"This is the biggest fraud in the history of the capital markets."
"The financial crisis was a product of our irrational reaction, which protected crony capitalism rather than capitalism. In capitalism, the shareholders who took the risk would be wiped out and the debt holders would take a discount but banking would go on."
Janet Tavakoli is one of the very few people in this country who not only had the brains to understand the complex topic of structuring synthetic financial derivatives like Collatoralized Debt Obligations (CDOs) and Mortgage Backed Securities (MBS's), but who also had the courage to raise her voice in warning of the systemic danger these types of derivatives could bring to the market if they continued to be created and traded in a completely unregulated fashion...and this, way back in the early 2000's. These MBS and CDO products are one of the core issues at the center of the current foreclosure mess, but of course, back when Janet was warning anyone who would listen, no one in the banking industry or Congress gave her the time of day....they were all too busy getting richer, and now we, the citizens of the United States, are left holding the bag.
Below, the full interview with Janet from Ezra Klein of the Washington Post, another financial reporter who has been able to maintain his personal ethics while working within the confines of mainstream media.
Janet Tavakoli is the founder and president of Tavakoli Structured Finance Inc. She sounded some of the earliest warnings on the structured finance market, leading the University of Chicago to profile her as a "Structured Success," and Business Week to call her "The Cassandra of Credit Derivatives." We spoke this afternoon about the turmoil in the housing market, and an edited transcript of our conversation follows.
Ezra Klein: What’s happening here? Why are we suddenly faced with a crisis that wasn’t apparent two weeks ago?
Janet Tavakoli: This is the biggest fraud in the history of the capital markets. And it’s not something that happened last week. It happened when these loans were originated, in some cases years ago. Loans have representations and warranties that have to be met. In the past, you had a certain period of time, 60 to 90 days, where you sort through these loans and, if they’re bad, you kick them back. If the documentation wasn’t correct, you’d kick it back. If you found the incomes of the buyers had been overstated, or the houses had been appraised at twice their worth, you’d kick it back. But that didn’t happen here. And it turned out there were loan files that were missing required documentation. Part of putting the deal together is that the securitization professional, and in this case that’s banks like Goldman Sachs and JP Morgan, has to watch for this stuff. It’s called perfecting the security interest, and it’s not optional.
EK: And how much danger are the banks themselves in?
JT: When we had the financial crisis, the first thing the banks did was run to Congress and ask for accounting relief. They asked to be able to avoid pricing this stuff at the price where people would buy them. So no one can tell you the size of the hole in these balance sheets. We’ve thrown a lot of money at it. TARP was just the tip of the iceberg. We’ve given them guarantees on debts, low-cost funding from the Fed. But a lot of these mortgages just cannot be saved. Had we acknowledged this problem in 2005, we could’ve cleaned it up for a few hundred billion dollars. But we didn’t. Banks were lying and committing fraud, and our regulators were covering them and so a bad problem has become a hellacious one.
EK: My understanding is that this now pits the banks against the investors they sold these products too. The investors are going to court to argue that the products were flawed and the banks need to take them back.
JT: Many investors now are waking up to the fact that they were defrauded. Even sophisticated investors. If you did your due diligence but material information was withheld, you can recover. It’ll be a case-by-by-case basis.
EK: Given that our financial system is still fragile, isn’t that a disaster for the economy? Will credit freeze again?
JT: I disagree. In order to make the financial system healthy, we need to recognize the extent of our losses and begin facing the fraud. Then the market will be trustworthy again and people will start to participate.
EK: It sounds almost like you’re saying we still need to go through the end of our financial crisis?
JT: Yes, but I wouldn’t say crisis. This can be done with a resolution trust corporation, the way we cleaned up the S&Ls. The system got back on its feet faster because we grappled with the problems. The shareholders would be wiped out and the debt holders would have to take a discount on their debt and they’d get a debt-for-equity swap. Instead we poured TARP money into a pit and meanwhile the banks are paying huge bonuses to some people who should be made accountable for fraud. The financial crisis was a product of our irrational reaction, which protected crony capitalism rather than capitalism. In capitalism, the shareholders who took the risk would be wiped out and the debt holders would take a discount but banking would go on.
SingleMalt Commentary: I think the interview covers this topic pretty well on a stand alone basis, but there are a few things I want to emphasize a bit more.
