Slime in the Ice Machine
For the last 30 years of his life, Mr. Zindler was a television news reporter with channel KTRK in Houston. Zindler was famous for his 1973 story which led to the demise of the Chicken Ranch near La Grange, ultimately inspiring a Broadway musical, stifling the area's unofficial tourist industry, and giving Burt Reynolds a shot at another hit movie before resuming work on "Smokie and the Bandit III." Zindler's specialty was consumer affairs, but his most popular work came to be known as the "Rat and Roach Report." Here, Zindler shared with viewers details from health inspector reports on Houston's restaurants. The segments weren't for those with weak stomachs, and no doubt the city's restaurant owners got queasy each time Zindler and his silver toupee appeared on the evening news. Often, after reviewing the cleanliness of the work areas, or determining whether there were signs of rodents passing through the kitchen, Zindler would utter his trademark line, "and there was slime in the ice machine!" Because Marvin Zindler wasn't afraid to call a slime "a slime," I think he would have been skeptical of so-called financial innovation early on. After all, more complicated is not necessarily better. Ask anyone over fifty with a new a cell phone. Alan Greenspan, of course, loved financial innovation more than he loved pontificating - unless he was pontificating on financial innovation. In a May 2000 speech he was doing just that and said: The rising share of financial services in the nation's national income in recent years is a measure of the contribution of the newer financial innovations to America's accelerated economic growth. Derivatives and private equities have been in the forefront of the recent financial expansion, fostering the financing of a wider range of activities more efficiently and with improved management and control of the associated risks. Wake up, there's more: Nonetheless, some find these developments worrisome or even deeply troubling. The rapid growth and increasing importance of derivative instruments in the risk profile of many large banks has been a particular concern. Yet large losses on over-the-counter derivatives have been few. Derivatives possibly intensified the losses in underlying markets in the liquidity crisis during the third quarter of 1998, but they were scarcely the major players. Credit losses on derivatives spiked but remained well below those experienced on banks' loan portfolios in that episode. Blah, blah, blah. Here it appears that the former Fed chairman is so enamored with derivatives that he preferred them to the real thing. Why waste capital on a real bank loan when there are so many modern alternatives? Sure, lots of adolescents would rather text message a pal ten feet away than talk with them face to face. But that's why they are called "adolescents." Alan Greenspan was the Fed chairman, and his enthusiasm for the new-fangled should have been as tempered as his answers to simple yes or no questions. Certainly there was a lot about securitization that was attractive – from a bank's point of view. In this week's issue of The Deal magazine, Vipal Monga reviews these pleasantries: Banks able to offload risk in securitized mortgage and corporate loan markets could charge lower rates by cutting the risk premium they had formerly charged for holding the debt. That, in turn, gave access to a wider swath of borrowers to the debt, allowing private equity firms to load up on cheap financing for acquisitions, and lower-income Americans to borrow enough to buy homes. The astute reader, or any reader able to fog a mirror, will see from the above that risk has not been eliminated under this arrangement. In fact, while it has, admittedly, been spread around, risk in the system has increased. As Mr. Monga writes, "... diffusing risk doesn't actually reduce it." Just because you can't see the ice box doesn't mean there's not slime in there. Besides, according to IMF bigshot John Lipsky, not as much risk was placed outside the traditional banking system as many believed. He figures that banks themselves bought lots of securitized paper as did their SIVs. And even though banks don't own all the paper, it's not as if problems in a financial instrument held elsewhere have no relationship to that same financial instrument held on the bank's balance sheet. That's why those Too Big To Fail Banks didn't blow out the assets in their SIVs – they would have knocked down the prices of the very securities that resided in plain view. And besides that, banks weren't shy about loaning money to other players in that market. Mr. Monga quotes Andrew Senchak of Keefe, Bruyette & Woods who points out, "The money to buy CDOs, CLOs... had to come from somewhere." When reading IMF's Lipsky, it's evident that the risk to the financial system from unregulated, sophisticated products has been around for some time. It's evident because he comes right out and mentions some of these earlier instances and notes that "What happened during these earlier instances is similar in many ways to the events of the last couple of months: Issuance of sophisticated products grew so rapidly that market capacity implicitly became stretched. When uncertainty about pricing relationships increased, liquidity dried up and price gaps appeared, further boosting market volatility and raising uncertainty." No kidding... Mr. Senchak also points out what Marvin Zindler would have surely known - that fewer crummy mortgage loans would have been made (and fewer crummy mortgage products sold) if their final resting place was the balance sheet of the lender. Mr. Monga has a great quote from an un-named banking insider that addresses this very issue: "If you don't have to eat what you've cooked, then you'll pay less attention to what you're cooking." To argue otherwise is to argue that Houston restaurateurs would keep slime out of the ice machine out of compassion for their patrons. Marvin Zindler knew differently. If only we could have said the same for Alan Greenspan. ***
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If Marvin Zindler were alive he would have seen this coming. That is, if he were a Fed governor instead of a news reporter.