2008's Eight worst ideas
Posted Dec 27th 2008 4:45PM by Peter Cohan
Filed under: Amer Intl Group (AIG), Federal Reserve, Financial Crisis
It looks like America has shut down until 2009. And that's probably a good idea because there were so many bad ones in 2008. Bad ideas are like vampires. They charm their way into the good graces of a host society and then they suck the blood right out of them.
Although they all didn't just pop into our lives in 2008, these eight ideas reached a peak of awfulness in 2008:
Deregulation is good.
The wave of deregulation that started in the early 1980s has created enormous problems for society. Sure there were some bad regulations on the books, but just one deregulated industry -- the $62 trillion Credit Default Swaps (CDS) market -- has cost taxpayers hundreds of billions of dollars in the bailout of American International Group (NYSE: AIG).
If you can lend against it, securitize it.
Securitization -- the practice of buying, credit-rating, and bundling loans backed by assets like mortgages, credit card receivables, and leveraged buyout loans -- created the illusion that you could mix risky loans in with safer ones and you could earn above average returns with no risk. Bad call -- securitization has spread toxic waste around the world from Iceland to Whitefish Bay, WI.
Home-ownership is good for everyone.
The hungry maw of securitization created enormous demand for new mortgages. And that led mortgage originators to lend to people who couldn't afford to pay back the loans. The $1.3 trillion subprime mortgage market was born and it grew so big that its collapse refused to remain contained. In 2004 Bush bragged about home-ownership reaching 69.2% -- three million foreclosures later it seems we should be careful what we wish for.
Leverage up your balance sheet
30:1 or more. In 2004, the SEC gave financial institutions (FIs) discretion to borrow more money than they had ever borrowed before. Most banks and hedge funds borrowed as much as $35 for every $1 of equity. If they had used their $340 billion in equity to buy the $13 trillion worth of Mortgage-Backed Securities (MBS) and Collateralized Debt Obligations (CDO), a 3% decline in the MBS's and CDO's value would wipe out the FI's capital.
To cure an economy crippled by debt, add $8 trillion more debt.
The Fed is run by a fellow who styles himself an expert on the Great Depression. He thinks that the Great Depression could have been prevented by pumping more liquidity into the system. So when he sees trouble, he assumes that the thing to do is add more liquidity. In so doing, he takes on over $7.4 trillion in new obligations to bail out financial institutions -- tripling the Fed's balance sheet with toxic waste absorbed from bailed out FIs. Did it work? Not much evidence of it. The economy has been shrinking for a year and $30 trillion in global stock market value has gone up in smoke.
To sell an unpopular idea, terrify people with the alternatives.
Just as America was terrified into invading Iraq with false claims of weapons of mass destruction (WMDs), so was it convinced to spend $839 billion in taxpayer money to buy toxic waste from FIs or heaven help us. Once the sale was closed, it turned out that buying that toxic waste didn't matter after all. The money went instead to buy $159 billion worth of stock in FIs who had no strings attached to the money -- they'll probably spend $16 billion of it on bonuses.
Privatize profit and socialize losses.
The idea of free markets sounds really good. But what does it really mean? We saw that the top nine banks reported $305 billion in profits over the last few years and in 2007 alone, bankers got $32 billion in bonuses. When it turned out that they had to write off $323 billion in bad investments and teetered on the edge of bankruptcy, we discovered that free markets meant that the bankers kept their bonuses while the taxpayers bail them out of their money-losing deals.
Let managers write their own report cards.
We keep making the same mistake over and over again. If Enron's executives did not have the right to make up their own financial statements, it's entirely possible that a responsible auditor - not the now-bankrupt Arthur Andersen -- would have realized that as Enron burned through cash it made no sense for it to be reporting profits. Similarly, if those who had $50 billion invested with Madoff Securities had received their account statements from an independent auditor, they would have known that they were not really earning the 1% per month returns that thought they were getting.
2008 played host to eight vampire ideas. And unless we plunge a spike deep into their hearts, they'll be back to suck our blood in 2009.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits and edits The Cohan Letter. He owns AIG shares and has no financial interest in the other securities mentioned.
bloggingstocks.com |
