The Washington Independent - U.S. news and politics - washingtonindependent.com: Stories by Charles R. Morris

Credit Crisis Only Begins With Mortgages

Charles R. Morris — Tue, 12 Feb 2008 13:16:17 GMT

Illustration by: Matt Mahurin

One can pity Federal Reserve Chairman Ben S. Bernanke. No other federal reserve chairman ever cut interest rates by a full 1.25% within just eight days, as Bernanke has done. But the monetary skies remain as leaden and thunder-clouded as ever. The stock market keeps quivering downward, crowds thin at the malls, jobless queues grow. Wal-Mart reports that customers are using their Christmas gift cards for groceries.

The hard reality is that the economy is facing a one-two knockout blow from a collapse in consumer spending, plus a shock-and-awe wave of asset write-downs that is wreaking havoc in the financial sector. The more Bernanke floods the economy with easy money, the worse the final reckoning is likely to be.

First the consumer. For decades, personal consumption’s share of GDP averaged in the 66 percent-67 percent range. In 2000, however, it moved up sharply, hitting 72 percent in early 2007, the highest rate of consumption in any modern country ever.

How did consumers pay for it? Well, not with their wage packet -- median household incomes were roughly flat in the 2000s. Instead, households doubled their debt load, and personal savings rates dropped to zero.

Almost all the new borrowing was against houses. Very low interest rates and super-easy mortgage rules drove house prices up 50 percent between 2000 and 2005, one of the fastest jumps in history. As prices soared, consumers refinanced again and again, rolling over the proceeds into pricier houses and more consumption. Wall Street’s economists looked on happily, and constructed elaborate theories proving that the debt spiral could continue indefinitely.

But as outstanding mortgages balances ratcheted higher and higher, they finally smacked up against the ability of homeowners to service their debt, no matter how low the interest. A tipping point was crossed last year, when it dawned on markets that houses were overpriced – and by a whole lot. Home prices are now in free fall; price drops of 20 percent to 30 percent will be required to get them back in line with incomes. Stuck with heavy debt service and no cash left in their homes, consumers are cutting back hard. The credit merry-go-round, in short, has started to run backwards.

The truly bad news is that the credit crisis is not just about home mortgages. The truly bad news is that the credit crisis is not just about home mortgages. The same problems infect almost every important asset class. Commercial mortgages had a drunken spree of their own in 2006 and 2007. A sign of the times: the big New York developer, Harry Macklowe, is unable to pay $7 billion in debt on seven prime Manhattan office buildings he bought less than a year ago. The takeover loans that fueled the 2006-2007 stock market boom are also faltering badly. Trading markets are now pricing prime takeover loans and commercial mortgages as if they were junk bonds.

On quite reasonable assumptions, total market losses from defaults and writedowns on mortgages of all kinds, and from junk bonds, leveraged takeover loans, credit cards, and auto loans, will be in the range of $1 trillion.

(What are "writedowns?" Suppose I pay $1000 for an apparently high-quality 10-year bond that pays 5 percent, or $50, a year. Then, suppose my bond turns out to be riskier than I thought – say, the kind that usually pays 9 percent returns. How much can I sell it for? The answer is about $720; at that price, the $50 in interest equates to a 9 percent yield on the investment. The $1000 bond, that is, has lost 28 percent of its value. If it is held in a bank trading account, the bank would have to reduce its stated profits and equity capital by that amount.)

Roughly half the shaky mortgages and other loans are on the books of banks, with the rest spread among hedge funds, pension funds and individual investors. Banks have already written off $130 billion of bad loans, so they have some $250-$350 billion to go. Reductions in equity capital have about a 10-to-one downward ratchet effect on a bank’s ability to lend.

That is the source of the great "‘credit crunch" that has sent bankers scurrying around the world to Arab, Chinese and other Asian investment funds to replenish their capital. And those are the worries that have pushed the "fiscal stimulus" program through Congress and prodded Bernanke to turn on his fire hose of new money.

