In modern life we pay a lot of premiums almost automatically for the convenience of faster commerce, more security, trust and peace of mind in our social and economic lives. Brand names like Microsoft software, Maytag appliances, or State Farm home insurance imply top of the line products or services with implicit warranties of good value and service to be maintained by the vendors over time. So we pay a price premium for their products and services. We vote Republican or Conservative to get less government and frugal, efficient financial management of our taxes.
We also pay a premium to doctors, lawyers, and bankers/financiers to get top quality services of the highest integrity and trust. The financial sector even has a name for a key component of this risk premium we pay it, fiduciary trust – we can assign our assets and money to them knowing that trust, fairness, and integrity of our entrusted assets is the financial institutions number one goal. And top CEO’s argue that, just as in the case of their own compensation, payment of this financial risk premium is a bargain to stockholders and consumers alike.
To borrow a phrase from the Hertz brand, “Well, Not Exactly”
The latest set of Financial Community malfeasance, the continuing sub-prime Mortgage Crisis wracking the US economy and world debt markets is a classic case of Greedy Guts Itself – the financial greedies proceed to gut themselves as well as their customers. The sub prime debacle sees one portion of the Financial Community duped by another to the tune of $200billion or maybe even half a trillion dollars in bad debt €“ nobody knows yet because of all the derivative financial finagling, the resulting complex contaminations, and the time delayed denouement. But the economy and US consumers surely know because the debt markets have been in increasing turmoil since the beginning of the year. The essence of the crisis is the fact that Mortgage Lenders sold hundreds of billions of dollars in mortgages to consumers on nasty bait and switch terms €“ variable rate mortgages set initially at very low values but with huge kickers if US prime interest rates rose or they faltered in their payments. Now stop right here.
If those lenders, be they CountryWide Financial or other banks and lenders, had stopped right here and lived (or more likely died) with their bad-term loans, there is a big hurt; but as Ayn Rand and your favorite Capitalist would sanctimoniously point out, the Darwinian efficiency of the markets would have done their efficiency deed and would have weeded out and bankrupted these bad players.
If only Ayn could see the con-men and grifters these financial players have become . The Countrywide grifter cleverly chopped up their dead loans and hocked them as diversfied derivatives to other financial institutions. Fiduciary trust? Are you kidding me? €“ the financial community “players” are out to make their fortunes and if the client prospers as well – that might as well be called collateral damage. In fact, Charles Schwab brokerage has had national commercials citing that – “what do I get from my investment consultant ? Advice that is going to make him a fortune and maybe I … well you know…”. So the mortgage con-men proceeded to con their own financial shops with too-good-to-be-true derivative investments.
The primary bad lenders, like CountryWide Financial and others, played a clever grifter’s shell game €“ they chopped up their bad mortgages, mixed them in with good bonds and debt in derivative instruments that helped to disguise the bad debt. These derivative instruments were further split and melded together to create a second derivative class known as SIVs. The companies then proceeded to get financial risk rating firms such as Moodys, Standard and Poors and others to attach very good and low risk ratings to these instruments and proceeded to sell them to various major banks and financial institutions which were looking for high return, low risk investments.
The net result: some of the biggest US financial institutions such as Bear Stearns, Citigroup, and Merrill Lynch got duped by their own financial colleagues and bit on this chum-like bad debt. In the third quarter of 2007 alone these firms took bad debt losses of $2 billion, $4billion, and $8 billion respectively. What makes matters worse is that this is not the end of the line. It is projected that many of the bad loans will start to appear as foreclosures throughout 2008 €“ making for a quarterly bad write off watch from the major banks and financial institutions.
So when interest rates drifted up and borrowers were not able to meet the their new, higher and much more punishing mortgage payments, derelict homeowners had to sell, were foreclosed or even abandoned their homes and properties. So the end of the housing market boom, admittedly overheated by speculative second and third home buyers, was made worse by huge overselling of usurious mortgages which were €œdebt-money laundered€ into respectable financial derivatives and debt instruments. CountryWide and other mortgage lenders got their greedy financial compatriots to fall for their derivatives shell game, and to effectively gut themselves by buying huge quantities of fundamentally bad debt.
Now remember, this is why we as consumers are paying banks and other financial institutions ever larger risk premiums for their services – clients get less and less of what they pay more and more for because a)self regulation in the financial community is in a shambles and b)financial institutions are buying out federal regulation. Financial institutions are supposed to be a)constantly reducing the risk to our money and assets managed by them and b)constantly delivering on the fiduciary trust agreement. Instead of delivering efficient and frugal banking, lending, insurance and other financial services, financial institutions are now part of the problem in more cases of gross financial misconduct. It is as if the premiums we are paying to financial institutions to reduce risk and financial misconduct are just going to make sure that managing financial risk is not regulated. And let the record show how financial institutions are becoming increasingly a part of the next big financial misdemeanors
Look at the recent record of financial institutions:
Accounting firms brought us the Enron, Worldcom, Tyco, etc accounting disasters that brought huge stockholder losses and employee layoffs and lost pensions plus the onerous Sarbanes Oxley reporting requirement simply because accounting practices were dodged in shortsighted and self-aggrandizing fashion by accountants and top managers.
Brokerages and Investment Bankers exacerbated the Web Bubble of 2000 with brokers giving bad recommendations so investment side of the business could pick up huge investment banking jobs. This deviance is likely to resurface because all the misinformationists got were a few public wrist slappings while back up went the so-called Chinese walls that separate the two divisions of one financial shop. Chinese walls are made of crepe paper aren’t they – nudge nudge, wink wink, know what I mean Know What I Mean. But worse, these houses have huge 35-1 debt to equity leverage-so if 3% of their debt goes bad it wipes out all of their capital, and heaven knows how to valuate all those derivative based debt.
All the major big banks have fallen for the Sub Prime Mortgage Scam. And approval came from the top – and most of these managers got dismissed but still with huge $20Million++ severance packets while their shareholders are jolted with the first of multi-billion dollar write-downs. One CNN Business commentator blithely said this was not over and, really, he could forsee another huge financial flop coming along in a year or two – its built into the system.
And that is the problem, fiduciary trust is losing out more often to self-aggrandizing greed. Take the $1billion++ compensation packages for individual private equity and hedge fund managers as the new Greed standard. Against that does fiduciary trust really stand a chance ?
Financiers, gulp down another 5th and try this whopper on the public: “it is because all those other guys are Greedy Guts you have to pay a big financial risk premium, and likely even more before we get this problem sorted out – but trust us, we are experts in working around trust”.