Christopher MarkowskiArticle, Research & The EconomyLeave a Comment

One of the most beautiful places I have had the opportunity to visit is the Greek island of Santorini. I am well-aware of my own limitations as a writer; therefore I do realize I do not have the descriptive abilities of a John Steinbeck, so I will not even attempt to illustrate how striking the place is. Instead I want to discuss the ancient inhabitants of the volcanic islands and their mysterious disappearance.

The island itself is essentially a crater formed by a volcanic eruption that occurred around 1650 BC that some scientists link to the biblical plagues that Moses wrought on Egypt. Prior to the epic eruption (one of the greatest in history), there was a civilization that inhabited the island, a nation called Thira, with an estimated population of upwards of 30,000. Archeological excavations that started in 1967 have uncovered that the Thirans were an advanced culture in regards to art, architecture and even indoor plumbing.

What the site doesn’t reveal is what is most striking; no jewelry, gold, valuables, and most fascinating, no people. One would assume that you would find some victims of one the greatest volcanic
eruptions in history in a manner like the victims of Mt. Vesuvius at Pompeii. Even more mysterious is the fact that there is no evidence of Thirans showing up on the nearby island of Crete or anywhere else in the Mediterranean, which has led to the speculation that Santorini was the lost city of Atlantis.

Where did everyone go?

The strongest and most probable theory was that despite all the usual volcanic warnings that something wicked this way comes, the Thirans despite their obvious intelligence chose to ignore what was transpiring in front of their very eyes.

What’s the big deal…So what, a couple of eruptions here and there, everything will be fine. It’s just a little smoke and ash, pass the ouzo.

Life was too good, so these very smart people decided to ignore warnings of their own demise. They decided to view their situation not as it was, but rather how they wanted it to be.

Does this at all sound familiar?

How many warning signs (eruptions) have we been witness to over the past several years. Why did Wall Street and Washington choose to ignore it? In this piece I will attempt to explain the factors that have led us to where we are today. I find it very unfortunate that in an attempt to find a single boogey-man to place the blame, many of the substantive reasons for the credit crisis have been completely ignored.


Fannie Mae, Freddie Mac and their Enablers

A great comparison can be made regarding the failure of these two financial oxymorons, similar to the collapse of the USSR’s centrally planned economy. A walking, talking economic contradiction that was kept alive for decades, before falling apart completely with corrupted politicos and their henchmen economists claiming everything was working marvelously all along the way. We are hearing calls across the fruited plain from these very same politicos, in an all-out cover your derriere mode, that the reason behind the collapse was lack of regulation, or the Bush card (when in doubt blame Bush). Never let facts get in the way of a good excuse.

In the 1990’s the administration put the Community Reinvestment Act, which was a Carter era law (1977) that compelled financial institutions to make loans to poor borrowers who often cannot pay them back. This forced many lenders into high-risk areas where they had no choice but to reduce their lending standards to make loans that reasonable lending practices would deem ridiculous. The government pulled a Luca Brasi (making an offer they couldn’t refuse) on the lenders; either sign off on the loans or face the consequences. Banks could also face the wrath of Mr. Shakedown himself, Jessie Jackson, and his trusty sidekick Al Sharpton. This anti-logic, anti-capitalism pressure led to the birth of all those exotic mortgage products which are now deemed predatory.

Commencing in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers. In 1996 the Department of Housing and Urban Development (HUD) gave Fannie and Freddie a dubious target, 42% of their mortgage financing had to go to borrowers with income below the median in their area. That target increased to 50% in 2000 and 52% in 2005. In 1996 HUD required that 12% of all mortgage purchases by Fannie and Freddie be “special affordable” loans targeted to individuals with income less than 60% of their area’s median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was 28%.

The one and only thing that Fannie and Freddie did get right was that between 2000 and 2005, they met those goals, funding billions of dollars in loans, most of them subprime, adjustable-rate and made to borrowers who put less than 10% down.

The Wall Street Journal reported that Fannie and Freddie went on a shopping spree worthy of any dumbass trust fund twit, buying billions of subprime securities for their own portfolio in an effort to make money and help aide their HUD mandates. This led to an unrealistic demand for subprime securities which was akin to throwing gasoline on a fire. With the implicit guarantee of an Uncle Sam backstop, why not buy these unrealistic high yield securities?