The questipn is, what are we are trying to accomplish? Do we want consumers to keep on spending and borrowing? Are we hoping over-levered companies will pile on more debt? Are we trying to make house prices go up? Isn’t that why we’re in trouble in the first place?
Those questions are the subject of Part II of this article.

Charles R. Morris is the author of "The Trillion-Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash," which will be out in March. His earlier books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P Morgan Invented the American Supereconomy" and "Money, Greed and Risk."

Imploding Credit Bubble to Hit $1 Trillion

Charles R. Morris — Tue, 12 Feb 2008 17:12:50 GMT

Illustration by: Matt Mahurin

The current credit and financial crisis, unusually, is almost entirely the creation of the financial services industry.

Financial services now dominates American business to an astonishing degree. Though the industry accounted for only about 16 percent of corporate output in 2007, it racked up more than 40 percent of corporate profits. From 2000 through mid-2007, total American stock market value grew about 6 percent, while the value of financial services stocks grew by 78 percent. And though total corporate profits roughly doubled, business investment was almost flat.

Where did the profits go? Mostly to dividends and stock buybacks, much of which, in turn, poured into the hedge funds and private equity funds driving the company buyout boom. Martin Wolf, an economist and columnist for the London Financial Times, laments that America is turning into "a giant hedge fund."

From 2002 through 2005, Federal Reserve Chairman Alan Greenspan kept banks’ own borrowing rates lower than the rate of inflation – in effect, for bankers, money was free. Bankers also began to package up their loans into new types of bonds that they could sell off to pension funds and other investors to free up their capital for more lending. When money is free, and banks can earn rich lending fees without tying up capital, the rational banker will lend to infinity.

...in effect, for bankers, money was free... Countrywide Financial, one of the more notorious pushers of toxic mortgages, is a good example. Unusually easy money allowed it to employ extreme leverage, and incur heavy cash flow deficits – a total of $38 billion in operating cash deficits from 2003 through 2007. Not to worry. That was covered by $44 billion in low-rate borrowing from the Atlanta federal home loan bank. Angelo Mozilo, the Countrywide CEO, was paid $48 million in 2006, and made another $100 million-plus selling his Countrywide stock just before the subprime mortgage crash.

Your taxpayer dollars at work.

Over the past few weeks, there has been a steep fall in the trading value of company-takeover loans. That is a huge market, and forced sales and rising delinquencies are ominously reminiscent of last summer’s subprime debacle. The unfolding consumer recession will only make it worse.

The total losses and writedowns from the imploding credit bubble – leveraged loans, mortgages of all kinds, credit cards and much else – (See Part I of this article) will be on the order of $1 trillion. About half of the losses will be absorbed by banks. They have already taken some $130 billion of writedowns, so they have some $250-350 billion to go.
Which brings us back to the Fed. The floods of easy money from chairman Ben Bernanke look like a doomed effort to paper over the inflated asset values, the phony triple-A ratings and the hidden liabilities marbled through American balance sheets.

There is a precedent for such behavior. In the late 1980s, Japan experienced an asset bubble much like our current one. The tight network of government and financial executives conspired to conceal it with cheap money. And the crisis dragged on for another 15 years.

It is desperately important that we start the painful conversion from the recent debt-driven consumption circus to a more balanced, higher savings economy. It is desperately important that we start the painful conversion from the recent debt-driven consumption circus to a more balanced, higher savings economy. But that transition can’t start until the financial sector reprices assets down to real values – and the faster the better.

The scale of the required writedowns is scary. Bank capital will be decimated, necessitating perhaps $150-$200 billion in new capital raising. The tens of billions in new capital raised by banks last year almost all came from sovereign wealth funds – murky investment vehicles mostly under the control of Asian and Arab governments. It is not xenophobic to worry about the sale of yet another huge block of ownership to such entities.

