Tuesday, March 17, 2015

Unhidden in plain blogging

The HSIB Committee on What's Past is Prologue, has taken note of a number of new readers clicking on this 2012 post. Undoubtedly drawn by the newly published Peter Wallison book, Hidden in Plain Sight: What Really Caused the World's Worst Financial Crisis and Why It Could Happen Again.

And it is, indeed, another dose of corporal punishment for Housing Cause Denialists. It's worth the price of the book just for the clear explanation of derivatives...and why they were not the cause of the financial crisis--they're not any more at fault than a fire insurance company would be for the work of arsonists.

Though we wish Wallison had not said (p. 80) that Brooksley Born (along with Wallison, a member of the Financial Crisis Inquiry Commission) when head of the Commodity Futures Trading Commission, had drawn wide praise on the left for her efforts in the late 1990s to regulate derivatives and particularly CDS.... Because Brooksley Born never mentioned CDS--Credit Default Swaps--back in that day. Nor did anyone else, because very few people even knew what they were. The issue then was over who should regulate interest rate, and foreign exchange, futures. And the answer was; not the CFTC, because they were not commodities.

To say that derivatives were unregulated by the CFTC, is not to say that firms trading in them were unregulated. In fact, those firms were heavily regulated by banking (American and international) regulators, such as the Fed and Comptroller of the Currency, and securities regulators like the Securities and Exchange Commission. Or, insurance regulators at the state level.

Which brings up another unfortunate omission by Wallison. That the one firm that did get into trouble because of its derivatives trading--the insurance giant AIG--wouldn't have been in the position it was in in 2008, but for the interference in that firm's governance by the egregiously ambitious politician Eliot Spitzer, as we detailed back in 2013;
Anyone remember the financial crisis of September 2008? One of the reasons for that was the liquidity crisis of insurance firm AIG. A crisis that simply would not have happened, but for the interventions of one Eliot Spitzer.  Who, as NY Attorney General in February 2005, used his political muscle to oust the founder of AIG--then one of the world's soundest financial services firms--Maurice (Hank) Greenberg from his position as CEO. That action transformed AIG, and especially its Financial Products arm from a AAA rated credit risk to one seen as much riskier by its counter parties in the marketplace.
Bolstering that was this from a 1998 Fortune article;
 Greenberg doesn't suffer smart people gladly if they happen to challenge something he holds dear--like the proper operation of his company. A case in point concerns Howard Sosin, who came to AIG in 1987 from Drexel, bringing with him a sophisticated financial-products operation that sold derivatives and the like and that became the nucleus of AIG's push into financial services. By 1992, Sosin's operation, called AIG Financial Products, was delivering around $172 million in pretax profits.
The trouble, though, was that Sosin wanted to run things in an all-out way that accelerated the recognition of profits (of which Sosin got a rich cut) and that also created more risk than Greenberg, a financial conservative, could abide.
 But those quibbles aside, Peter Wallsion has written a very informative explication of just what the subtitle of his book says. About which, more anon.

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