Freddie and Fannie were for all intents and purposes, the mortgage market. If there wasn’t a market, they conjured it out of thin air with the full backing of Uncle Sam. Franklin Raines the former CEO of Fannie Mae, while being grilled by some reformers in Congress stated that his buying of mortgages were essentially “riskless.” The reality is that these “riskless” investments would only remain so if housing prices would continue to rise. If they happened to fall, the whole scheme would implode.

I wish I could open up a Government Sponsored Enterprise (GSE) like Freddie and Fannie. I wouldn’t even need to run it, I could get my six year old son Stephen to do it and he would still have plenty of time for soccer, kindergarten and superhero playtime. Step one: Borrow money from the government at below market rates. Step two: lend that money out at much higher rates, all with an implied Uncle Sam guarantee. That’s easier than opening a lemonade stand. In fact, we would have been better off if Stephen was at the helm. Franklin Raines took over Fannie in 1999. He looted over $100 million in compensation by the time he was ousted in 2005 for overstating earnings and hiding losses so he and his other buddies, Janet Reno and Jamie Gorelick could reap another $75 million. Fannie eventually had to pay a $400 million fine while promising to make changes. So, in reality we the tax-payers paid the fine.

What happened next was surreal…

Peter Wallison, the SEC’s chief accountant told Franklin Raines that Fannie’s position on the relevant accounting issue was not even “on the page” of allowable interpretations. Alan Greenspan told Congress how important it was for Congress to act quickly to deal with Fannie and Freddie’s problems, “If Fannie and Freddie continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate aversion, they potentially create ever-growing potential systemic risk down the road. We are placing the total financial system of the future at a substantial risk.”

After the Raines scandal, for the first time ever, a reform bill passed the Senate Banking Committee. The bill would have allowed for a new regulator with the power to oversee the doings of Fannie and Freddie and require the companies to eliminate their investments in high risk assets. Kevin Hassett writes in Bloomberg that if that bill had become law, then the world today would be quite different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed. The bill did not become law, for a simple reason: Democrats opposed it on a party-line vote in the committee.

Hassett continues, “Now that the collapse has occurred, the roadblock built by Senate Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly did so for honorable reasons. But we now know that many of the senators who protected Fannie and Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd, have received boggling levels of financial support.”

When President Bush signed the housing and Fannie Mae bailout bill back in July after the Senate passed it with 72 votes, a largely unreported part of the story aside from the Wall Street Journal, was the fact that Majority Leader Harry Reid refused to allow a vote to bar political donations and lobbying by Fannie and Freddie. Some of Fannie Mae’s cash recipients include the Brookings Institution, Rainbow Coalition (Jessie Jackson’s shakedown outfit), Congressional Black Caucus Foundation, Congressional Hispanic Caucus Foundation, and the quasi-communist organization and now infamous Acorn.

Another departure point and enabler of Fannie and Freddie was the tenure of Andrew Cuomo as secretary of Housing and Urban development. Wayne Barrett explains in the Village Voice how Andrew Cuomo, the youngest HUD secretary in history, with zero banking experience made a series of decisions between 1997 and 2001 that laid many bricks in the foundation of the current crisis. His actions helped to plunge Fannie and Freddie headfirst in to the subprime markets without putting in to place the means to monitor their increasingly risky portfolio.

Barrett writes, “He turned the Federal Housing Administration mortgage program into a sweetheart lender with sky-high loan ceilings and no money down, and he legalized what a federal judge has branded kickbacks to brokers that fueled the sale of overpriced and unsupportable loans.” In an unbelievable stroke of ignorance which has come to symbolize his campaign, John McCain actually tapped Cuomo as a possible head of the SEC in his administration.

The Nefarious Relationship Between Wall Street and Washington They went to the same schools. They are members of the same clubs. They golf together. They hitch
rides on each other’s private planes. Politicians love Wall Street. Despite the occasional perp-walk hearing, where our fearless leaders wag their fingers at their own campaign contributors, below-market cheap mortgage providers and golfing buddies; Wall Street and Washington are the best of friends. The biggest and best parties thrown at both the Democratic and Republican conventions this past year were courtesy of Fannie and Freddie, the big investment firms and the auto makers. Gee, I wonder who got bailouts and loan guarantees?