Wall Street seems to be hoping that the federal government will simply take over its bad assets, much as we funded Countrywide; such ideas are floating around the Congress. The banks would doubtless garner big fees for helping the government manage its new financial garbage dump.

There is a better alternative. Instead of a government bail-out, or a fire sale to foreign governments, let the banks absorb their writedowns and then recapitalize by selling new debt and equity to the American government on private market terms. The securities would be deposited in the Social Security trust funds, doubtless improving their long-term returns. Contractual and legislative provisions could protect against political meddling.

But choices are narrowing fast. The Great Inflation of the 1970s was ended only when then Fed Chairman Paul Volcker restored financial stability by forcing a painful repricing of the American economy. It took more than two years, but laid the groundwork for the high-growth era of the 1980s and 1990s. Or we could temporize as Japan chose to do – and slide into the assisted-living limbo of nations that have run out of energy and ideas.

Charles R. Morris is the author of "The Trillion-Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash," due out next month. His earlier books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed and Risk."

Bailout Bernanke: Hero of Wall Street

Charles R. Morris — Mon, 17 Mar 2008 01:22:46 GMT

Federal Reserve Chairman Ben S. Bernanke may be running for a "Hero of Wall Street" award. Over the last few months, he has opened up the Fed’s coffers for banks and brokerages to the tune of hundreds of billions, and is accepting riskier loan collateral than ever before. Last week, he threw his body – or, more accurately, ours – over the railroad tracks to slow an onrushing Bear Stearns trainwreck.

This time, at least, the acrobatics may have worked. On Sunday, JP Morgan Chase announced that it would buy Bear at a tiny fraction, less than 2 percent, of its market value last fall. According to early reports, the Fed is also kicking in $30 billion of taxpayer money to sweeten the deal.

Is Wall Street happy? Of course not. David Rosenberg, the chief economist of Merrill Lynch kvetched that the Fed’s actions do "not materially improve the solvency of the institutions exposed to assets under stress…and does nothing to put a floor under home prices."

Rosenberg makes Merrill and its pals sound like Katrina victims -– just innocent bankers quietly going about their business when they got hit with all these "assets under stress." Who knew?

Bear Stearns’s most recent financial filings with the Securities and Exchange Commission make rich reading. The largest chunk of its assets, $46 billion, are in home mortgages and home mortgage-backed securities. They’re funded 20-1 with borrowed money, a lot of it very short-term. They’re clearly culled from the riskier end of the market, and recent delinquency rates are far higher than the (very high) industry norm.

Given that housing values are falling by some 10 percent a year, a reader would naturally conclude that this is a company on the brink of insolvency –- as, indeed, it turned out to be. But JP Morgan Chase still got a bargain. The $30 billion from the Fed will cover most of Bear’s mortgage losses, and JP will pick up Bear’s lucrative back office business for a song.

Why did the the Fed think it had to pay to make a deal happen, instead of just letting the market take its course? According to Bernanke and Treasury Secretary Henry M. ("Hank") Paulson, who made the rounds of the Sunday talk shows, it is because Bear is at the center of a web of other funds that look a lot like Bear – heavily leveraged and holding lots of mortgage-backed paper. If the Fed didn’t act, a lot of them, perhaps most of them, would also fail.

Would that be so awful? That depends on what kind of assets we’re propping up. Bear skimps on loan detail, but Countrywide Financial is another big mortgage lender on federal welfare –- $50 billion worth, all from Atlanta Federal Home Loan Bank. It is a rich target for litigators, so its lawyers must have insisted on unusually detailed disclosure.

Almost all the mortgages on Countrywide’s book are so-called "prime" mortgages. But if you look closer, it turns out about a third of them are nasty things called "pay-option loans." Borrowers can defer both principal and interest. Most of the loans are ARMs (adjustable interest) with monthly interest resets and annual payment resets for deferrers, plus unlimited resets every five years. Countrywide goes on to tell us that 81 percent of such loans – about $24 billion worth – were underwritten "with low or no stated income documentation;" 71 percent are "electing to make less than full interest payments," and – surprise – delinquencies went up about nine times in 2007, from 0.65 percent in 2006 to 5.71 percent now. Although they’re carried at full value on the Countrywide balance sheet, in reality, they’re junk.

