"Anatomy of a Financial Crisis"-Banks & Brokerages
Tuesday, October 28, 2008SUSIE GHARIB: How did it happen? What went wrong and who's to blame? When it comes to the financial crisis, there are many questions and few answers. That's left investors struggling to understand what led to the meltdown. So, tonight, we're kicking off a special three-part series, "Anatomy of a Financial Crisis," looking at the roles Wall Street, Washington and Main Street played in the crisis. Clearly, there is no shortage of culprits, but as Erika Miller explains, Wall Street's banks and brokerage firms are squarely in the bulls-eye.
ERIKA MILLER, NIGHTLY BUSINESS REPORT CORRESPONDENT: This is probably what you think of when you hear the word ninja. But the financial crisis has given the word a whole new meaning. Ninja loans were given to people with "no income, no job, no assets" -- the lowest of the sub-prime loans. Princeton economics Professor Alan Blinder says lenders should have known better than to give money to people who were unable or unwilling, to provide such basic information.
ALAN BLINDER, ECONOMICS PROFESSOR, PRINCETON UNIVERSITY: This is where the earthquake started and they were granting loans on terms that, in retrospect, are ludicrous and even in prospect, should have been seen as ludicrous.
MILLER: Mortgage lenders were comfortable relaxing their loan standards when home values were rising. But when prices started to decline and interest rates edged up, sub-prime borrowers increasingly defaulted on their loans.
BLINDER: The system cracked on sub-prime mortgages and once it cracked, more and more fissures started to appear; more and more weak points in the system started to become apparent. The contagion then spread to other mortgages.
MILLER: Initially, the damage was limited to companies like Countrywide Financial, which were directly tied to residential real estate. But it was Wall Street's securitization of mortgages that eventually turned a nasty housing downturn into a full-blown global banking crisis. Major brokerage firms bought up risky mortgages, bundled them together and sold them off in slices to investors, often keeping big chunks for themselves. As bond market expert Tony Crescenzi points out, credit ratings agencies gave the securities top marks.
ANTHONY CRESCENZI, CHIEF BOND MARKET STRATEGIST, MILLER TABAK: They didn't think through the risks in their entirety, particularly the liquidity risk, which is to say that the ratings agencies didn't think about what would happen if securities were difficult to buy and sell in the financial markets.
MILLER: Former Lehman Brothers CFO Brad Hintz -- now, a brokerage stock analyst -- says the problem wasn't the securitization, it was the way it was done.
BRAD HINTZ, BROKERAGE ANALYST, SANFORD C. BERNSTEIN: Securitization, fundamentally is a good thing. The problem with securitization is when you take it too far and that's the idea that I can securitize something and I don't care the quality of what I'm securitizing. You know, it's a box of dirt; I'm going to sell a box of dirt, and that's fine.
MILLER: The crisis also would not have escalated so quickly had it not been for esoteric financial contracts called credit default swaps-CDS for short. The buying and selling of these complex derivatives were supposed to reduce risk; instead, they ended up ensuring that problems at one firm had a domino effect.
CRESCENZI: Where CDS went wrong was that they lacked transparency. We couldn't know for sure how many CDS existed for an underlying security. For example, a company might have $1 billion of bonds outstanding, but there could be $4 billion, $5 billion, $10 billion of CDS outstanding.
MILLER: On top of that, many financial firms used leverage strategies to try to magnify gains. The SEC had limited brokerage firm leverage to 10 to 15 times core holdings. But in 2004, in a climate of deregulation, the agency loosened restrictions to allow the five biggest brokerage houses to borrow 30 to 40 times core holdings.
HINTZ: That's an astounding change in terms of total leverage and for the banks, you saw a similar move, but not quite as much, because the regulatory regime for the banks was a little tighter. But you certainly saw them taking more risk.
MILLER: Bear Stearns was the first brokerage to collapse, which made other financial firms reluctant to lend to each other. The ensuing credit crisis led to the demise or government bailout of Lehman Brothers, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia and many other financial institutions around the world. The role of greed in the financial crisis shouldn't be minimized. Homebuyers eagerly purchased houses they couldn't afford and Wall Street was only too happy to lend them the money, dazzled by bigger year-end bonuses. But such risky bets did not just hurt the participants; they endangered the economy and the global financial system. Erika Miller, NIGHTLY BUSINESS REPORT, New York.
