As if in tune with the swooning stock market, the face of Lehman Brothers CEO Richard Fuld grew darker and gloomier throughout the grueling grilling he received from the members of the House Committee on Oversight and Government Reform Monday morning. Chairman Henry Waxman, D.-Calif., got the hearing off to a cheery start when he pointed out that while Fuld's company had gone bankrupt and the American public was on the hook for $700 billion to bail out his competitors, Fuld himself had done pretty well -- pocketing hundreds of millions of dollars.
"Is that fair?" asked Waxman.
Fuld evaded giving a straight yes or no answer, though he looked a bit shocked at the effrontery of the question. Wall Street CEOs always believe they are worth every penny of their compensation, even when the companies they have commanded lie in wreckage around them. But to be perfectly fair, when the markets behave as they did on Monday, plunging 750 points, then swinging wildly back up and down before closing around 370 points down, just under 10000, Congressional class warfare grandstanding on executive compensation by angry Democrats seems almost as out of place as Republican attempts to pin all the blame for the current crisis on Fannie Mae and Freddie Mac. We've got a problem here, folks, that goes to the heart of how modern financial markets operate -- can we focus, please?
Peter Welch, D.-Vermont, did his best. Late in the hearing, he posed a long, complex question asking how a relatively simple transaction -- the provision of a loan to a consumer with which to buy a house -- could have become transformed into a morass of exotic financial complexity that literally sucked in the entire global economy. (I will post the full question once I've got access to the entire transcript of the hearing).
Richard Fuld side-stepped. I paraphrase from memory: "None of us expected house prices to decline as fiercely or sharply as they did," he said.
To the extent that he is referring to Wall Street traders betting the house on collateralized debt obligations, he may be correct. Others, however, like CEPR's Dean Baker, and "Irrational Exuberance" author Robert Schiller, were warning of a dramatic end to the housing boom years ago. Judged against historical data, it was clear to them that the vast runup in home prices from 2001-2005 far outstripped longterm trends in the U.S. housing market.
So Wall Street blew it. We will be arguing until the cows come home a hundred years from now how much Fannie and Freddie contributed to the current mess, but there will still be no exculpation for Wall Street's risk management specialists.
Which brings us to George Soros' timely contribution to the ongoing conversation; his new book: "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means." Writing in The New York Review of Books, financial journalist John Cassidy takes an in-depth look at Soros' 162-page "I told you so." One quotation from the text jumps out:
Soros slams the "shocking abdication of responsibility on the part of the regulators."
If they could not calculate the risk, they should not have allowed the institutions under their supervision to undertake them. The risk models of the banks were based on the assumption that the system is stable. But, contrary to market fundamentalist beliefs, the stability of financial markets is not assured; it has to be actively maintained by the authorities. By relying on the risk calculations of the market participants, the regulators pulled up the anchor and unleashed a period of uncontrolled credit expansion.
In other words, government regulators trusted the market to self-regulate. So if Wall Street thought it was OK to borrow billions to bet on risky derivatives tied to the mortgage market, then those derivatives by definition must have not really been that risky. The market can't be that badly wrong, can it?
Yes it can. Richard Fuld admitted exactly that this morning to Congress.