NBR Transcripts-November 27, 2008
Thursday, November 27, 2008"From Bubble to Trouble: The Financial Crisis of 2008"-The Role of The Mortgage Meltdown
SUSIE GHARIB: The financial markets were closed for Thanksgiving Day, so in this program, we'll take a closer look at one of the worst market and economic upheavals of the past generation -- the financial crisis of 2008. We'll go from its root causes to how it's likely to play out in the coming months.
PAUL KANGAS: If there is a ground zero for this crisis, it would probably be located in the red- hot housing markets of a few years ago. With home prices rising in these cities at double-digit rates, home ownership seemed to be the road to riches and plenty of ordinary Americans wanted to get on the bandwagon. It was a trend the mortgage banking industry and Wall Street were happy to encourage, making sub-prime and other loans available to borrowers with poor credit. But by mid-2007, the housing bubble was turning into a housing bust and the financial repercussions began. Erika Miller looks at how players in the mortgage market helped lay the groundwork for the crisis.
ERIKA MILLER, NIGHTLY BUSINESS REPORT CORRESPONDENT: When you hear the word ninja, this may be what you think of, but the financial crisis has given the word a whole new meaning. Ninja loans went to people with no income, no job, no assets, the lowest of the sub-prime loans. Princeton economics Professor Alan Blinder says mortgage lenders should have known better than to give money to people who didn't 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: 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 then 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 rating 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 was that buyers of mortgage-backed securities didn't know what they were getting.
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. These complex derivatives were supposed to reduce risk by guaranteeing against losses in particular mortgage securities. Instead, they spelled disaster for companies which backed them, like AIG, the nation's largest insurance firm.
CRESCENZI: Where CD's 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: Last March, Bear Stearns was the first brokerage to reach the brink of 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. Fraud did play a role in getting the crisis started. In many cases, home buyers inflated their incomes and brokers got appraisers to push up home values and because they wanted to keep the number of new mortgages growing, many financial firms chose to look the other way. Erika Miller, NIGHTLY BUSINESS REPORT, New York.
"From Bubble to Trouble: The Financial Crisis of 2008"-The Reforms In The Works
SUSIE GHARIB: Ultimately, the tidal wave of bad home loans brought the American financial system to the brink of collapse. That led Congress to pass a $700 billion bailout package. So why didn't the U.S. government act sooner? Some analysts say Uncle Sam missed the danger signs because it didn't keep a close eye on trading in new financial products. But that may be changing. As Stephanie Dhue reports, major reforms are in the works to strengthen the government's regulatory role.
STEPHANIE DHUE, NIGHTLY BUSINESS REPORT CORRESPONDENT: In the wake of the financial crisis, a major overhaul of the financial regulatory system seems almost inevitable. Nevertheless, Senate Banking Committee Chairman Chris Dodd says he wants to be careful not to overreact.
SEN. CHRISTOPHER DODD, BANKING COMMITTEE CHAIRMAN: I want to make sure that we are -- we are -- we have a regulatory system that has the transparency, the proper supervisory role that we ought to be playing, but at the same time does not strangle creativity and imagination that has been a hallmark of our success as well.
DHUE: Some of that overhaul is already under consideration. Back in March, Treasury Secretary Henry Paulson unveiled a blueprint for reform. He wants the Federal Reserve to be a kind of super-regulator, overseeing market stability and risk. Currently, the Fed shares those responsibilities with other agencies, including the Securities and Exchange Commission, which has come under fire for not doing more to regulate investment banks. Barry Barbash worked at the SEC in the 1990's. He says making the Fed a super-regulator could work, but he still expects a now-wounded SEC to flex its muscle.
BARRY BARBASH, PARTNER, WILLKIE FARR & GALLAGHER: Whenever the SEC wants to show its strength, what it does is it brings enforcement cases, so from that standpoint the securities business -- the hedge fund business -- will be under pressure from the regulators in the form of enforcement cases and really hard examinations, as well.
DHUE: A mortgage regulator may also be part of a fix. Former FHA official Ira Peppercorn says any overseer should be able to sound an early trouble warning.
IRA PEPPERCORN, FORMER DEPUTY FEDERAL HOUSING COMMISSIONER: What we need is an early detection system that can say, this community is experiencing a high level of foreclosures or not just by the community level, but by a lender or by a broker that can say, look at the default rate on the portfolio that this lender is originating. Someone needs to step in.
DHUE: Mortgage lending will also need to be addressed. A bill to crack down on predatory lending and create a national licensing system for mortgage originators passed the House of Representatives last year. Congress will also have to address Fannie Mae and Freddie Mac. The Treasury's authority to lend money to the mortgage giants expires in a year. But analyst Andy Laperriere says it may take longer to get Fan and Fred back on track.
