Bankers Stare into the Abyss
The last year has not been kind to bankers. Many of them probably feel like the whole world has turned against them. Regulators and auditors are crawling all over them. They are facing massive write downs in their portfolios. Loan defaults and foreclosures are rising at an unprecedented rate. They are forced to go begging investors all over the world for more equity capital just to survive.
By some estimates, such as those of noted economist Nouriel Roubini of NYU's Stern School of Business, banks may face over $1 trillion of losses and write downs from this credit crisis and as many as 1,000 US banks will fail. Nobody knows how severe this banking crisis will be or when it will end, and there are those who say it will be resolved a lot more quickly and less painfully than expected. Regardless of what happens in the future, what can lenders and borrowers learn from this crisis so that we don't find ourselves in this mess again for a long time?
There is a lot of blame to go around. The Federal Reserve failed to properly regulate the banking system and kept interest rates way too low for way too long to avoid being criticized for the recession that was caused by the previous stock market bubble of the late 1990's. Lenders became originators and salesmen and threw out the underwriting process because they believed there would always be a greater fool to buy even the worst loan and remove it from their balance sheet. Borrowers believed asset prices would rise forever and didn't want to be left behind while everyone else was getting rich by borrowing as much as possible to speculate. Nobody cared that it was a bubble. Everyone just wanted to get theirs.
There is a common theme to all of this. Everyone throughout the financial system was suffering from a simple lack of character. Although there were excesses in Europe and all around the world, by far the worst excesses in this credit bubble were here in America. We need to ask ourselves why this happened here so much worse than everywhere else. On this topic, the head of the Swiss central bank said recently, "What is going on in the American economy is unbelievable and shameful." What is he talking about?
I think he was talking about our financial system, which for too many years has excessively rewarded extreme risk taking, especially on Wall Street, and has failed to sufficiently punish recklessness, incompetence, and even outright dishonesty. In fact, on too many occasions, bad behavior has gone completely unpunished or even rewarded. A great example of this recently has been the enormously lavish severance packages given to Wall Street CEOs who completely destroyed the balance sheets and possibly the entire futures of their respective companies.
What does it say about the character of a financial system that pays someone $150 million for destroying a company that he was hired to lead?
With this kind of example being set in the corporate boardrooms and on Wall Street, is it any surprise that so many Americans, even those who can afford it, see no reason to continue making their mortgage payments if they no longer have equity in their homes? This credit crisis in America, at its most basic level, is a crisis of character in this country, and character begins at the top. Alan Greenspan's and Ben Bernanke's refusal to accept responsibility for their obvious and horrendous failures of regulatory oversight and interest rate determination has trickled down to Wall Street and Main Street CEOs who gorge themselves on generous pay packages even as their companies sink into oblivion. That same lack of character has trickled down to bankers who see no reason to honestly underwrite loans or to take responsibility for their mistakes and honestly mark assets down to current market value. Borrowers, similarly lacking in character, frequently will not even consider trying to pay back a loan unless doing so in their own best interests. The basic concepts of responsible regulation, compensation, lending, and borrowing were largely thrown out the window for many years and this credit crisis is the inevitable and disastrous result of that reckless process.
How can we reverse this process and get our financial system back on track? Some people think government bail outs are the answer. While there is no doubt that the government must offer some assistance to save Fannie Mae and Freddie Mac and stabilize the system, this is not the answer to our problems. I believe the real answer and antidote to future crises like this is for some people at the top of our financial system to start setting an example for everyone else and take some responsibility for their mistakes.
Here are a few of specific suggestions that I think would be very helpful and send the right message to the country. Alan Greenspan should make a public apology and donate all of his book proceeds and speaking fees to a charity that helps families who have lost their homes in foreclosure. Ben Bernanke should immediately resign and recommend that Paul Volcker, the last successful Fed Chairman, take over his job. Stan O'Neal and Chuck Prince should return all of their severance packages to the shareholders of Merrill Lynch and Citibank. Dick Fuld, the CEO of Lehman Brothers, and Kerry Killinger, the CEO of Washington Mutual, should resign and accept no severance. I am not saying that any of these individuals are bad people. I do not know any of them personally, and I will give all of them the benefit of assuming that they are all wonderful people. However, I think they are all very high profile examples of people who made horrible errors in judgment and have failed to take responsibility for those errors. We cannot begin to heal our financial system until people at the top start setting an example for the rest of us. How can we ask a struggling family to keep making their mortgage payments instead of walking away if the people at the top who created the system that caused this mess do not take responsibility for what they did?
Bankers are staring into the abyss. Will they find their character? I hope so.
Christopher Grey and his partners pursue opportunities in distressed real estate.
September 08, 2008