? No. Fraud, in my book. Apparently Dodd-Frank now makes it clear that this sort of information must be disclosed.

Again, as you know, the housing market peaked in the summer of 2006. The 2 year Option ARMs sold in subprime deals and packaged into RMBS bonds in 2004 began to trigger to new, higher rates, and defaults began to jump. There was a brand new CDS index measuring CDS spreads on subprime. The index didn't start moving for six months. And then, in early 2007, the shit began to hit the fan. Bear Stearns fell in March. So why didn't the crisis happen then? What put this off until September 2008? The shorts. Paulson. Magnetar. And their synthetic CDOs' that probably only 5% of either side of the Steeet understood. The synthetic CDO: truly a creation of evil genius. It looks like a AAA, investor grade, all is well in the mortgage world bond offering. What it really was is a huge bet that the mortgage market is about to tank, with true "chump" investors on the buy side, presumably convinced by the AAA rating that the investment was safe. For 2007 and the first half of 2008, the synthetics dominated the market, and probably kept the bubble going 18 months beyond its "sell by" date. Goldman picked the market peak in late 2006 and decided to start a scramble to offload subprime bonds in their inventory. They were a prime player in the synthetics market, and shoved a lot of their dreck into the offerings. What should we call this sustained, strategic, and focused behavior? "Screw your customers. Kill them. Give them all the shit you can..." Some traders, after just a short period "in the pits" with the real "killers" at Morgan or Goldman were heard to report: " Brother. I've had competition before. But this pure bloodlust to tear the eyes out of your customers. This was absolutely brand new and exciting." What do you call this? I call this money-making pornography, where, like sexual excitement and other excesses, it all turns eventually to violence. When the Wall Street denizens sat and faced their Congressional interrogators, and seemed surprised and confused by some of the questions, that implied that they might have acted badly...these were the violent capitalist warriors that Congress faced. When you trade, a customer is an object. Nothing more. And the possibility that someone might think they were more than objects to be toyed with, and sometimes crushed, was literally confusing. The people Congress met were traders. Warriors. Kill or be killed. And of course, as Goldman's CEO, Lloyd Blankfein said: "We are doing God's work."

The malfeasance and fraud was extensive. And we haven't even touched the rating agencies, who allowed themselves to be convinced that a pile of crap, subprime mortgages, if organized in descending, waterfall-like trenches, could, as if by magic, be turned into AAA gold securities, on a par with US Treasuries. And how about the next "miracle", when the unwanted triple B, mezzanine portion of the first CDO, comprised totally of crappy, subprime mortgages, was repackaged, sprinkled with fairy dust, and magically converted into a triple A offering, called a CDO-squared,  without any new, higher quality mortgages being added to the pool. And no one, from bank or non-bank Wall Street has complained.

This is a very sorry story, well deserving of criticism. And the fact that no one from the Street has provided any form of self-critique convinces other Americans that most of Wall Street simply lives in a separate universe, hopefully running parallel with our universe, but we are not quite sure of that. To my mind, Obama is not guilty of too much populism. He's guilty of molly-coddling the banks, listening to Geithner and "extending/pretending". Not too much populism. Too little real critique. Not done for politiical gain, but to excise a wound in the American experience.