This is the kind of garbage that Bear had on its books, and is precisely the kind of mortgages likely to back the complex "Collateralized Debt Obligations" and other mortgage-backed instruments preferred by yield-seekers like hedge funds. But Paulson and Bernanke seem determined to keep the Ponzi game going. Shamefully, the two biggest rating agencies, Standard & Poors’ and Moody’s, are playing along by maintaining triple-A ratings on mortgage bonds that probably qualify as junk.

But Wall Street is even marking down bonds from Fannie Mae and Freddie Mac, the complaint goes. That’s crazy, right? Everyone knows they’re guaranteed by the federal government.
But there is no federal guarantee. In its annual report, for example, Fannie insists that "We are a stock-holder owned corporation…funded exclusively with private capital," with no guarantee "either directly or indirectly" from the federal government. Of course they would say that -– how else to justify a $14.5 million pay package for the boss?

But Paulson and Bernanke seem to be hinting that there really is an "implicit" federal guarantee, as Wall Street has always suspected. They should stop insisting. Fannie and Freddie, between the two of them, have $225 billion in subprime and ‘Alt-A’ mortgages on their books. (The Countrywide pay-option loans would be categorized as Alt-A.) People with eight-digit pay packages, we have learned, like taking risks with other people’s money. If they get into trouble, that shouldn’t be a taxpayer problem, and bond-buyers should mark Fannie and Freddie paper for what it’s really worth.

The hard truth is that a decade of flooding markets with easy money enabled greedy and stupid lending, and probably a good deal of conscious fraud. Houses, like most other leveraged assets, are now grossly overpriced relative to home-buyers’ ability to pay. Home prices have perhaps another 15-20 percent to fall – maybe even more as the recession starts to bite.

"Placing a floor under home prices" benefits nobody but the banks and hedge funds, and will delay essential market adjustments. It’s time to start letting the dominoes fall.

Charles R. Morris is the author of "The Trillion-Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash," published this month. His earlier books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P Morgan Invented the American Supereconomy" and "Money, Greed and Risk."

Wall Street as Black Hole

Charles R. Morris — Wed, 19 Mar 2008 14:29:15 GMT

Stock markets rebounded mightily yesterday, dazzled by yet more center-stage virtuoso turns by Federal Reserve Chairman Ben S. Bernanke. Over the weekend, he out-Greenspanned Greenspan by engineering a takeover of Bear Stearns, and then opened the Fed’s resources to investment banks in addition to the commercial banks that are its normal constituency. Tuesday he cut the Fed fund rate target, or the bank funding rate, to only 2.25 percent, a full 3 percent rate cut since the fall.
Surely now, with crises once more brilliantly contained and Fed money flowing freely, consumers will get back to borrowing and buying, housing markets will stabilize and the economy will turn smartly upward.
Not a chance. The Fed has now committed all the ammunition it has to prop up Wall Street, and shore up shaky mortgages. All that’s left in its trick-bag is to turn on a Weimar-style printing press.

With all the attention focused on the Fed, investors may not have noticed that the so-called Government-Sponsored Entities, (GSEs) Fannie Mae, Freddie Mac and the utterly obscure Federal Home Loan Bank, have been pouring even more money than the Fed into housing, with little effect. The mortgage mess, it now appears, is a black hole that can swallow up the Fed without a trace.

Consider the sequence of events during the Bear Stearns takeover negotiation over the weekend, as participants have described them to the media. JP Morgan Chase apparently came into the Saturday session expecting to do a deal in realm of $10-$12 a share, without any guarantees from the Fed. Bear, after all, owns lucrative low-risk businesses like stock-clearing, plus a trophy Skidmore, Owings building in midtown Manhattan. The equity in the building is worth at least $6 a share by itself.

