By Brandes Elitch
CrossCheck Inc.
Recently, writer Michael Hirsh released a book called Capital Offense: How Washington's Wise Men Turned America's Future Over to Wall Street. His theory is that the financial crisis was 30 years in the making.
"It began with the counterrevolution led by Milton Friedman, and in the political sphere by Ronald Reagan, against Keynesian economics, against too much government and regulation," Hirsh wrote. This process was turbocharged by the end of the Cold War, when it became clear to policymakers on both sides of the aisle that markets had to be allowed to operate unencumbered.
"This created a mentality that overreached in the long run through these years, during which it became a kind of heresy to advocate government intervention or even government oversight," Hirsh stated. "Regulation became a kind of lost art. ... A whole series of policy decisions from the late 1980s on through the 1990s and early 2000 ensured that you would have this multitrillion-dollar market (structured financial products) that was effectively completely unmonitored."
Hirsh tells the story of a Brooksley Born, who was Chair of the Commodities Futures Trading Commission in the 1990s. Early on, she was concerned about the unregulated over-the-counter (OTC) derivatives market. She called it, "the hippopotamus under the rug."
The top government officials involved (Robert Rubin, Alan Greenspan and Larry Summers) told her to go away. Of course, it was unregulated derivatives (such as credit default swaps) that were major causal factors of the financial crisis.
A congressional inquiry panel, the Financial Crisis Inquiry Commission, concluded, "The greatest tragedy would be to accept the refrain that no one could have seen this coming, and thus nothing could have been done. ... If we accept this notion, it will happen again."
Said commission found fault with two Federal Reserve chairmen: Alan Greenspan, a skeptic of regulation who led the central bank as the housing bubble expanded, and his successor, Ben Bernanke, who did not foresee the crisis but played a crucial role in the response.
The commission criticized Greenspan for advocating financial deregulation and cited a "pivotal failure to stem the flow of toxic mortgages, as the 'prime example' of government negligence." It also criticized the Bush Administration's "inconsistent response" to the crisis by allowing Lehman Brothers to go bankrupt after bailing out Bear Stearns Companies Inc. This added uncertainty and even panic to the financial markets. The decision to shield OTC derivatives from regulation, made during the Clinton Administration, was critical.
According to the commission, the New York Fed "could have clamped down" on excesses by Citibank, but didn't. Regulators (particularly the Office of the Comptroller of the Currency and the Office of Thrift Supervision, which were in turf wars battling each other) "lacked the political will" to scrutinize the investment and commercial banks they were supposed to oversee.
The credit rating agencies were worse than incompetent. The real blame lies in what might be called bumbling incompetence by bank and corporate chief executives, of which the list is endless - it was just poor business sense and lack of judgment. But there might be one chief tortfeasor (wrongdoer).
In a new book, Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America, author Matt Taibbi blames one person: Alan Greenspan, who created "The Greenspan Put," a belief system that the Fed would bail out large financial institutions with cheap money.
After he became Chairman in 1987, Greenspan faced a series of financial crises: Orange County, Calif. and the Mexican peso crisis in 1994, the 1997 Asian Flu, the Russian debt default, the implosion of Long-Term Capital Management in 1998, the bursting of the dot-com bubble in 2000, the 9/11 terror attacks in 2001 and the beginning of the end of the housing bubble in 2006.
In each case, Greenspan's "solution" was to flood the system with money and bail out the speculators. He pushed for deregulation (such as the repeal of the 1932 Glass-Steagall Act) and opposed efforts to regulate derivatives, predatory mortgage lending or anything else. Then he refused to take responsibility for his own actions.
Deutsche Bank Managing Director Ajay Kapur wrote in a research report in 2009, "We were all drinking the Kool-Aid, while Greenspan was tending bar, and Bernanke and the academic establishment were supplying the liquor." Judge for yourself whether Greenspan is an incompetent.
Low interest rates created by the Fed after 2001 created increased risks, but were not a critical factor in creating our financial woes. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac) also contributed to the crisis but were not a primary cause, nor will doing away with Fannie and Freddie solve all the problems in the mortgage market right away.