By Ezra Klein | October 8, 2010; 1:27 PM ET
1. Janet is spot on with her comments about the banks and everything that has been done to bail them out - from TARP, to the changes in mark-to-market accounting rules, to zero interest borrowing from the Fed. Taken all together, this represents an unprecedented level of Government assistance to private industry, and it was sold to the American people as something completely warranted and in the best interest of our country. Two years have now gone by, and as I have been saying to friends and family this whole time - absolutely NOTHING has changed. The banks are still sitting on a pile of toxic debt (though a lot of it has been transferred to the Fed - which means to the taxpayer), they have not used any of this assistance to free-up credit markets, and in fact, have taken this funding and cheap credit, and used it pump the markets, creating huge trading profits for their firms and obscene bonuses for the very assholes who got us into this mess in the first place. The recent news we're seeing on the fraudulent foreclosure practices is now going to bring a lot of this back out into the sunlight, and my biggest fear is that the banks are going to once again go running to Congress looking for a bailout. We, as members of a democracy, simply cannot let this happen. TARP 2 would be even more ruinous for Main Street than the last TARP, so if we start seeing word of this in the press, I highly encourage everyone to start writing letters to their Senators, Congressmen, Attorneys General, and anyone else who claims to be representing a constituency. I've written just such letters in the past, and if it looks like we're headed for TARP 2, I will gladly post sample letters here for you to copy and send. The more people who participate, the louder our message. Those who know me well, know that I have never been an activist, and I still don't consider myself one today, but when it comes to issues like this, at some point we all need to stand up and say, "enough is enough". We have bigger problems to deal with in this country today than ensuring a bunch of rich, corrupt bankers get another bonus check.
2. As Janet points out above, there are ways for us to resolve these issues. It will be painful, particularly for the Too-Big-To-Fail (TBTF) banks. In fact, most, if not all of them should go into some form of receivership and restructuring so that we can recognize the toxic assets and write them off. There is a method allowing us to do exactly this, and it is spelled out in the recently signed Dodd-Frank financial reform bill. It's time to use this legislation and clean up the banks. Unfortunately, as Janet also notes, shareholders in these big banks will be wiped out, but that's what happens in a capitalistic system, and should have been happening all along. Instead of letting corporate executives suffer the consequences of making poor choices, our Government, via direct bailouts and indirect stimulus programs, has rewarded these people...and not just the banks, but the auto and real estate industries, as well.
What we cannot allow to occur, is for the banking lobby and Congress to convince the American people that these organizations are still too big to fail, and therefore worthy of another bailout. We all need to stand up in unison voicing a resounding "Bullshit!" to that idea.
3. Finally, since Janet touched on the Savings & Loan crisis from the late 80's and early 90's as a concrete example of how we have dealt with this type of fraudulent activity before, I think it is high time that we bring in someone like William K. Black again to start investigating and prosecuting these bankers. As part 3 of this series of posts, I will provide you with a full background sketch of Mr. Black along with a number of interviews that he has conducted, but for the purposes of this post, suffice it to say that he was the lead investigator in the S&L fraud of the early 90's and was directly responsible for not only cleaning up the mess, but for sending hundreds of crooked bank executives to prison.
I hope that you have found this informative, and likely a little troubling. If this is all new to you, I ask that you don't take my word for it, but to do your own homework and dig into these details yourself. As my mother always said (and likely yours too), there are two sides to every story. What you hear in the mainstream media is often just one side of the story, and the side that those who are in power want you to see and hear, because most members of the mainstream media are famous for trying to (and often times being directed to) put a positive spin on most anything. It's usually not until things are so bad that they can no longer be suppressed that the negative stories start getting real press time.
What? Can't be true, you say? Take a gander at this excerpt taken from a zerohedge.com post, from a Shadowstats letter to clients [click here for full story].
"Let me recount two personal experiences. Back in late-1989, I contended that the U.S. economy was in or headed into a deep recession. CNBC had me in to discuss my views along with a senior economist for a large New York bank, who was looking for continued economic growth. Before the show, the bank economist and I shared our views in the Green Room. I outlined my case for a major recession, and, to my shock, his response was, "I think that pretty much is the consensus." We got on the air, I gave my recession pitch, and he proclaimed a booming economy for the year ahead. He was a good economist and knew what was happening, but he had to put out the story mandated by his employer, or he would not have had a job. More recently, following an interview on a major cable news network (not CNBC), I was advised off-air by the producer that they were operating under a corporate mandate to give the economic news a positive spin, irrespective of how bad it was."I contend that the behavior illustrated in the above example is representative of standard operating procedure at most major business & finance reporting stations - the Dylan Ratigan show on MSNBC is a notable and welcome exception. Fortunately, the Internet has provided an outlet for reporting that can remain unbiased by corporate and Government agendas, and this is where I encourage you to do your digging. Some of you will immediately point out that many of the financial blogs that I follow also have a bias, and that some could actually be accused of "negative sensationalism" by the manner in which they headline their articles. Quite frankly, you would be correct. This is also your responsibility in your search for the truth - to be able to filter out all of the biases and come to your own conclusion. This leads to one of the main reasons why I follow sites like zerohedge.com. While they definitely have their own slant on how they report the news, they almost always provide a link to the article, document, or website that is providing the source material for their post so that you can download and read the entire thing yourself. I like this a lot, because it not only gives me the opportunity to form my own opinion, but also gives me some insight into the quality of reporting being done - i.e. is the zerohedge author just taking something out of context, or is he/she providing an accurate accounting of the facts?
Apologies for going off the original topic here at the end, but the message is equally important. Stay tuned for more to come....
Very interesting Singlemalt Trader. Thanks for your work here and I look forward to reading more in the future.
ReplyDelete