Then JP Morgan looked at Bear’s books and had a drastic change of heart. The deal was finally done only after Morgan’s price was cut to $2 a share, or $236 million, and the Fed ponied up a line of credit of $30 billion (that’s ‘billion’ with a ‘b’) to cover potential losses. Morgan, that is, got the entire company for less than 1 percent of the total investment, while accepting almost no risk until all of the Fed’s $30 billion is burnt through.

What made Morgan demand such terms, and why would the Fed agree? Or to rephrase the question, what did the Morgan executives see on Bear’s balance sheet that made them so terrified?

Bear’s published balance sheet is perfectly standard –- tradable assets are mostly liquid corporate stocks and bonds –- except for a $46 billion dollar slug of mortgage-backed securities. The only evidence that they’re worth $46 billion is that Bear Stearns said so. But they are almost all opaque strips of the same kind of ‘CDOs’ and other "structured securities," that have brought Citigroup, Merrill Lynch and UBS to grief. As Bear explains in the fine print, you have to value them partly or wholly with sophisticated internal models because their values are difficult to tie closely, if at all, to "observable" market data.

The obvious inference is that Morgan looked at those securities with its own models and said, "Hell no." Even Bernanke’s -– or the taxpayers’ –- $30-billion deal sweetener must not have fully covered the risk in Morgan’s eyes, or the stock price wouldn’t have been cut so drastically.

According to the widely accepted calculations of intrepid Fed-watcher and blogger Steve Randy Waldman, the Fed can plow, at most, $400 billion into Wall Street balance sheets. After last weekend, they’ve already used up $90 billion of it. In the second half of 2007, however, the three housing GSEs poured more than $600 billion in new money into the mortgage markets, obviously without "fixing" the problem. In the third quarter, when GSE financing peaked, according to analysts at BNP Paribas, it was equivalent on an annualized basis to 15 percent of GDP.

The huge volume of GSE financing, of course, has begun to push up the cost of GSE borrowing, despite the winks and nods from the Treasury and the Fed that this is really federal debt. Congress and the Bush administration, in the meantime, are working on legislation that will raise GSE borrowing limits and allow it to lend on lower-grade paper.

If you’re into housing bubbles, the thinking seems to be, you might as well make it a really big one – like a dirigible. We could call it the Hindenberg.

Charles R. Morris is the author of "The Trillion-Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash," published this month. His earlier books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P Morgan Invented the American Supereconomy" and "Money, Greed and Risk."

Not So Fast on Mortgage Solutions

Charles R. Morris — Tue, 25 Mar 2008 14:44:34 GMT

A drumbeat is building for some form of federal takeover of troubled home mortgages. Sen. Christopher J. Dodd (D-Conn.) is leading the charge in the Congress, while Bank of America has been lobbying hard behind the scenes. Respected economists like Paul R. Krugman and Alan S. Blinder, both of Princeton, have added intellectual heft to the bandwagon.

To construct new legislation, the two most cited precedents are the Resolution Trust Corporation (RTC) that cleaned up the mess left by the 1980s Saving and Loan bust, and the Depression-era Home Owners Loan Corporation (HOLC), Blinder’s favorite, that took over some four million mortgages in the 1930s.

Neither precedent is fully on point. The RTC was a mortgage seller, not buyer. When the government paid off the depositors of bankrupt S&Ls, it automatically acquired a mare’s nest of dicey commercial and residential mortgages. The RTC then ran one of the biggest fire-sales in history, bundling up assets into big collateral pools that were sold off en masse to Wall Street and other big investors. Inevitably, many of the firms that made a bundle creating the crisis made a second one on the way out.