ANDY LAPERRIERE, MANAGING DIRECTOR, ISI: The companies are going to be bleeding money a year from now and that's just a very tough environment in order to spin them off and have them go back in the private sector and do what they were doing.
DHUE: Lawmakers and regulators also want to address the role of the credit rating agencies. Enron's collapse seven years ago unearthed serious conflicts that compromised the rating system, but regulators and lawmakers didn't fix the problems back then. Also on the to-do list, addressing the largely unregulated derivatives market, which nearly brought down insurance giant AIG. Michael Greenberger headed the CFTC in the 1990's and at the time pushed for national derivatives regulation. It didn't happen then. He expects it will happen now.
MICHAEL GREENBERGER, FORMER DIRECTOR, TRADING & MARKETS, CFTC: At the very least, I think it is going to go under a sophisticated regulatory system -- maybe onto regulated exchanges -- but at the very least a system where a Federal regulatory agency will have reporting, will ensure adequate capital reserves, proper marking to market and anti-fraud and anti- manipulation authority.
DHUE: President-Elect Obama has made fixing the economy his top priority, but he has offered few details on what changes he would make to the regulatory system. Clearly, any overhaul will be a complex and lengthy process. Stephanie Dhue, NIGHTLY BUSINESS REPORT, Washington.
"From Bubble to Trouble: The Financial Crisis of 2008"-The Fate of Wall Street
PAUL KANGAS: Even without a government crackdown, the financial sector has already paid a high price for taking on too much risk. In fact, the crisis has reduced the American financial establishment -- better known as Wall Street -- to only a shell of its former self. That's raised the question: is Wall Street dead or will it rise again to its former spot at the pinnacle of international finance? We turn once again to Erika Miller.
MILLER: Take a walk down Wall Street and you'll still see all the familiar landmarks. But the banking landscape has been forever changed. Eight months ago, there were five standalone investment banks. Now there are none. Lehman Brothers went bankrupt, Bear Stearns and Merrill Lynch were forced into the hands of giant commercial banks and Goldman Sachs and Morgan Stanley had to convert to bank holding companies in order to stay in business. Long-time Wall Street observer Robert Albertson says 2008 marks the end of an era.
ROBERT ALBERTSON, CHIEF STRATEGIST, SANDLER O'NEILL: There is no more Wall Street. It is eviscerated. If you want to look at what Wall Street will look like, go to Europe. We now have universal banking.
MILLER: Universal banking means giant financial firms offering a vast array of products under one roof. For years, Citigroup was the poster child for this model. Although Citi has size and scale, it has been widely criticized for being too bloated to manage growth effectively and for lacking innovation. Making the universal banking model work is not the only challenge facing surviving financial firms. After years of lax oversight, Washington is certain to tighten regulations. Wall Street veteran Jim Awad says that will curtail profit growth, although there could also be some upside.
JAMES AWAD, INVESTMENT STRATEGIST, ZEPHYR MANAGEMENT: It's going to be a little less exciting, a little bit less of a thrill, a little bit less of people making huge amounts of money. But it will be a stronger, more regulated, transparent system, with a more durable business model and more consistent growth.
MILLER: One of Wall Street's traditional profit centers, merger and acquisition activity, has been decimated this year, a victim of the weak stock market and tight credit conditions. S&P's Richard Peterson says the depth of the financial crisis makes recovery in M&A unlikely anytime soon.
RICHARD PETERSON, DIRECTOR, MARKETS, CREDIT & RISK STRATEGIES, STANDARD & POOR'S: We're probably going to see our expectations of about a 40 percent drop in deal proceeds this year. It changed the personnel; it changed the composition; it changed the entire perspective of deal making, not only for the year ahead, but for the foreseeable future.
MILLER: However, there is at least one area where experts expect to see more consolidation, the financial sector. For example, Awad predicts smaller brokerage firms will be forced into the arms of big banks or risk becoming irrelevant. That's not the only possible change on the horizon. There is growing debate over whether the U.S. will lose its super power status in the global financial system. Even before the crisis, the New York Stock Exchange was losing (INAUDIBLE) to exchanges in London and elsewhere. (INAUDIBLE) systemic changes in the U.S. banking model have set the country back another notch.
AWAD: You have to have a competitive edge. We probably won't now because we are degrading it to a level that is more like a 1980s model and guess what, we're in 2008, headed for 2010. It's not going to have the credit creation function and capital distribution capability it once had.
MILLER: The tilting of power away from Wall Street also has social implications. The people that worked here were known for being smart, aggressive risk takers with oversized egos and bonuses. Now, many are walking more humbly, just grateful to have a job. Erika Miller, NIGHTLY BUSINESS REPORT, New York.
