Bailout Nation (39 page)

O
ther than CFMA and repeal of Glass-Steagall, I will not point to any single vote of the legislative body; those are political choices, which it is not my purview to second-guess. Instead, I want to specify two relatively new ways Congress carries out the people's business that are utterly reprehensible.

The first is the abhorrent practice of passing legislation sight unseen. This is simply beyond the comprehension of any rational person. It makes a mockery of the idea of a representative government elected by the people. Is there any meaningful difference between a dictatorship and an elected body that votes on legislation it has not so much as read?

It wasn't just the Commodity Futures Modernization Act that passed unread. The Patriot Act, the Digital Millennium Copyright Act, the TARP, and other legislation have been voted on essentially unread. If proposed laws are going to be passed without so much as a single reading, then we might as well elect a Congress of illiterates; perhaps we already have. How could we tell the difference?

The second form of Congressional idiocy that has come into vogue is the “nonvote” vote. Rather than actually vote for a specific act, Congress grants authority to a third person to exercise judgment on behalf of Congress. The president and Treasury secretary have each received authority they claimed they wouldn't need or use. “If you've got a bazooka, and people know you've got it, you may not have to take it out,” Paulson famously said in July 2008, explaining the rationale for giving him the power to nationalize Fannie and Freddie.
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One cannot tell whether it is sheer foolishness or cowardice that leads to this absurdity, but consider these nonvote votes that have occurred so far this decade:

Such cowardice. Rather than actually confront the issue head-on, we get this foolish subterfuge. Anytime an administration obtains congressional authority to do something (go to war, spend money on bailouts), it is identical to actually authorizing the act—meaning yes, this is now guaranteed to eventually occur. Claiming you are merely granting authority only reveals your cowardice in not voting yea or nay on the act in the first place. The enabling vote may make the act more politically palatable, but it is obviously an attempt to hide it from the public. Don't ever kid yourself—it is no different than the actual act itself.

One understands how Mark Twain came to remark, “Suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself.”

S
tructured financial products, from residential mortgage-backed securities (RMBSs) to collateralized debt obligations (CDOs), lay at the heart of the global credit and financial meltdown. The process of creating, rating, and selling this paper is complex. As we have learned after the fact, the rating agencies were not (as they claim) passive participants who just happened to underestimate the likelihood of future defaults. Rather, when they placed precious triple-A ratings on all sorts of mortgage-backed and related securities, they were active participants—collaborators, according to the
Wall Street Journal
.
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The subprime paper that eventually collapsed found its way onto the balance sheets of many banks, funds, and other firms. Had “the securities initially received the risky ratings” they deserved (and many now carry), the various pension funds, trusts, and mutual funds that now own them “would have been barred by their own rules from buying them.”
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Nobel laureate Joseph Stiglitz, economics professor at Columbia University, observed:

In 2008, the House Oversight Committee opened a probe into the role of the bond-rating agencies in the credit crisis, and Congress held a hearing on the subject, featuring a now-infamous instant message exchange: “We rate every deal,” one Standard & Poor's analyst told another who dared to question the validity of the ratings process. “It could be structured by cows and we would rate it.”
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When they are not rating bovine structured products, the rating agencies can be found belatedly downgrading junk paper into bankruptcy. In March 2009, Moody's Investors Service came out with a new ratings list: The Bottom Rung.

“Moody's estimates about 45% of the Bottom Rung companies will default in the next year,” the
Wall Street Journal
reported.
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Perhaps the cliché about analysts is better applied to rating agencies: You don't need them in a bull market, and you don't want them in a bear market.

While it was the investment banks that sold the junk paper, it was the rating agencies that tarted up the bonds. It was the equivalent of putting lipstick on a pig: This paper could never have danced its way onto the laps of so many drooling buyers without the rating agencies' imprimatur of triple-A respectability.

Yet considering the massive damage they are directly responsible for, the rating agencies have all escaped relatively unscathed. Given their key role in the crisis—
were they corrupt or incompetent or both?
—one might have thought an Arthur Andersen-like demise was a distinct possibility. Warren Buffett should consider himself lucky—he is the biggest shareholder of Moody's, and is fortunate the scandal hasn't tarnished his reputation.

O
f course, none of this would really have mattered if a few hedge funds and a much larger number of institutional investors—including foreign central banks—didn't suck up so much of this suspect paper (China evidently bought $10 billion in subprime mortgages). Through the indiscriminate use of leverage and by failing to know what they owned, the purchasers of the triple-A-rated junk paper must also shoulder some of the blame.

How did so much of the investment world manage to overlook these issues? Didn't anyone do
any
due diligence? Or was it simply a case of the casinos keeping the securitization process rolling? I've had conversations with CDO originators and insiders, as well as money managers, who unabashedly claimed: “We knew we were buying time bombs.”

So we can rule out sheer ignorance. Rather, it appears that as long as deal fees could be generated, Wall Street kept the CDO factories running 24/7.

Talk about your misplaced compensation incentives. This is precisely the kind of self-destruction that Alan Greenspan believed was impossible in a free market system. The flaw he misunderstood was simply this: It wasn't that the free market would prevent it from occurring; it was that relentless competitive forces would drive such firms out of business. That is what began to happen in 2008. The free market actually worked as it should—firms that managed risk poorly were demolished by market forces. The trouble was, none of the erstwhile free market advocates had the stomach to live through the creative destruction Mr. Market was serving.

That is the risk that excessive deregulation brings: We can eliminate regulations that might prevent systemic risk. However, the free market advocates whine when the market doesn't do their bidding. Bad choices by management led to failure. That failure brought on a global recession, bankrupted over 300 U.S. mortgage companies, and turned many of the biggest banks and investment firms into tapioca.

The firms that allowed excessive risk taking and leverage found themselves on the wrong side of the corporate version of Darwin's laws—which was precisely where they belonged.

S
everal of the states with the biggest foreclosure problem today had an opportunity to confront the problem when it was much smaller. These are the states that now lead the nation in foreclosures. Their regulatory agencies had long lists of complaints brought to their attention. None acted upon them.

A 2008 exposé by the
Miami Herald
revealed that Florida allowed thousands of ex-cons, many with criminal records for fraud, to work unlicensed as loan originators. More than half the people who wrote mortgages in Florida during that period were not subject to any criminal background check. Despite repeated pleas from industry leaders to screen them, Florida regulators refused.
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And in California, attempts to regulate the many subprime mortgage lenders working in the state were beaten back, primarily by Democratic lawmakers who were protecting the then fast-growing industry.

Today, California and Florida are the nation's leading foreclosure factories.

Then there is Arizona. When Internet real estate service Zillow began publishing online housing price estimates in the state, it received a cease and desist order from the Arizona Board of Appraisal. Zillow's site makes it clear that its data are merely estimates and not actual appraisals. Regardless, misguided Arizona pols did not want some online firm horning in on their local business. It is no wonder Arizona is ranked fourth in the nation in terms of defaults and foreclosures listed by RealtyTrac.
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T
he misguided deification of markets is the primary factor that led us to being a Bailout Nation. Markets can and do get it wrong—not by just a little, either; occasionally they can be wildly wrong.

Recall those two Bear Stearns hedge funds that blew up in June 2007. The S&P 500 stumbled in August 2007 at that early sign of a brewing credit crisis. But in the market's infinite wisdom, it determined that credit wasn't such a significant problem after all. The S&P 500 and Dow Jones Industrial Average proceeded to set all-time highs a few months later, peaking in October 2007. That they got cut in half over the next year makes one wonder why anyone would call the stock market prescient.