The HOLC actually did buy and hold mortgages, but it was intervening in a market where only the most solid citizens had qualified for mortgage finance. In the 1930s, less than half the housing stock was owner-occupied. Minimum down payments were typically high, and mortgage maturities rarely exceeded 15 years. All HOLC clients, in short, had a massive economic stake in their homes. HOLC rules forbade lending to anyone with less then 20 percent equity in the home.

Today’s subprime and "liar loan" mortgage holders are a different breed. Perhaps one-third are speculators; another third, reasonably well-to-do folks whose appetites for jacuzzi-ed McMansions got ahead of their incomes. Only the remaining third are the plausibly victimized lower middle-income families, that everyone wants to help. As economists are wont to do, Blinder assumes into existence a neo-HOLC able to sort out the speculators and fraudsters from the proper beneficiaries of government largesse. He might first check out the Small Business Administration’s experience in the wake of Katrina.

The real problem with any new HOLC-like initiative, however, is that it is almost certain to be a windfall for the custom-suit set. Dean Baker, co-director of the Center for Economic and Policy Research, is a careful researcher with a decidedly left-liberal bent. He calculates that the mortgage-subsidy plans now floating around Congress will actually work as a heavy tax on lower-income home owners.

The normal ratio of home prices to annual rental costs is about 14-1. Because of the credit bubble, they are now 20-1, a 43 percent premium. Most subsidy plans seem to contemplate mortgage principal reductions only in the 20 percent range. Keeping lower-income people in homes at that rate would entail a substantial wealth transfer from poorer people to bankers, while still leaving home owners little prospect of accumulating equity. Baker’s preferred solution is to amend the bankruptcy law, so judges can convert mortgages into market-rental leases. Tenants get a fair price for their housing, and the banks take the losses.

But that brings us to the real nub of the issue. Responsible officials, from Federal Reserve Chairman Ben S. Bernanke through Treasury Secretary Henry M. Paulson, fear that a true valuation of assets on bank balance sheets could bring down the world financial system.

The federal mortgage agencies -- Fannie Mae, Freddie Mac and the Federal Home Loan Bank Board -- poured hundreds of billions into dicey mortgages over the past year, and have now been authorized to spend $350 billion more. In just the last few weeks, the Fed has authorized some $400 billion in new finance, targeted at bank-held mortgages. And Bernanke took barely a heartbeat to sign off on a $30-billion credit to prevent a default at mortgage-heavy Bear Stearns. All those prodigious financings are almost pure waste -- aimed solely at maintaining the charade that banks are correctly valuing their huge holdings of mortgages.

There is a better way. But it would set the possibly unthinkable precedent of allowing taxpayers to get full value for their money, instead of absorbing only the losses.

Economists have already reached a near-consensus that the required home mortgage writedown is about $400 billion. Add in commercial mortgages, highly-leveraged takeover loans, credit cards and the rest, the total tab will come to between $800 billion and a $1 trillion. About half of it, or some $400-$500 billion is at the banks. Subtract the $150 billion in writedowns to date, and there is $250-$350 billion to go.

The SEC and the Federal Reserve have the authority to require a full-scale revaluation of bank balance sheets -- applying tough, consistent rules to force restatements to realistic levels. The capital losses would require an immediate infusion of perhaps $200 billion in new equity. That’s far more than we could, or should want to, raise from the Arab and Chinese sovereign wealth funds that have been the main recent source of new bank capital.

But Washington does do have a sovereign wealth fund of its own. The Social Security Trust Funds own more than $2 trillion of U.S. treasuries that, conservatives have long argued, earn too low a return. The trust funds could supply whatever equity shortfalls are left after true private investors have had their shot. At most, bank stocks would be 10 percent of trust fund holdings, and over the long term, would probably be quite profitable. Current shareholders, of course, will take it on the chin -- but they will have the satisfaction of inflicting appropriate punishments on their executives.

A return to a world of solvent banks would allow us to focus, finally, on the far more serious business of repairing the real economy. It will allow us to take a long careful look at the kind of regulatory regime we need to reap more of the benefits of the new world of hyper-finance, with fewer of the cataclysms.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "The Cost of Good Intentions," about the New York fiscal crisis.

