From a Wall Street Insider (Anonymous)

Thursday, October 16, 2008, 7:46AM ET - U.S. Markets open in 1 hour and 44 minutes.
Laura Rowley Money & Happiness

'We're All Hosed': A Wall Street Insider on the Economic Crisis
by Laura Rowley
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Posted on Wednesday, October 15, 2008, 12:00AM
Earlier this week I interviewed a veteran banker at a major Wall Street investment firm, seeking an insider's view on what caused the current economic crisis, what life is like for people on Wall Street, and what's ahead for the economy.
On condition of anonymity, the banker provided a blunt assessment of the risks taken, mistakes made, and the toll of the financial destruction. Here are the highlights:
Q: What's the cause of the economic crisis from your perspective?
A: There is an awful lot of blame to go around on Wall Street, in Washington, and in the irresponsible behavior of individuals. But stepping back, the critical error was that everyone [thought] there would not be a substantial, nationwide decrease in real estate prices. The whole subprime debacle was predicated on the fact that people said, "Well, this borrower is not really credit worthy and can't afford the house, but in four years it will be up 20 percent or more."
It was widely believed that if you had bad mortgages from different geographic areas that all those [real estate markets] weren't going to go down together. You had a pool of 100 bad mortgages from borrowers with low income or bad credit, that were each a piece of [expletive]. The idea was you put them together and now it's not a piece of [expletive]. People believed that through geographic diversification you can diversify risk. That was what undergirded the entire breakdown, and this was not a 3-year phenomenon, it was building for 10 years. Fannie Mae and Freddie Mac were absurdities; those firms were recklessly and incompetently run.
Q: What role did the rating agencies play?
A: The rating agencies facilitated this by giving investment-grade ratings to the securities. In the stretch for yield, you could [buy] AA-rated corporate bonds and earn 50 basis points over Treasuries, but if you bought AA-rated mortgage-backed securities you'd get 150 basis points. From the buy side, there was a real breakdown in their fiduciary obligation, because they overly relied on ratings agencies and didn't do their own research.
Rating agencies are incredibly powerful; you can't do debt financing without them. You have to play by their rules. They hold themselves out as these objective providers of ratings advice, but they are human beings, and [rating structured finance deals] was a higher-margin profit [center] for them. But I think [the bad ratings] were more due to sheer incompetence than being bribed.
Q: But weren't these the so-called "smartest guys in the room"?
A: These are not the smartest guys in the room. The ratings agencies don't pay as well, so people working there are using it as platform to get on the Street, or they work there because they're tired after a career on the Street, or they couldn't get hired on the Street.
Q: But wasn't leverage the real problem? Lehman was leveraged about 30 to 1 when it collapsed.
A: The investment banks were imprudently leveraged, but what killed Lehman and Bear was they had bad assets. You can survive a painful downturn -- and believe me, de-leveraging has been painful for everyone, but you can survive. Wachovia was only levered ten times, but had terrible exposure [to bad mortgages] and therefore couldn't raise capital. In hindsight Lehman shouldn't have been leveraged 30 times, but in a bull market having [a leverage ratio] of 25 times is not necessarily crazy. The real issue is asset quality.
Q: What's your view of the government's $700 billion-plus bailout?
A: I think Paulson was well intentioned around the notion of moral hazard, but he was wrong. I think if he could redo it, he would have saved Lehman. The devastation of Lehman failing -- the implication of their failure is hard to predict. I think you're seeing it play out in the stock market and the credit markets; I think you're going to see some hedge funds go out of business. Some of it has already been made public and some will come soon, but there are a lot of implications of Lehman reflected in the capital markets.
Q: What about the move to backstop the commercial-paper market and guarantee money market funds?
A: I think it's unfortunate, but it's one of the situations where the government has to step in. You've got to have confidence in the basic functioning of the banking system. The risk borne by the government is quite small, and the benefits are incredibly high. Unlike industrial companies, where bankruptcy works well, it does not work well at all in the financial system and Lehman is a poster child in that regard. If you're one of the big car companies and you go bankrupt, you can keep making cars; it's an ongoing business. With financial institutions, so much of what you do is predicated on confidence -- business literally evaporates overnight.
Q: What do you say to the taxpayers who didn't participate in the borrowing frenzy of the last few years, who saved diligently and are now paying the price with their tax dollars? And who may have to pay it again when the baby boomers retire and the government raises taxes to bail out people who haven't saved?
A: I also lived very conservatively and did not borrow, and I think we're all going to get hosed. But the reality is it's in our interest that the economy doesn't melt down. I'm a right-wing free market [supporter], and the last person to ask for government intervention, but if we allow a breakdown in the financial system you're going to have a depression. It's like the military -- incredibly expensive, but the cost of not doing it is far worse.
Q: What about the characterization that the greedy Wall Street bankers made their millions in the boom and left others holding the bag?