Encouraging subprime debt was a factor, but this crisis was about more than subprime debt (when it first came to the public's attention, everyone thought that this was just about a few hundred million dollars in subprime debt. It wasn't).
The nation's five largest investment banks had only $1 in capital to cover losses for about every $40 in assets.
Thus, a 3 percent drop in asset values could wipe out these firms. The banks hid their excessive leverage using derivatives, off-balance-sheet entities and other devices. The speculative binge was abetted by a giant "shadow banking system" in which banks relied heavily on short-term debt.
Neil Barofsky, the special inspector for the Troubled Assets Relief Program (TARP), said TARP's biggest legacy is "the moral hazard and potentially disastrous consequences associated with the continued existence of financial institutions that are 'too big to fail.'"
Nevertheless, the big banks response is to say, "If you regulate us, we will move to other countries," (like that could happen) and "public policy priority should not be banks, but rather the spending cuts needed to get budget deficits under control." Let's get real: the banks lobbied long and hard (almost $3 billion in lobbying from 1999 to 2008 and another billion in campaign contributions) for rules that allowed them to behave recklessly, which they did.
Daniel Altman just released a book called Outrageous Fortunes: The Twelve Surprising Trends That Will Reshape the Global Economy. He concludes that the United States has some good fundamentals for business and innovation.
One of our biggest advantages is our ability to sell. "We can sell our own products, sell other people's products, and we'll be able to teach other people to sell," he wrote.
We take this skill for granted, but it doesn't happen in the rest of the world. "We're very good at coming up with products and services that appeal to people no matter where they're from," Altman stated. Isn't this what we do as ISOs?
You have probably heard rumors that California will default on its debts. Decades of "crazy liberalism" and "runaway spending" have destroyed the economy and caused "wealth creators" to flee the state. Actually, the budget deficit (call it $20 billion for starters) is less than 1 percent of the state's gross domestic product. This is a political problem, not an economic problem.
Over the last 10 years the California economy has grown faster, per person, than the national average, according to the U.S. Bureau of Economic Analysis. It's grown 10 times faster than the Texas economy. According to PriceWaterhouseCoopers and the National Venture Capital Association, California got 50 cents out of every venture capital dollar in 2010.
Regarding taxes, the Tax Foundation stated that in 2008 (the most recent year analyzed), state and local taxes in the average state came to about 9.7 percent of the annual state economy. In California, it was 10.5 percent, a less than 1 percent difference. And regarding a "bailout," California sends billions of dollars in surplus dollars to the rest of the country, because we send vastly more in federal taxes then we ever get back in federal spending.
The Tax Foundation calls this a "fiscal transfer." During the 25-year period ending in 2005, California bailed out the rest of the United States to the tune of about $620 billion in today's dollars. By comparison, other states in the South and West haven't balanced their budgets without incoming fiscal transfers from the federal government.
Will California default? State debt costs come to just $6 billion a year, a fraction of the $90 billion budget. Under the state's constitution, interest on the debt gets paid second (after kindergarten through twelfth-grade education). Yes, there is a big gap: $100 billion-plus in the state pension and benefits system. But the state's economy is $2 trillion a year - 14 times the size of the pension-fund gap.
If you thought about all of the economic factors, domestic and international, that are problematic, it would make you crazy. I try not to do that. But one thing does worry me: the increasing gap between the rich and the middle class.
Because I work for a company in the check guarantee and collection business, I pay attention to demographics. The reason we have a company in the first place is because of these demographics. Our check product makes a sale happen that would not otherwise happen, and our accounts receivable management product converts uncollected bills into cash, the lifeblood for small business.
Due to the housing bubble, the gap between the rich and the middle class is larger than ever. Don't believe me? A study in 2009 by the Economic Policy Institute (based on the Fed's survey of consumer finances and flow of funds report) showed that the richest 1 percent of U.S. households has a net worth 225 times that of the average American household. The average household's net worth is $62,200.
Middle class incomes have been stagnant for at least a generation. Remember, ISOs get paid on clicks when American consumers buy something. The "trickle-down" theory of economics was disproven a long time ago. For you to make money, consumers have to spend money. The question is how to stimulate the economy without increasing deficits or the risk of inflation. I don't have an answer.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.
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