Inside Story - The US financial crisis - 21 Sep 08 - Part 1
Al Jazeera English
Transcript
It's a financial tsunami not seen since the Great Depression in the 1930s. A crisis that has forced the US government to step in and save the financial system after trillions were wiped off global stock markets and once revered institutions were swept off the face of Wall Street. Is the US intervention too little too late to save the economy? This is Inside Story. Hello, I'm Aron Naidder. Welcome to this special edition of Inside Story from New York. It's the first in a series of five editions that will discuss the fallout of the ongoing crisis on world markets. Well, the roots of the panic in financial markets around the world are deep and complex. But at the bottom of it all, this crisis is the convergence of three factors. Millions of people pursuing the American dream of home ownership. Politicians and regulators who dismantled a system of financial safeguards and then ignored warnings of impending disaster. And financial markets and institutions disregarding risk in headlong pursuit of profit. Al Jazer's senior Washington correspondent Rob Reynolds has more. Let's start at the beginning. Around 2000, the dot boom went bust, driving down stocks and sparking a recession. Then came the attacks of September 11th, 2001. A body blow to the US economy. To hasten economic recovery, the US central bank, the Federal Reserve, headed by Chairman Alan Greenspand, used the most powerful weapon in its arsenal. It cut interest rates repeatedly. Lower rates made it easier for banks to lend and for consumers to borrow and spend. It did stimulate the economy. stimulated housing because effectively the cost of investment was negative. You know, you could borrow money for virtually nothing. [Music] Home ownership is the bedrock of the American dream. Now, with mortgage interest rates at near record lows, millions of Americans went shopping for homes. But many of them couldn't really afford them. It got to the point where the mortgage brokers were essentially offering mortgages to people who had little or no uh income, but who, you know, somehow thought that they could put these payments together. From 2000 to 2006, the price of housing nearly doubled. Sensing a potential bonanza to be made in fees, banks and mortgage companies began lending to riskier segments of the population, especially lowincome and firsttime home buyers. In the new hands-off regulatory environment, banks and mortgage companies transformed the loans they were making into commodities. You get the mortgage from your bank and the bank immediately sells the mortgage to some other Goldman Sachs or to Layman Brothers. They then buy all these pools of mortgages and they put them together into new securities. Think of them as bonds uh or think of them as stocks. Millions of securitized loans were bundled together and sold to firms all over the world. At first, it was a lucrative deal. High returns, little apparent risk. But there was a worm in Wall Street's Apple. Millions of the mortgages being sold, more than 20% at the peak of the frenzy were high risk. It was a kind of alchemy in which uh very risky mortgages got sold uh to people uh under a label of very good. The global financial community seemed to believe housing prices would just keep going up and up. But then the bubble burst. One of the lessons of history is that really smart people make big mistakes. Uh, and they tend to do it often at the same time. And that's what we've just seen. I think that their big mistake was to underestimate the possibility of a decline in the real estate markets. In 2007, mortgage lenders with lots of risky loans on their books started going bankrupt. Then major investment banks came under pressure and began to fall. The problem now isn't just houses. It's credit. Lack of credit. Banks have stopped making loans to individuals, to businesses, and even to one another. And that's why the US government is considering sweeping and costly measures to bail out the system. For the first time since the 1930s, a true systemic financial crisis is underway. We've never seen this kind of crisis before in the sense that it's brought on by a real estate bubble of mammoth proportions. The question now is what happens next? It could get a lot worse. I haven't read any significant empirical evidence to suggest that we should believe we're near the bottom. Where's the bottom? I don't want to know. I don't want to know. Um the bottom could be very deep. Rob Reynolds, Al Jazera, Washington. Well, joining me to talk about this turbulent week are our guests. Ken Golstein from the conference board, a leading economic and business research group, Ravi Batier from Madison Equities, a private real estate developer and a lecturer at New York University's Real Estate Institute, and Gregory Larkin. He's a senior analyst at Innovst Strategic Value Advisors. Gentlemen, thank you all for joining me here. Robbati, let me start with you. Uh, as I mentioned, a turbulent week, but we're hearing now of a bit of a blame game going on. Who is responsible for this? And there's also some kind of a surge going on for where it all started. Uh, and some are pointing the finger at Ellen Greenspan, the former Federal Chairman, a Federal Reserve chairman, and saying he was responsible for starting this by reducing interest rates and by advocating a loosening of uh regulatory controls. Can we blame Alan Greenspan for this? Well, if the problem was that simple, and I don't think it is a simple problem, uh I think it's difficult uh to blame one person for this. I also think it's unfair uh we're sort of Monday morning quarterback uh to assess everything and say, okay, the you know, pin the problem on one person at one given time. There are so many other factors involved. But was lower interest rates one of the major factors? Uh, I believe it contributed, but I think that interest rates themselves being lower, I don't think that that would precipitate this kind of mess. Ken Goldstein, how much of the blame should go to banks who if they had lower interest rates took it and ran with it and were dishing out loans to everybody who asked? It's not about Allan Greenspan. It's not about the banks. This largely is a story about leveraging, about securitization, about what I'm going to call Tetris financing. You know, in the computer game Tetris, when you bring