A: Everyone on Wall Street wants to make as much money as he can -- we're not missionaries. But no one thought, "Let's do this loan because we know it won't blow up for a while, and we can get fees today or get this year's bonus." Because everyone knows his stock position at a firm is worth far more than this year's bonus.
Look at the stock prices and the value of Bear, Lehman, Merrill, Morgan Stanley, Goldman, Deutsche Bank -- that's hundreds of billions of dollars evaporating, and a good chunk of that was owned by employees. For most employees that was the majority, and in some cases all, of their net worth, because of deferred compensation. People read these big numbers that bankers make in good years, but much of it you don't have yet, it's locked up for three to five years; you thought you made $2 million but you actually made $1 million. It's huge value destruction for people who work on Wall Street.
There are thousands of unemployed bankers with no prospects to get a job. And on Wall Street, if you're out a year or two, it's as if you never worked there. There's a real bias toward young people. If you're in your mid- to late 40s and you're shot, and you don't get a job in 12 to 18 months, you may never work on the Street again.
But I don't feel bad for anybody on Wall Street, because we knew what we signed up for when we got the job. No one complains in the good years, and you have to live your [financial] life accordingly. The guys who bought big houses or a second house or who lived a lifestyle they couldn't afford -- some of those guys have a very tough next couple of years, because they'll be caught on the wrong side of the spiral.
Q: What do you see ahead? Should long-term investors be buying equities?
A: I think the equity markets will recover before the credit markets will. I think you're going to see much more cautious lending. The U.S. continues to have the best, most innovative workforce, and the core fundamentals are good. There could be more legs down, but over a long period of time as long as we maintain our free markets and have reasonable capital gains taxes and a framework where risk-taking is rewarded, you'll still get the best risk-adjusted rewards in the U.S.
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31 Comments
Showing comments 1-5 of 31Next >> Sort: first to last
Yahoo! Finance User - Thursday, October 16, 2008, 7:44AM ET Report Abuse
Overall: 1/5
The article gets a rating of 1 star - interviewee has to remain anonymous -why? What's he, or she, afraid of? Might only make 10 million this year instead of 20 million? Why waste your time talking to these fools? Talent on the"Street"? The only talent that thrives there is criminal and immoral. "We're not missionaries" - that's a good one. You don't have to be a Jesuit - just be honest. Seen the news? That bastion of sound fiscal responsibility, AIG, is spending your tax dollars lobbying to restrict the oversight on mortgage loans. Today!! After all that's happened over the last month! They got some big brass ones for sure. Interview someone about that, Laura. I'd be interested to hear that story. Oh wait, AIG refuses to comment. Anybody wonder why? I don't know why I bother. I guess I still haven't come to the realization that it's all the irresponsible liars fault - everything.
golfwarhero - Thursday, October 16, 2008, 7:36AM ET Report Abuse
Overall: 3/5
Every one, YES EVERY ONE, knew the housing bubble would burst. If you didn't know then I have some wonderful property to sell you that will never decrease in value. This investment is so safe that you'll be able to leverage it many times over and you'll be rich.
Yahoo! Finance User - Thursday, October 16, 2008, 6:46AM ET Report Abuse
Overall: 4/5
The role of CDS for the meltdown is not mentioned. Wall street thrives on Conflict of interest; Accounting firms and rating agencies making more money on the side than their 'Core Business'. Rajen
Slugabug - Thursday, October 16, 2008, 6:20AM ET Report Abuse
Overall: 4/5
You can almost draw a parallel between Enron artificially running up electric rates and House Flippers artificially inflating real estate. The first caused an explosion in the construction of natural gas fired power plants, which still sit idle today, worth pennies on the dollar. The latter caused an explosion in housing developments, many frozen in various stages of construction, worth pennies on the dollar. The housing boondoggle is much more insidious though because everyone took part in it. When they make a reality show called "Flip this House", it's time to get out of realestate
rraccoon333 - Thursday, October 16, 2008, 6:15AM ET Report Abuse
Overall: 5/5
The insiders have first-hand knowledge and experience and I encourage hearing from more of them. This veteran banker make it clear that rotten mortgages can spoil a financial system so let's learn a lesson and prepare for the next housing bubble by vowing never again to allow Fannie Mae to loan our money to a borrower with no money down. 100% financing or 100 CLTV (Combined loan-to-value) gambles everyone’s future on the belief that real estate values will never see a rainy day but will always see the sunny days of 20-30% yearly growth. If we continue this practice of lending to the limit of real estate value and never plan for a stormy housing market, then maybe we should relocate the Fannie Mae office to Las Vegas where risk-taking is more accepted. It was refreshing to hear from an informed banker who provided a good insight and it would be beneficial to hear from more of these financial professionals.
Showing comments 1-5 of 31Next >>
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'We're All Hosed': A Wall Street Insider on the Economic CrisisThu, Oct 16, 2008