The parade of new, bombshell financial plans included a new one Thursday, from ultra-busy, Treasury Secty. Geithner. Leaving no doubt as to the breadth and scope of these proposed reforms, Geithner explained in testimony Thursday before the House Financial Services Committee, that this is “comprehensive reform. Not modest repairs at the margin, but new rules of the game.” Wall Street groaned.
Geithner’s bold new plan would require registration with the SEC for hedge fund, venture capital fund, and private equity fund advisors. Then, confidentially, these advisors would have to share information with the SEC about their borrowings, the leverage involved in their investments, and, hitherto sacrosanct, information on their trading partners and investors.
This would enable the SEC, hopefully, to provide enough information for a yet another new czar, called a “Systemic Risk Regulator,” who would be able (again, hopefully) to guide our financial system like a lighthouse guides ships on dark nights tossed on stormy seas away from running aground on the rocky shores.
If adopted, this would help end the runaway era since Glass-Steagal was repealed in 2000 and other post-1930’s-Great-Depression regulation was tossed aside by both major parties, who combined to remove the brakes from the hot rod that our economy became in the last year and a half. As the wreckage is being picked over now, the amounts of money wagered, risked and leveraged by de-regulated and off-the-books investments like Credit Default Swaps, Collateralized Debt Obligations, and other exotic financial instruments, are absolutely staggering.
Estimates now range from $50 to $65 Trillion worth of these Paper Tigers, that were sold worldwide – amounts of money which exceed the entire world’s GDP – which were bet and wagered on investments that were risky beyond belief, but packaged so as to appear nearly risk-free, then blessed by Rating Agencies in the pockets of those who sold the investments, and, finally, sold like hotcakes to buyers that should have known better, ultimately producing mega-millions, if not billions, in profits and bonuses.
If I lend you $100 and Joel Fox bets with his buddy on whether or not I will pay you back, and then sells more of these bets to 10,000 of his favorite investors, Joel would have parlayed these wagers on the original $100 loan into millions and billions of dollars of investments – all of which was very, very profitable for the sellers of these bets. As long as you are financially stable and can pay back the $100 which I loaned you, all of the 10,000 investors will be made whole and everybody will be happy. That was how it was supposed to work.
But, that $100 loan was based on the incredible theory that inflated real estate values would just keep going up, up and away – forever. Once nature took its inevitable course, that $100 loan based on real estate values which had been pumped up to the moon, did not look so secure with real estate taking a 40 or 50% drop in value (“Haircut,” as the financial types like to say) – and, that’s where the trouble with these supposedly risk-free investments began.
Adding to that is their sheer complexity, dreamed up and elaborately constructed by physics and math geniuses (the financial community called them “Quants,” when they came over from academia to get rich) armed with powerful computers, and there are not many of us who can even begin to understand these exotic financial instruments. This recipie for disaster has, not surprisingly, become an unmitigated disaster.
AIG went into exotic financial instruments (called, famously, by Warren Buffet, some years back, “Weapons of Mass Financial Destruction”) in a big way and made boatloads of money selling and arranging them before the roof fell in. Recall, AIG is in the insurance business, not in the exotic financial instruments brokerage business, but, when regulation was done away with, this became a game that anybody could play – from tiny Iceland banks to the titan Masters of the Universe on Wall Street.
One of AIG’s justifications for the $165 Million they paid in bonuses with your and my tax dollars was that they needed to pay Retention Bonuses to keep working for them the geniuses who dreamed up these Financial Weapons of Mass Destruction, and to pull them apart and deal with each of their trading partners – note that AIG also paid Billions of your and my tax dollars to some of the trading partners.
Geithner’s plan is bold. Wall Street will hem and haw and moan and cry, but, this is an essential part of the going forward cleanup of this ungodly financial mess caused by people betting gobs of money that they did not have to back up those bets. As we have demonstrated, left to their own devices, instead of ruling the financial world, these Masters of the Universe could well have destroyed the financial world.