Tag: Bethany McLean

The Rise and Fall of Jon Corzine

Bryan Burrough, William D. Cohan and Bethany McLean have a piece in this month’s Vanity Fair on Jon Corzine, the man behind the spectacular crash of MF Global. It doesn’t provide much insight into what happened at MF Global or where the missing money went. But is does paint an interesting picture of the captain of the ship.

Unlike a nautical captain who drowns when his ship sinks, Corzine may escape. According the article, he had only a small percentage of his wealth in the firm. His wealth did not vaporize. The lawyers and class action suits against Corzine will likely take a big chunk of his remaining wealth. His career as a trader and money manager are likely over.

In piecing together earlier episodes in his career, one stuck out at me from a compliance and risk perspective. While a young trader at Goldman Sachs, Corzine was involved in a screwed up trade that was mishandled and exceeded the firm’s risk limits. In the end, the trade ended up making money, but that won no accolades. The trade violated compliance and risk policies and was non grata. We generally only hear about rogue traders when they lose money. At the time, at least according to the article, Goldman took a dim view on rogue traders who made money.

The other item that emerged is the Corzine was self-made. He is certainly part of the 1% now, but didn’t start out that way. One thing that has bothered me about the Occupy Wall Street movement is a somewhat misguided rage against the 1%. When looking at the income discrepancies over the last twenty years, I think people miss the fact that the people in the 1% are not all the same people that were int he 1% twenty years ago.

Unlike aristocracy, you do not need to be born into the 1% to become part of the 1%. (Sure, it usually helps to start off well-to-do.) It seems to me that combining lots of hard work, lots of education, and little bit of good luck can get you an entrance ticket to the 1%.

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What Caused the 2008 Crisis?: All the Devils are Here

Was it Fannie Mae? Was it the lack of regulatory oversight? Was it the rating agencies? Was it pure greed?

Yes, yes, yes and yes. Plus, there were lots of other factors.

Bethany McLean and Joe Nocera put together an insightful look at the many factors that created the housing bubble and amplified the destruction when it popped in All the Devils are Here: The Hidden History of the Financial Crisis. Pundits and purists have tried to pin the blame on a single element. It seems clear that many “devils” were at work. It’s not just institutions that failed in the crisis. The authors paint the pictures of key individuals who helped inadvertently build up the housing bubble or allowed for it cause mass destruction.

Certainly, Fannie Mae and Freddie Mac were part of the problem. It was their stranglehold on the securitization of conforming mortgages that lead Wall Street to look at non-conforming mortgages as a source of profits. Subprime mortgages, by definition, were outside the definition of “conforming” by Fannie Mae and Freddie Mac standards.

Wall Street’s thirst for product was an ample funding source for subprime lenders. They didn’t need the deposits of conventional banks for funding. They could just sell their loans to Wall Street for packaging into mortgage-backed securities. Wall Street would also provide the warehouse funding to help subprime lenders with capital to originate mortgage loans.

The federal government was pushing for increased home ownership. The Clinton administration announced its National Homeownership Strategy, with the goal of raising the number of homeowners by 8 million over the next 6 years. (Bush carried on a similar strategy.) The flaw is that to meet that goal, riskier borrowers would need be made homeowners.

JP Morgan developed Variance at Risk, an analytical method to analyze the risk in a bank’s portfolio. They understood that the mathematical models were merely an indicator risk. Although correct 95% of the time, they were also wrong 5% of the time. Other lenders adopted VaR, but failed to grasp its limitations.

AIG and its Financial Products division played a key role. They helped provide the back stop that helped the market accept the AAA rating of mortgage-backed securities. Eventually they also moved into credit default swaps. The authors paint a picture of AIG-FP as a collaborative workplace where employees could express their skepticism about deals. Then Hank Greenberg threw out the management and replaced them with Joe Cassano. He ran the shop in a more dictatorial manner and doled out information on a need-to-know basis.

Of course there were the rating agencies who gave the RMBS and CDOs undeserved AAA ratings. That was supposed to mean that the securities are just a little riskier than US Treasuries. It was Fitch that changed things. Moody’s and Standard & Poor’s had a business model based on subscribers. Fitch changed things by charging the issuers instead of the subscribers. That would eventually lead to the ratings shoppings that became part of the subprime bubble. Of the AAA rated subprime residential mortgage-backed securities from 2007, 91% were downgraded to junk status and 93% of those from 2006 were downgraded to junk status. That is a horrible track record.

I suppose that was a bit of a spoiler, but we all know that the financial markets came to a grinding halt in 2008, crushing big banks, speculative investors, small banks, and those just hoping for a small part of the American Dream.

There are a dozen other “devils” discussed in the book, but you should just read it yourself instead of reading my ramblings.

The worst part of the subprime crisis is that the bigger goal of increasing ownership was a failure. Between 1998 and 2006 only about 1.4 million first-time home buyers purchased their homes using subprime loans. That was only about 9% of all subprime lending. The remaining 91% of subprime lending was refinancings or second home purchases (or third or fourth …). “By the second quarter of 2010 the homeownership rate had fallen to 66.9% percent, right where it had been before the housing bubble.”

I found this book to be a great companion to The Big Short and In Fed We Trust. The Big Short does a great job of focusing on how the CMBS and CDO markets worked. In Fed We Trust focused on the events of 2008. All the Devils are Here focuses on the macro events that swarmed together into an apocalyptic mix of bad bad loans, bad underwriting, bad risk assessment, bad investing and bad goals.

Repeal of Dodd-Frank?

Most compliance professionals have trepidation about parts of the Dodd-Frank Wall Street Reform and Consumer Protection Act. I would bet that most of the Representatives and Senators who voted for it (and against it) did not read the whole law and do not understand the changes being made.

But should it be repealed in it’s entirety?

Since the Republicans have taken over the House of Representatives there is growing backlash against the law. Take a look at the new Republican-authored House Committee on Financial Services website. Here are the headline topics:

  • Collateral Damage – the real impact of the Democrat’s bailout bid
  • Financial Regulatory Reform
  • Fannie and Freddie Reform
  • What’s NOT in the Dod-Frank?
  • What’s Really in Dodd-Frank?

Along with the changes to the website comes a H.R. 87: To repeal the Dodd-Frank Wall Street Reform and Consumer Protection Act from Representative Bachman:

“I’m pleased to offer a full repeal of the job-killing Dodd-Frank financial regulatory bill. Dodd-Frank grossly expanded the federal government beyond its jurisdictional boundaries. It gave Washington bureaucrats the power to interpret and enforce the legislation with little oversight.

“Dodd-Frank also failed to address the taxpayer-funded liabilities of Fannie Mae and Freddie Mac. Real financial regulatory reform must deal with these lenders who were a leading cause of our economic recession.”

Speaking personally, I don’t like Dodd-Frank. But repealing it would be worse. I think needs the SEC needs more funding and a longer time frame to promulgate the new regulations. The SEC normal produces just a handful of new rules each year. Dodd-Frank tasks them with dozens that need to be in place in the next few months.

As for Fannie Fae and Freddie Mac being the cause of the crisis, I think Representative Bachman should take the time to read All the Devils Are Here by Bethany McLean and Joe Nocera. (I’m halfway through it.) Fannie and Freddie played a role, but lots of things went wrong to get us into the trouble of 2008.

Putting companies into a limbo of whether they need to change or not is bad. I may not like the law, but uncertainty is worse.

On the other hand, I think the repeal is unlikely. It’s merely a political football to throw around.

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