"From Bubble to Trouble: The Financial Crisis of 2008- Main Street Roundtable"
SUSIE GHARIB: The financial crisis is also having a huge impact on Main Street as the resulting credit crunch is now hitting businesses and consumers. So where will the crisis take the U.S. economy and how will it look when the dust finally settles? I talked about that with three prominent financial journalists: Floyd Norris, chief financial correspondent at the "New York Times," Chrystia Freeland, U.S. managing editor off the "Financial Times" and Allan Sloan, senior editor-at-large for "Fortune" magazine. I began by asking Allan what surprised him the most about the saga of this financial crisis.
ALLAN SLOAN, SR. EDITOR AT LARGE, FORTUNE: The first thing is that this has gone on for over a year and shows no signs of stopping. The second thing is the magic people who would always stop previous crises - the chairman of the Fed would smile and wave. It was almost like the pope and the problem would go away or the Treasury secretary or occasionally president, the waters would calm. And now, no matter what happens, it's getting worse and worse and worse.
GHARIB: Chrystia, what surprised you?
CHRYSTIA FREELAND, US MANAGING EDITOR, FINANCIAL TIMES: I agree with Allan. And in addition to that, two other things have surprised me. The first one is how global this crisis is. We were talking a year ago about decoupling, the idea that America could suffer this crisis alone; the rest of the world might be OK. That has turned out not to be true at all. Second thing is, really astonishing, is this is a crisis made in America, very successfully exported by America to the rest of the world and yet you see the U.S. dollar strengthening and the U.S. government having an increase and enhanced ability to borrow money in dollars from the rest of the world.
GHARIB: Floyd?
FLOYD NORRIS, CHIEF FINANCIAL CORRESPONDENT, THE NEW YORK TIMES: I've been surprised at how long it took the government, the Treasury and the Fed to realize how bad it was. We've never had a recession like this one before, at least in my lifetime. The Fed usually brings on recessions by tightening interest rates. They're afraid about inflation. They didn't do it this time. If anything, the Fed's error was in the Greenspan time when they let the asset bubble blow up and blow up and blow up. And that has alarmed me.
GHARIB: And so it's been dragging on, this crisis, Chrystia. What is going to be the next phase?
FREELAND: Well, I would've said a few weeks ago that the financial crisis was easing, the credit markets definitely were -- they weren't, sort of robust, but they were beginning to thaw and that we were moving into a really painful recession in the real economy. It has seemed to me since Hank Paulson's statements about the TARP and since he ruled out using the TARP to buy the troubled assets themselves, we've had some real anxiety in the credit markets and so I'm really concerned that the financial crisis part of it may not yet be over.
GHARIB: Is there another shoe to drop, Floyd?
NORRIS: Oh, we fear there is. At the moment, people have been getting worried that there could be more shoes. I think Mr. Paulson's -- what may be his big error was saying he wasn't going to spend any more of the money and let the Obama administration spend it. The idea that everything should stop until January 20 may prove to be very problematic. I'm not sure they have that luxury of time. GHARIB: So, Allan, let's fast forward to the year 2010. Maybe the financial crisis will be over by then. What kind of economy are we going to be looking at?
SLOAN: First, I hope it's over by then because I can't take much more of this. And by then I'll be 65 years old or 66. I may have to retire.
GHARIB: How will your 401(k) be doing by then?
SLOAN: Well, it's a 101(k). My retirement plan is I have three children, I will spend four months rotating among the basements. That's how I'm going to do it. I think we'll crawl out of this sooner or later, but the United States will be diminished. The standard of living will be lower and one of these days, Chrystia's people will come to us and say, if you want to borrow more money, you have to borrow in a real currency, not the dollar and that's when we're really in trouble.
GHARIB: Floyd, we see that people are spending less, they're saving more. Are we entering a new age of frugality?
NORRIS: Well, temporarily we might be. It will be interesting to see how that comes out in the end. Those who have forecast that Americans will stop spending have been wrong over and over again. This time they may stop spending because nobody will lend to them.
FREELAND: I think in 2010 the new thing that might start coming up is inflation because the U.S. government is going to have to spend a lot of money right now, both on fixing the financial crisis and on a really significant fiscal stimulus, which Obama is talking about. At some point, it's going to have to start paying for that and one way to do it is the printing presses.
GHARIB: Let me get another prediction from you, Chrystia. The U.S. has been the leader in the world economy in the postwar period. Do you see that dominance continuing or is it nearing an end?
