News Analysis: Up 420 Points! Down 293 Points! Up 261 Points! Down...?

By Richard Hylton
Friday March 21, 2008

It’s called the stock market, and that’s what the past few days have been like on Wall Street. Go easy on yourself if you have no idea what is going on and who is responsible for it. Sure, you’ve heard lots of people talking about “market meltdown” and “major banking crisis,” but how did we get to a worldwide financial crisis so quickly? It seems like only yesterday that Berkeley’s 1920s shingle houses were flying off brokers’ shelves for a paltry million each. And sure, a lot of people got mortgages that they couldn’t really afford. But the biggest financial crisis since the Great Depression? 

A few clarifying points: First, the crisis in mortgages is not nearly over and it is not only the so-called “sub-prime” sector of mortgages that is tallying up increases in late payments, missed payments, and foreclosures. Many well-off folks also bit off more than they can chew. Second, we are no longer facing “just” a mortgage crisis: The value of many securities in institutional portfolios all over the world is now suspect. The MIT math whizzes on Wall Street have sliced and diced all kinds of assets and liabilities and then repackaged them as securities with clever-sounding acronyms. These securities have been sold to banks, pension funds, money-market funds, hedge funds, and governments all over the world. Now that many of these securities seem to be far riskier and far less valuable than represented, every financial institution is seen as vulnerable. Result: No one wants to lend any money to anyone else. For all they know, that other guy might already be insolvent.  

If there is a single individual and a single institution that should take the lion’s share of blame for this mess they are Alan Greenspan and the Federal Reserve Bank. A central function of the Fed is to regulate the terms on which credit is extended in our economy. That means the Fed should have stepped in sooner to curb the reckless underwriting standards and crazy-quilt loan terms that banks were using to rake in enormous fees. But it didn’t. Neither did the comptroller of the currency, another regulator whose job is to make sure that banks are stashing away enough capital for economic dark days. These and other federal regulators, especially the Securities and Exchange Commission, Wall Street’s regulator, sat idly by for years as too much cheap capital was creating unsustainable booms in asset prices and the amount of debt throughout the financial system had risen to code-red levels.  

Only three days before the Federal Reserve felt compelled to bail out Bear, Stearns & Co., the failed Wall Street investment house, or face the possibility of collapsing banks and investors throughout the economy, Christopher Cox, chairman of the SEC, assured reporters that his team was on top of it and they had full confidence in Wall Street. He assured reporters that the SEC was monitoring Wall Street firms’ capital position on a “constant” basis. 

“We have a good deal of comfort about the capital cushions at these firms at the moment,” Cox said. Three days later the Federal Reserve agreed to buy $30 billion of the worst securities on Bear Stearns books and arranged a shotgun wedding between J.P. Morgan Chase & Co. and Bear Stearns. If it hadn’t, Bear Stearns would have gone down in ruins in a bankruptcy filing. 

The SEC was asleep at the wheel, but Greenspan was the main apologist for Wall Street and the banking system. He repeatedly assured Congress and the public that allowing the markets to do whatever they wanted to do was fine because an unfettered market was undoubtedly more efficient than one that had the regulators peering over its shoulder—despite the fact that history, and the Fed charter, strongly support the belief that left on their own, banks and investment houses will drive themselves and the rest of us off any precipice that promises great fortune. Does anyone remember the S&L crisis? Talk about deja vu all over again. 

Don’t expect the financial markets to settle out anytime soon. Institutions all over the world have still not recognized that they have billions in losses. Their books are still inflated by Wall Street securities that may be worth only 50 or 60 percent of what they paid. Folks with adjustable rate mortgages are still seeing their payments rising. Vast amounts of debt and hidden risks in derivative securities still loom over financial companies. And corporate pension funds are still egregiously underfunded by the companies that promised their workers secure retirement plans. 

There are a few things you can count on, though: First, more taxpayer money will be used to bail out the reckless investors, banks and financial houses, without securing any benefits for the taxpayers. And when this crisis is all over and the buying and selling and slicing and dicing begins again, Wall Street and the banks will begin whining that too much regulation is what’s wrong with America.