The Banksters

Some of the most interesting stuff in D.C. is going on at the Federal Crisis Inquiry Commission. Here is the link. Check out some of the stories in the news section. The most puzzling thing is how few media are covering it. If we are to make sound policy decisions, we need to know the causes of the financial crisis. This is still very much in dispute.

Here is a recent story on FCIC hearings.# At dispute are not only the causes of the crisis, but the remedies. Specifically, the taxpayers bailed out AIG who bailed out the big banks that were part of the cause of the crisis, particularly Goldman Sachs and Societe Generale (a French bank). AIG had sold them credit default swaps, which were "insurance" on their investments. If AIG had gone bankrupt, these would have been worthless. Yet federal regulators paid 100 cents on the dollar on these claims after the taxpayers bailed AIG out. This smells of insider dealing, particularly between the big banks and the New York Fed (led by Geitner). I have not found a persuasive argument for why they did this.

We need to go back to the days of the initiation of TARP to find some of the answers. It is interesting how Lehman was allowed to fail and Bear Stearns owners got cents on the dollar, yet how Merrill was sold to Bank of A in a questionable deal and Goldman managed to make it through unscathed. Is it just a coincidence that Paulson was the former head of Goldman? And how about Rubin? The fifth large investment bank was JP Morgan which was arguably more cautious. And how did these investment banks manage to change to bank holding companies in the nick of time to be able to gorge at the Fed discount window?

The FCIC is having a forum on the causes of the crisis tomorrow and Saturday. Here is the link to the rough draft of one of the presenters, who argues that changes in the banking industry, specifically the increasing power of shadow banking, led to a panic. But it wasn't a panic of depositors like the 1930's bank failures. It was a panic of institutional investors in the "repo" market.

The whole story is not out there. We should be paying attention to this. We have new books out next month by Michael Lewis, Simon Johnson and Roger Lowenstein which should be interesting. While I tend to see the ultimate results of the Wall Street House of Cards as something that was beyond the vision most of the players, who were also drinking the kool-aid,* the way AIG was handled troubles me deeply. This was after the crisis hit and it looks like a huge rip-off of taxpayers.

While many predicted the housing bubble, almost nobody saw the ultimate results of the bubble's burst. Perhaps the most prescient was Nassim Taleb, who published Fooled by Randomness in 2004. There he argued that the quants on Wall Street had deceived themselves and everyone else by thinking that they could model the risk that traders were taking. We already had this happen in 1998 with Long Term Capital Management. Why didn't those in the know learn from that episode? There are many questions and few very persuasive answers in this whole tale.

*There was a good article in Economist's View Feb. 18 on how insiders could be so self-deceived.

#I can't figure out why this link is failing. It was an article on Feb. 23 at bloomberg.com by Richard Teitelbaum. I posted in on my Facebook page. Hat tip to my friend Scott for the article.