Saturday, September 27, 2008


Great questions and points made by Al. I think his comments highlight an extremely important point, one that is seldom made.

The fact of the mater is that our banking system is the envy of the world. Banking is one of the things American does great. In fact, if you look at the growth of revenues for business sectors over the years, you find that US banks have gotten not just bigger, but better in almost every way. Our banks employ millions of people and they make it possible for our businesses to grow and for our businesses to hire ever more people.

One of the four necessary components Peter Bernstein says is necessary for a vibrant economy is a sound banking system. The struggles in countries such as Russia, Iran and China are partially the result of not having the relatively free and powerful banking system that we have. Only in recent years have European banks begun to shed the archaic rules that prohibit growth.

Politicians and "news critics" like to point their fingers at bankers and saddle them with the blame for our problems. I know at least a couple of dozen bankers who are the salt of the earth; good men and women who serve their community well. People who, in their daily lives, demonstrate high ethical standards and honor beyond reproach.

When Al asks how did the banks get into this situation? Was it bad management? One must conclude that if it was bad management, there was bad management in the majority of the banks. The reality is that the bank managers were mislead, snookered, just as badly as the rest of us. Were there some crooks, who knowingly made bad loans? certainly. Obviously, had anyone known for sure the outcome of the policies in place, that person would be a multi-billionaire today. Politicians and pundits are pointing fingers at people who have or who are at risk of losing their jobs and accusing them of being bad people. If those pointing their fingers had had a clue, they too would now be billionaires. There are a few people who had great foresight and they made a lot of money but the managers at the banks that are in trouble did not know.

If one only looks at the people who did extremely well during this debacle, one would have to include the executives at Goldman and JPMorgan, who all made millions in bonuses over the past several years. Their success does not make them crooks. If one were to point a finger toward the one person who seemed to be most aware of the trouble ahead and the one who benefited himself and his firm the most, one would have to point toward Hank Paulson. Again, awareness of a problem does not make him a crook.

As far as many of the people who pushed Fannie Mae and Freddie Mac to be ever more aggressive in purchasing no doc and other high risk loans, their hearts were probably in the right place. Here there were many politicians, lobbyist and executives who got wealthy off a semi-government corporation, which is a terrible idea in the first place. Most who supported these entities had good hearts, but a poor understanding of economics.

I am among those who have applauded efforts to help the poor become homeowners, but I have never been in support of excessively loose lending practices. It has been proven time and again that loose lending is a huge mistake. In Proverbs there is a verse about running from a loan like a Gazelle from a Cheetah. The admonishment does not say to never make a loan but to be extremely careful if you do.

Furthermore, it is not the job of government to perform charity. As a former credit union General Manager, I always draw on that experience when it comes to charity. While credit unions have a stated goal of service, it is easy for a credit union board to confuse the objective with charity. Making a low cost loan is a service which requires careful execution as there is a fiduciary duty to recover those funds. In the old days of the Credit Union movement, neighbors were required to help neighbors in the establishment of credit. Had a credit worthy person or entity been required to cosign the low down-payment loans offered by Fannie, an experienced person or entity would have been there to carefully consider the terms of the purchase price and the loan. Later, when trouble came, they would have been quick to work with the lender to work out a long term payoff plan. The problem would never have gotten so large. The great majority of loans would have been more sound in the fist place.

It is always tempting to raise taxes on some so that charity can be given to others. Such plans do a disservice to the both parties. The poor do not want handouts, they only want a fair chance.

Those of us who study cycles sometimes wonder if cycles are not pushed to extremes by the powerful, in order to take advantage. While at Goldman, Hank Paulson developed the concept of mixing a few weak credits with mostly strong credits and calling the package triple A. He has since reigned over the collapse of his nemesis at Bear Sterns and he has broken the legs of the government corporations, Fannie and Freddie, that have been in competition with Goldman. While I do not accuse Paulson of any wrong, I prefer to make sure that he nor anyone else is given the power over $700 Billion which could be used to pick losers and winners. The formula for evaluating the mortgages needs to be determined up front, if at all possible.

I must say again that the great majority of bankers in America are principled people. I do not believe this melt down had to happen. I believe the mark to market rules, instituted after the Enron debacle, should have been adjusted months ago. I believe bank capital requirements could have been reduced just a little to give time. Give the lenders time to set up work out agreements and for the market value of homes to turn and this crises would be over. As Lamar noted, it is the cessation of building homes and the gradual growth of demand for homes that will ultimately make almost all of the homes in America worth much more than their current mortgage balance.

On Fri, Sep 26, 2008 at 1:38 PM, Al wrote:

I would like a better understanding of this "crisis", but many of the statements being made on and by the media seem at odds. The hue and cry is that banks are not in a position to make loans and our credit system will fail. How do banks make profit? They lend money for a larger amount of money than it costs them to borrow money (deposits, fed loans...). Why are banks in this position? Is it bad management, insufficient regulations, lack of enforcement of the existing regulations, excessive costs or old fasioned greed? TS Paulson says $700 billion check made out to him with no strings attached, is needed to "solve" the problem. The FDIC has become a business broker which is resulting in the reduction of competition in the financial sector. The public is not buying the "collapsing economy and we must bail it out at any cost" fear mongering by the Bush administration at a ratio of over 3 to 1. The longer it is taking to reach a settlement, it seems the less the taxpayer will be on the hook for direct payments, but less competition will exist when the dust settles and many financial stocks will have tanked. As Jack has pointed out, there are other, possibly much better ways to solve this "crisis". Banks must lend money to survive and changing the current rules along with providing government support will put them back in the lending business. My opinion is that if congress would do nothing else but protect the depositors and go home, most of this "crisis" would be solved by private money. But it is an election year and it is likely that huge amounts of public funds will be pored into Wall Street, the ghosts of old J.P. and the rest of his robber baron cronies will be at the post election party.