Phil Gramm’s Evisceration

The Wall Street Journal has an interesting opinion piece by none other than Phill Gramm this weekend.  It begins thus:

"The debate about the cause of the current crisis in our financial markets is important because the reforms implemented by Congress will be profoundly affected by what people believe caused the crisis."

Oh good.  You intend to talk about what people believe caused this crisis, instead of what did cause it?

Fantastic Phil.  This is going to be amusing.

I believe that a strong case can be made that the financial crisis stemmed from a confluence of two factors. The first was the unintended consequences of a monetary policy, developed to combat inventory cycle recessions in the last half of the 20th century, that was not well suited to the speculative bubble recession of 2001. The second was the politicization of mortgage lending.

Politicization of mortgage lending?

You mean to tell me that the creation of 2/28, 3/27 and OptionARM loans was the result of politicization of mortgage lending?

Oh boy, this is a good one.

The 2001 recession was brought on when a speculative bubble in the equity market burst, causing investment to collapse.

The speculative bubble in the equity market burst Mr. Gramm because the companies in the Internet space were making knowingly inflated statements about their prospects for growth and in fact factually incorrect statements about demand growth after the first "burst" of adoption of the technology took place. 

This is not conjecture, it is a fact – a fact that I outlined several times leading up to the bust.  It was the reason that I, as CEO of MCSNet, refused to finance any of my equipment, refused to take any debt whatsoever in the operation and expansion of my enterprise and refused to get involved in what I knew for a fact was a game of Russian Roulette – with five bullets.

Nonetheless I was able to operate that company with greater than a 40% pretax operating margin for more than five years, while at the same time having 100% ownership and payment for every piece of hardware we had – all of it paid for in cash.  I’ll take it.  That’s called an honest profit which is something that fewer than 1% of the firms in that space could lay claim to.

Buyers bought houses they couldn’t afford, believing they could refinance in the future and benefit from the ongoing appreciation. Lenders assumed that even if everything else went wrong, properties could still be sold for more than they cost and the loan could be repaid.  This mentality permeated the market from the originator to the holder of securitized mortgages, from the rating agency to the financial regulator.

There’s the money quote right there.

Banks made loans they knew could not be repaid on the original terms, and thus were not mortgages – they were rental contracts.  They sold them to consumers under false pretenses; a mortgage is an amortized loan that leads to ownership of the underlying real estate.  A loan that is intended to be refinanced, terminated or abrogated at some date in the future is not a mortgage, it is a lease.

Consumers did not buy houses they knew they couldn’t afford, they were sold those houses and the mortgage that came with them.  That sales job was performed by people who by your own admission knew that the mortgage was never going to be paid under the original terms on its face – that doing so was a mathematical impossibility.

Mr. Gramm, as someone who claims to understand finance, you of all people should know that the law of exponents does not permit the fanciful view you claim bankers had above to be the case. 

Advancement in income is a known, published fact – the government puts out this number for personal income (annualized) every month.  It is not possible for home prices to continually advance at a rate that exceeds the growth in personal income, and to the extent that it does, compounding (that is, the mathematical law of exponents) guarantees that a collapse will eventually take place.

GLB [Gramm-Leach-Bliley Act] repealed part of the Great Depression era Glass-Steagall Act, and allowed banks, securities companies and insurance companies to affiliate under a Financial Services Holding Company. It seems clear that if GLB was the problem, the crisis would have been expected to have originated in Europe where they never had Glass-Steagall requirements to begin with.

Psst: Northern Rock and Iceland.  I rest my case.

Moreover, GLB didn’t deregulate anything. It established the Federal Reserve as a superregulator, overseeing all Financial Services Holding Companies.

That same Federal Reserve then proceeded to remove all reserve requirements through various machinations with sweeps and most recently lobbied for (and got, in the EESA) authority to set reserve levels to zero!

Never mind that this "authority" has been roundly abused by issuing "23A Exemption" letters like Girl Scout Cookies at a kid’s convention to anyone who asks, thereby eliminating the supposed "regulation" and "oversight" that they were supposed to maintain over financial institutions.

In point of fact several of the firms that failed, including Wachovia, received 23A Exemption letters supposedly for the benefit of their stability.  In fact each of those 23A letters explicitly says that they are in the public interest, as granting them requires such a finding  How did that work out, exactly? 

Does "boom" count as success or "in the public interest"?

And yet, with the notable exception of Mr. Greenspan’s warning about the risk posed by the massive mortgage holdings of Fannie and Freddie, regulators seemed unalarmed as the crisis grew.

That’s right!  GLB – your law Mr. Gramm, as it bears your name – gave power to an organization that immediately abused it and refused to discharge its duties.  Yet there was no check and balance in that legislation, no "stick" to go with the "carrot", and the consequence was disaster.

The ultimate cause of the "blow-off top" in housing prices was excessive leverage.  So was the underlying cause of the business failures in the banking and finance system. 

Every single one of the firms that has failed – Fannie, Freddie, AIG, Lehman and Bear Stearns – was operating with more than double the previously-lawful limit of 14:1 leverage at the time of their collapse. 

All of them.

That limit was removed due to explicit lobbying by Henry Paulson (then in charge of Goldman Sachs) in front of Congress and the SEC in 2004 – after being rejected on the very same request in 2000.

The fact of the matter, Mr. Gramm, is that absent excessive leverage credit bubbles cannot grow to a dangerous size.  Leverage limits prohibit that growth by constraining the ability to grow a balance sheet beyond what tangible capital will reasonably support.  The housing bubble, LBO bubble, commercial real-estate bubble and consumer credit bubble had all reached their limit under the previous leverage ratio caps around the 2004 time frame, and so the banking industry went to Congress and the SEC and asked for it to be removed, claiming that they were "better able to manage risk."

We now know that this was a fancifully-false assertion; all removing the leverage limits did was give the bankers the ability to skim off a few hundred billion more for their homes in the Hamptons and yachts while ordinary Americans were sold loans that the bankers knew could not possibly be repaid on their original terms.

Mr. Gramm, you are rapidly making a total fool of yourself.  Do you remember this quote?

"You’ve heard of mental depression; this is a mental recession," he said, noting that growth has held up at about 1 percent despite all the publicity over losing jobs to India, China, illegal immigration, housing and credit problems and record oil prices. "We may have a recession; we haven’t had one yet."

"We have sort of become a nation of whiners," he said. "You just hear this constant whining, complaining about a loss of competitiveness, America in decline" despite a major export boom that is the primary reason that growth continues in the economy, he said.

"We’ve never been more dominant; we’ve never had more natural advantages than we have today," he said. "We have benefited greatly" from the globalization of the economy in the last 30 years.

Still trying to duck responsibility for what you’ve done, eh Phil?

You might get a pass from the "mainstream media", but you sure as hell won’t get one from me.  I suspect those who have seen fully half of their 401k and IRA money disappear in a puff of smoke or have lost their job and/or home won’t be as charitable as The Journal was in publishing your crass attempt at historical revisionism either.