Audit Notes: Greenspan’s Gall, Presidentializing Markets, Megabanks

Barry Ritholtz wrote an excellent post explaining to Alan Greenspan why, yes, his low-interest-rate policies were critical in the creation of the crisis. It’s a good overview of the prominent causes and how they were related.

Making loans to people with weaker credit scores, lower incomes, or more debt was a risky proposition, and hence, generated higher yields for that risk. By collateralizing these subprime mortgages, Securitizers could generate higher yielding paper for the managers of bond funds. And because the rating agencies — Moody’s, S&P, and Fitch were totally corrupt — the securitizers could purchase AAA ratings. Hence, all manner of unqualified junk paper could be sold to these funds that were only allowed to purchase investment grade paper…

The triple AAA rated junk paper sells well, increasing demand for more of it. Huge Wall Street demand for more junk to feed into the maw of the securitization beast compels all manner of non-bank lenders to issue even more sub-prime mortgages. And since they was a finite number of people who afford mortgages, they got creative with ways to make mortgages even cheaper. First came the 2/28 variable loans, with a cheap teaser rate the first two years.

Then came Interest Only (I/O), where there was no principal repayment. I called these loans “Rent with an option to default.” Lastly, we had the Negative Amortization (Neg/Am) mortgages, where the borrower paid less than the monthly interest charges, with the difference added to the principal owed. Hence, with each passing month, the mortgagee actually owed more on the house than the month before, rather than less. These loans defaulted in enormous numbers.

He even mentions the Bush doctrine of preemption, which prevented states from enforcing their tougher regulations against predatory lenders, something that was also critical in press failures.

— Bloomberg has an unfortunate tendency to, well, presidentialize the markets. Last March, six weeks into the Obama presidency (and three days from the bottom of the market), Bloomberg ludicrously called an “Obama Bear Market.” Six months later, amidst the current 60-plus-percent run-up, Bloomberg called it an Obama bull market—also silly.

Today it writes about the Treasury paying more to borrow than Berkshire Hathaway, headlining it: “Obama Pays More Than Buffett as U.S. Risks AAA Rating.”

Problem is, Obama has far, far less responsibility for the country’s deficits than his predecessor did. Bush had two (still ongoing, needless to say) unfunded wars, huge tax cuts accompanied by spending increases, new programs not paid for with taxes or spending cuts. All that, plus he presided over an economic collapse that has necessitated multiple stimulus packages, including Obama’s near-$800 billion one and hundreds of billions of dollars in bailouts—plus, critically, cratered tax receipts.

See a previous post on that. And see David Leonhardt’s analysis last summer of where the deficits really come from.

Simon Johnson notes Fed Chairman Bernanke’s new talk on too big to fail, but says he still doesn’t quite get the need to chop them up:

But he is still hampered by the illusion that there is any evidence we need megabanks in their current form – let alone in their likely, much larger, future form. Let me be blunt here, as the legislative agenda presses itself upon us.

I’ve discussed this issue – in public where possible and in private when there was no other option – with top finance experts, leading lawyers, preeminent bankers (including from TBTF institutions), and our country’s most prominent policymakers…

r. Bernanke, with all due respect: there is simply no evidence to support the assertion that, “our technologically sophisticated and globalized economy will still need large, complex, and internationally active financial firms to meet the needs of multinational firms, to facilitate international flows of goods and capital, and to take advantage of economies of scale and scope,” at least if this implies – as it appeared to on Saturday – we need banks at or close to their current size.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.