Monday, February 11, 2008

It's Everybody's Fault

There is a group called the Financial Stability Forum, which includes all the big guys from around the world. They recently issued a paper on what is wrong with the credit markets and how financial firms should shore up their balance sheets.

The paper includes this basic synopsis of who is responsible. The answer is, well, everybody involved:

The report said there is plenty of blame to go around for the chaos: The U.S. subprime-mortgage industry was marked by poor underwriting standards and "some fraudulent practices." Investors didn't carry out due diligence when they bought mortgage-backed securities.

Banks and other companies managed their risks poorly and didn't publicly disclose the dangers on and off their balance sheets. Credit-rating companies did an inadequate job of evaluating the risk of complex securities. Financial institutions compensated employees in ways that encouraged excessive risk-taking and gave insufficient regard to long-term risks.

The WSJ had this in one of the last paragraphs:

The forum urged financial firms to be more forthcoming about the underwriting standards used, for instance, in the mortgages that underlie complex securities, and to make their own due-diligence work available to investors and to the credit-rating companies.

Likewise, the credit-rating companies should be more open about the uncertainties in their own models, and should address any conflicts of interest in their work.

Let's tackle this one point at a time.

1.) There were no underwriting standards. There were instead medical requirements -- if you had a pulse, you got a loan. What financial firms really need to disclose is the medical records of borrowers to make sure all borrowers were in fact alive when they got a loan.

2.) All the major players -- mortgage brokers, banks, investment banks, rating agencies and the like -- should instead disclose all internal emails regarding their part in this mess. My guess is there is a contingent within each company that knew damn well each respective company was royally screwing up. The reason I think this is a Congressional investigation into tax evasion plans offered by the big accounting firms uncovered similar emails among the respective firms higher ups. The point all the players had to know -- they are filled with very bright and capable people who were well aware of the financial tsunami they would eventually unleash on the US economy.