FREELAND: Well, I think already just as a matter of mathematics, we have seen that dominance slowly declining. I think it's been less the decline of America and more the rise of the rest -- one billion Chinese people, one billion people in India, moving out of poverty and into the middle class. That's great, but inevitably, it means we're in a much more multi-polar world economy.
GHARIB: What do you guys think?
NORRIS: One of the big issues of this coming recession is going to be how well the Chinese and the Indians handle the downturn. I don't think they quite understand how bad it's getting there. And that may be a problem. I hope you're right, that emergence from poverty will continue, but I don't think that's a sure thing.
GHARIB: Let's talk about Barack Obama for a moment. Chrystia, you wrote in a new column that the new president has to rise above the blame game and focus on what needs to be done. What is the most important thing Obama needs to do?
FREELAND: I'm afraid that he will still have to cope with the sort of emergency room working on the economy and maybe even still on the financial crisis and trying to make sure that that is fixed. I think the big question about whether he manages to be a truly great president, as I think people are hoping, is whether in the midst of this economic chaos, he manages at the same time to act on his big goals -- on health, on energy. We'll see. It's going to be tough.
GHARIB: Floyd, you wrote a piece in the "New York Times," proceed with care, Mr. Obama. Your thoughts?
NORRIS: The most important thing he's got in the longer term is getting the financial system back in shape and re-regulated in a way that it was not and that's worldwide issue. Getting it right on that one is far more important than getting it quickly.
GHARIB: Allan, last word.
SLOAN: I feel that if president-to-be Obama needed my input, he would've asked me. And since he hasn't done that and I haven't heard from any of his appointees, I will leave it to the three of you to advise him and I will just write.
GHARIB: I will leave it there. Thank you all so much. Happy Thanksgiving Floyd, Allan, Chrystia.
FREELAND: Pleasure, Susie.
"From Bubble to Trouble: The Financial Crisis of 2008"-Who or What is at Fault?
PAUL KANGAS: Getting back to the origins of the financial crisis, it's hard to pin the blame on any one factor or institution. But in the end, the American public must share part of the responsibility. So as Suzanne Pratt reports, the fault may not be in our stars, but in ourselves.
SUZANNE PRATT, NIGHTLY BUSINESS REPORT CORRESPONDENT: Since the 1980's, Americans have been on a serious shopping spree. Our homes, our cars, our wardrobes and our gadget collections have gotten larger and more expensive. At first, we paid for things with cash or a few major credit cards. Pretty soon, however, our wallets were bulging with plastic. To make matters worse, by the middle of this decade, interest rates were at historic lows -- allowing banks to offer loans we couldn't refuse. And as home prices surged, many Americans extracted the value by refinancing mortgages or taking out home equity lines of credit. We used the extra cash to bankroll lifestyles we couldn't afford and some of us got greedy and irresponsible. Financial historian and NYU Professor Richard Sylla says consumers deserve at least some of the blame for the current mess.
RICHARD SYLLA, ECONOMICS PROFESSOR, NYU STERN SCHOOL OF BUSINESS: The American public is responsible -- the consuming public -- because the American public has been saving less and less over the years and went on this borrowing binge. You know, there have to be two parties to a loan transaction. Somebody says, yes, I agree to borrow it and the other person says, I agree to lend.
PRATT: Our need for things has gravely injured our household finances. Just look at the stats. Between 1990 and 2007, credit card debt more than quadrupled from $214 billion to $937 billion. At less than 1 percent, our nation's savings rate is the lowest in the developed world. Much of Europe is saving in double digits while China is at a whopping 24 percent. Nobel Prize winning economist and Princeton Professor Paul Krugman says we're bad savers partly because of easy credit.
PAUL KRUGMAN, ECONOMICS PROFESSOR, PRINCETON UNIVERSITY: You have to come up with a lot of cash if you want to buy a house in Japan and in a lot of Europe. In the United States the money has flowed freely, so saving doesn't seem quite as important.
PRATT: Still, others say our urge to splurge is also cultural. Psychotherapist April Benson is an expert on compulsive shopping and has written two books on the topic.
APRIL BENSON, PH.D., PSYCHOTHERAPIST: We think that happiness is only as far away as the next purchase, but really nothing could be farther than the truth. And in the pursuit of all of these goods, we really miss out on what's good -- community, time with family. There's such a race.
PRATT: OK, so maybe we over borrowed and maybe we did so to feel better about ourselves. But some experts say, don't be so quick to blame our fondness for debt on emotions. Blame instead our desire to keep up with the Joneses while our income was stumbling. Historians will debate for many years who or what should bear the blame for the 2008 financial crisis. But most experts already agree the experience will limit our irresponsible spending. Whether that change is permanent is another matter. Suzanne Pratt, NIGHTLY BUSINESS REPORT, New York.