The Federal Reserve and the Securities and Exchange Commission

Two things, EASY MONEY & LEVERAGE! From 2003 to 2005, the Federal Reserve held interest rates below the level of expected inflation which in turn creates a subsidy for debt which was utilized by homeowners, businesses and financial companies. If easy money was a small fire, leverage is the
gasoline poured on top. In 1996 Alan Greenspan gave his famous “Irrational Exuberance” speech warning of a bubble forming in the equity markets. I believed at that point that Greenspan should have raised the margin requirements on the purchase of stocks which was and is set at 50%, taking the gasoline away from the fire; he didn’t and eventually like all asset bubbles it popped. After getting their proverbial tails handed to them by the dotcom bust, Americans turned to real estate. Fueled by easy money, leveraged securitized bonds that transferred risk and a Federal Reserve chairman named Alan Greenspan that repeatedly stated that housing was a safe investment, it was off to the races.

In a brief meeting held on April 28, 2004, five members of the Securities and Exchange Commission met in a basement hearing room to consider a proposal by the large investment banks. They wanted to be exempted from an old rule that limited the amount of debt they could heap on their balance sheets. This would allow for billions of dollars in funds to be utilized in the brand new and at that time very lucrative mortgage backed securities business. The New York Sun interviewed former SEC official Lee Pickard, who stated this rule change in 2004 was a major factor in the current banking crisis. The SEC allowed five firms, Lehman Brothers, Bear Stearns Merrill Lynch, Goldman Sachs, and Morgan Stanley (three of which no longer exist) to more than double
the leverage they were allowed to keep on their balance sheets and remove discounts that had been required to protect them from defaults. The desire to repeal the net capital rule, which was created in 1975 to allow the SEC to keep an eye on broker-dealers that trade securities for their customers as well as for their own accounts was paramount to the executives at the big firms champagne wishes and caviar dreams. The net capital rule required broker-dealers to limit their debt-to-net-capital ratio to 12 to 1, plus the caveat of having to warn the SEC if this threshold was approached. If exceeded, they would be forced to stop trading. Using computerized models, the SEC under its new Consolidated Entities program allowed the broker dealers to increase their debt-to-net-capital ratio to as high as 40-1!

The big bad investment houses that I have been taking out to the woodshed and warning people about for years have not been rolling out products or providing a service. In fact they have not even operated in  the best interests of their shareholders and increased value. Wall Street has become completely selfserving in that it serves only to maximize employee compensation. For example: Lehman Brothers bonus pool, after the company went under is over $2.5 billion. John Thain, Thomas Montag, and Peter Kraus are getting $200 million for one year’s worth of work at Merrill Lynch when the end result was a shotgun marriage with Bank of America. Daniel Mudd, former CEO of Fannie Mae, is taking $9.3 million for aiding and abetting the destruction of his company. Richard Syron, the CEO of Freddie Mac, is getting $14.1 million because of a clause he added to his employment contract this past July when it was apparent that the company was going down in flames. The total bonus pool for Wall Street’s five biggest firms, wasmore than $3 billion paid to its top executives over the past five years. I could go on and on, but I think you get the picture. These CEO’s had their bonuses and pay based upon firm leverage of 40 to 1. Fake numbers, fake earnings and they all know it. These pay packages amount to outright fraud and should be dealt with accordingly.

Keeping Up With the Jones’s

Last time I checked this country was based upon the notion of personal responsibility. I have not heard of any reports of mortgage brokers holding a gun to anyone’s head and forcing them to take out a loan they could not afford. If you went out and bought five pre-construction condos with the notion that you would be able to flip them in a couple of weeks for a big profit, well…you speculated, and lost. If you decided to use your home as a personal bank, to buy stuff you don’t need, I hoped you learned a lesson. American’s need to take a long look in the mirror and understand that they aided and abetted this mess as well.


