Comfortably ensconced in a Sussex Countryhouse Hotel, at the Future of Finance Initiative, a conference organized (“organised,” if you are a British journalist) by The Wall Street Journal, top flight bankers and financiers are meeting to discuss the near-death experience of the banking industry in Fall 2008, and whither we goest from here. Former US Fed Chairman Paul Volcker told the impressive assembly that they had better ‘wake up’ before it is too late.
When I say these things here, it is just me; when Mr. Volcker says them, financial movers and shakers might actually listen.
Volcker told them that they failed to understand just how close to the edge the US economy, and therefore the world economy, had come in the Fall of 2008. He also told them they were being pigs about excessive compensation and that complex and exotic financial products (that I have written about here too many times to count), such as credit default swaps (CDS) were a real Witches Brew of trouble.
Volcker was in charge of the US Fed from 1979 to 1987 and currently chairs President Obama’s Economic Recovery Advisory Board. He should know from whence he speaks as Volcker presided over several up and down cycles in the US economy (for those who remember back that far).
Volcker challenged the gathered Masters of the Universe, using ‘financial innovation’ to describe the exotic financial instruments which helped drive entire economies almost over a cliff. “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence,” Volcker said, crediting only the ubiquitous Instant Teller Machines as the single, real ‘financial innovation in the more than two decades since he left his Chair at the Fed.
More chilling yet were other speakers like Sir Deryck Maughan (90’s head of investment bank Salomon Brothers, now a partner in “KKR” – Kohlberg Kravis Roberts, the private equity firm known for legendary transactions like the 1989 leveraged buyout of RJR Nabisco, then the largest buyout in history, which spawned the excellent book: “Barbarians at the Gate.”) Sir Deryck told the assembled Men of Money that the seriously flawed mathematics which lie at the heart of the gigantic risks posed by CDS’s and other exotic financial instruments, have not been fixed. He also told the bankers that they had failed to face up to “the intellectual failure of risk management systems, which are still hardwired into many banks and many trading floors.” And, Sir Deryck is precisely correct. Think: ticking time bombs on balance sheets (in addition to that Trillion Dollars of new re-fi money next year that commercial real estate needs to keep even more loans from defaulting).
Last, but far from least, Billionaire investor George Soros told the attendees that CDS’s, and their rarified ilk of highly leveraged while not clearly understood bets, should be permanently and forever outlawed. Soros compared these risky exotic financial instruments to buying life insurance on a person and then giving others the right to shoot the insured person dead in his tracks. “They really are a toxic market,” Soros said. “Credit default swaps give you a chance to bear-raid bonds. And bear raids certainly can work.” We saw enough of that in 2008, didn’t we? Both the former Bear Stearns and Lehman Bros., each saw their stock values plummet in mere days as their value and stock and very lives were both short-sold and hedge-funded into extinction.
Perhaps the worst irony of all is that financial institutions today are using your tax dollars and mine to pay high-powered lobbyists to go gunning for and to shoot down any real financial reforms, thus guaranteeing that the Big One (not the San Andreas or some other earthquake this time), may yet come to the US and world financial markets, despite all efforts, recoveries and happy-talk, while bankers and other financial types continue to overpay themselves and prepare now to set new bonus records later this month. Not a pretty picture.