the column down, that's a good thing. In finance, not so much. What they did is they took these mortgages uh and they borrowed against them multiple times. Now, they did that because it was highly profitable. So, on the way up, this was terrific. But clearly what we now see is on the way down it has tremendous destructive factors. Gregory Lin, where did the chaos come from? Well, I do think the banks uh deserve some of the responsibility. I think their definition of risk and the trust uh that they placed in three companies, namely the the credit rating agencies, was incredibly narrow and shortsighted and and the the price that they attributed to the risk of lending and extending too much finance to people that couldn't pay it back. uh the degree to which they had measured that risk and the cost that they anticipated would result from that risk was wildly wide of the mark. Um, and so I think independent due diligence was lax in the finance system and and based on that there was so much money to be made and and I agree with Ken. Uh there was a degree of irrational exuberance to borrow the phrase was it a lack of oversight uh and regulatory mechanisms partially? Uh I don't want to attribute it entirely to that, but uh yeah, there there was a lack of oversight. Uh there was this that what we're seeing right now is uh Fanny and Freddy should have never been allowed to run away and and deviate from from the the mortgages that they were allowed to deviate from. That's funny. May and Freddy might go ahead. I would go even stronger. I would say that starting in the late 1970s there was a general mood that deregulation was was better than regulation and so we gradually did this not just in the area of finance but across the economy but clearly what we now see in the financial field uh is that we went too far in deregulating the market and I think without a question what we're going to go to uh is back to a little bit more regulated market a few more rules perhaps not many just a but certainly much stronger oversight in terms of making sure that those rules are followed. And the third piece of this is more disclosure. We got into such complicated uh structures and such complicated uh things that none of us really fully understand. Uh and so I think that part of all of this is going to be some more rules uh because we didn't have enough to prevent this from happening. uh more oversight to make sure that those rules are obeyed and more disclosure about just exactly what these deals are about. One of the things that that will do of itself is to decrease this degree of le of uh securitization of leveraging so we won't see this again. Robert, you've uh done a lot of work in real estate. What would that do to the real estate market if we see more rules, if we see it more difficult to get money? I think that as long as uh the rules are uh you know properly enforced and that they're transparent and then everyone plays by the same game uh it will create some pain uh we were discussing earlier it will raise the cost somewhat uh of doing financing but in the long run I think it will benefit uh the real estate industry because people will do things the traditional way they'll actually have to put down money and what's happened is people don't have skin in the game when you don't have skin in the game you could walk away from a mortgage traditionally in America we have put down 20% on a mortgage You'll rarely walk away from a home if you have 20% down. And the fact is, if you had 20% down, that means that you're also financially stronger and you're more well equipped to handle that size of mortgage. So, you would think it through before you got into it. When can we start to see that happen? In the real estate market that I'm looking at in Manhattan, uh I think we're about a year away from uh let's say uh hitting that bottom and coming out. I would have said that three months ago. Now, I'd have to reassess that, but I think at some point uh we have to uh figure that the market's going to hit the that bottom and then then we'll look at a real estate market that's transparent and legitimate and then we can all go up from there. But with the new rules in place, right, Greg, we could expect to see those new rules coming into place in the future. But right now, if we look at what uh the administration has done, was it the right thing to do? In the short term, it was absolutely necessary. uh in the long term there is some structural reforms that we don't really know there will be a recovery I think all three of us agree on that this is not permanent the structure of that recovery there's a huge question mark hanging over it and yes it was absolutely necessary I think to quarantine the toxic assets that in the words of Treasury Secretary Pollson were were clogging the the system I agree with that Uh there also needs to be a a a system of rules which restructures finance so that the incentive is placed on making loans to people that you're confident can get paid back as opposed to how it has been which is the incentive was to close the deal as rapidly as fast as possible. We agree this was necessary and had to be done now. Was it the right thing? That's a much different question. So how do you see the well the coming weeks? How do you see that unfold? What happens with all this debt that is now being held by the government? Well, you know, we've seen this before. We've seen resolution trust uh at the tail end of the SNL crisis in the United savings and loans crisis in the United States in the late 80s, early 90s. We saw it in Japan. What they're obviously doing is taking the the assets that nobody wants uh or nobody wants right now uh and that nobody can price right now because nobody wants right now. They'll put them in a corporation. uh technically uh the taxpayer is on the hook for that. But just as was the case with resolution trust, just as was the case in Japan, eventually those were all sold off and the taxpayers, American taxpayers, Japanese taxpayers didn't lose a penny on that. I think that will happen this time around, but it's going to take time. Maybe over the next five, maybe over the next 10 years. Well, gentlemen, lots more to talk about, but we have to take a break right now. We'll be uh back talking about the financial crisis and its impact here in the United States and around the world. Stay with us. Don't go away. I'll be back in a moment.