The large investment houses/banks need to be broken up. If you want to be in the business of managing money and helping investors on Main Street, you should not be building toxic waste highly leveraged collaterized debt obligations in the office down the hall. Despite all the nefarious dealings of the late 1990’s that we covered extensively, at least the firms managed to create some value. Drug dealers get thrown in jail for selling harmful substances to the citizens, toxic paper pushers should share the same fate. Leveraging subprime mortgages 40 to 1, paying off the ratings agencies to put their AAA seal of approval on them and selling them to retirement accounts and pension funds worldwide is just plain evil.

The current plan as of 10/14/08 (it changes quite a bit) is out of the old Alexander Hamilton playbook. It’s as if Hamilton has decided to rise from his resting place at Trinity church in downtown New York and is taking the reins. The credit markets are frozen; nobody wants to do business with anyone because nobody trusts anyone. The word credit comes from the Latin word credere which means, to believe, or to entrust. What the world’s governments are doing is reestablishing credere. That credere is coming with a hefty price tag. The quasi-nationalization of banks is not without precedent, but definitely presents a litany of moral questions.

Using the classic board game Monopoly as a guide, where the banks were once dynamic, like theproperties, Boardwalk and Park Place, have now becomes the boring railroads and utilities. What I think and hope will happen over the next couple of years, is that we will see a resurgence of the old school boutique investment bank and venture capital firm. I foresee many of these big banking institutions spinning off these businesses which will be fantastic for job growth and our economy, unless of course we are hamstrung by more taxes and Sarbanes-Oxley type legislation.
A great example of the modern world and how it has changed was on display this past month when the

Irish government decided to insure all bank deposits. A flood of capital raced to Ireland on that news.Soon after, other European governments followed suit to prevent capital from rushing out the door. We must realize that we compete on a global scale, and where we do have many significant advantages to other countries around the globe, our tax-code and regulation is not one of them. The corporate tax-rate in the United States is the second highest in the industrialized world. Businesses have significantly more options than they did even ten years ago. We need to become competitive in this arena again. We also really need to revitalize and energize Wall Street to once again be able to take on the important task of fueling our economy, and aiding in building the hopes and dreams of our entrepreneurs.

Source Material:
Randall Tom & McGee Jamie Wall Street Executives Scored $3 Billion as Banks Rose And Fell Bloomberg 9/26/08
Johnson Glenn Frank Says GOP Housing Attacks Racially Motivated Associated Press
Grant James Why No Outrage Wall Street Journal 7/19/08
Blodget Henry Outrageous Severance Deals Paid For By You The Business Sheet 9/7/08
Keehner Jonathan Merrills Thain May Get $200 Million for Year Bloomberg 9/16/08
Prosser David Fury at $2.5 Billion Bonus for Lehmans New York Staff Independent 9/22/08
Barrett Wayne Andrew Cuomo and Fannie and Freddie Village Voice 8/05/08
Gilbert Mark Credit Crunch Villains Should Own Up Do Penance Bloomberg 8/14/08
Hassett Kevin How the Democrats Created the Financial Crisis Bloomberg 9/22/08
Novak Michael Our Horrible Economy National Review 7/17/08
Times Staff The SEC Rule that Banks Pile on Debt The New York Times 10/3/08
Editorial Fannie Maes Political Immunity Wall Street Journal 7/29/08
Roberts Russell How Government Stoked the Mania Wall Street Journal 10/3/08
Times Staff Clinton Signs Legislation Overhauling Banking Laws The New York Times 11/13/99
Antilla Susan Greedy Brokers Lying Borrowers Drank Subprime KoolAide Bloomberg 7/31/08
Editorial A Mortgage Fable Wall Street Journal
Blake David Greenspans Sins Return to Haunt Us Financial Times 9/18/08
Mavin Duncan Milken Astounded by Wall Street Crisis Financial Post
Satow Julie Ex-SEC Official Blames Agency for Blow-Up of Broker Dealers The New York Sun 9/18/08
Smith Elliot Race to Bottom at Moody’s and S&P Secured Subprime’s Boom, Bust Bloomberg 9/25/08
Lucchetti Aaron S&P Email We Should Not Be Rating It Wall Street Journal 8/2/08
Editorial The Real Culprits In This Meltdown Investors Business Daily 9/15/08

Leave a Reply

Your email address will not be published. Required fields are marked *