Time to Buy Gold Bars?

Charles R. Morris — Mon, 07 Apr 2008 05:42:51 GMT

If Federal Reserve Chairman Ben S. Bernanke was hoping that the rescue of Bear Stearns would calm financial markets, he is likely to be disappointed. Last week’s Senate hearings on the details of the rescue brought more of the gory details into the light. Investors might be tempted to phone their neighborhood dealer in gold bars.

Bear Stearns, readers will recall, notified the Federal Reserve on Thursday, March 13, that it was on the point of declaring bankruptcy. The Fed provided a short-term loan, funneled through JP Morgan Chase, and over the following weekend engineered a shotgun marriage with Morgan. The Fed had to put up a $30 billion credit line, later changed to $29 billion, to induce Morgan to do the deal.

All the senior figures in the rescue, including Bernanke, testified, but the useful details come almost entirely from Timothy Geithner, president of the New York Fed, who was the point man in forcing a deal. Christopher Cox, the chairman of the Securities and Exchange Commission, and Bear CEO Alan Schwartz seemed to dismiss the entire episode as a mugging. Bear, in Cox’s words, was "a major investment bank that was well-capitalized and apparently fully liquid." He makes its failure sound inexplicable. To Schwartz, Bear was just a victim of "unfounded rumors and attendant speculation…that grew into fear" about Bear’s solvency. Schwartz even managed to blame the Fed. He thought, he said, that he had 28-day loan, and discovered on Friday that it would be cut off Sunday night.

Though Geithner, like Cox, opened by filling the hearing room with a cloud of platitudes, he eventually got down to the real facts. After making the initial loan for "up to 28 days," Geithner looked closely at Bear’s books, and decided he would "have been very uncomfortable lending to Bear."

It didn’t require confidential information to get nervous about Bear. Geithner called in Morgan because they were Bear’s clearing bank and. presumably, familiar with their portfolio. Morgan, too, when they took a closer look, became "significantly more concerned about the scale of risk" in a merger. Too bad they hadn’t exercised the same vigilance when acting as Bear’s clearing bank.

It didn’t require confidential information to get nervous about Bear. According to its SEC filings, Bear, on the most generous definition, was leveraged 20:1. Their 2007 trading books showed $138 billion of securities, funded with a $102 billion in short-term borrowing. A third of the portfolio was in mortgages, which could be valued, either wholly or partly, only by using Bear’s proprietary internal models. Lenders would just have to take Bear’s word for what they were worth. But there was a lot there to make a lender wary.

Bear’s shift toward shorter and shorter financing – a 47 percent increase in 2007 – was further evidence of the deterioration in its credit standing. Oh, and it had also entered into derivative arrangements where it guaranteed either to repay the principal par value on defaulting bonds or to guarantee specific security prices on $2.5 trillion of other investors’ assets. Nervous yet?

It gets worse. Bear put up $30 billion in "high-quality" collateral to support the $29 billion Fed line of credit to Morgan. (Morgan is on the hook for $1 billion.) How do we know it’s worth $30 billion? Because Bear said so. Fed releases and Geithner’s testimony stress that the loan is secured by "$30 billion in assets of Bear Stearns, based on the value of the portfolio as marked to market by Bear Stearns." The supporting documentation (pdf) shows that the "assets" include unspecified "Unfunded Forward Commitments," which, to the skeptically-minded, may just include a slug of those par value guarantees.

It’s also interesting that the Fed chose to characterize the mortgage securities that make up the bulk of the credit collateral as all "BBB- or higher." BBB- is the lowest "investment grade" rating. Normally, one characterizes an investment portfolio by its average rating, not by its lowest. The "all BBB- or higher" wording suggests that the collateral is probably nearly all BBB-. There happens to be a trading index of BBB- bonds from standard residential mortgage-backed collateralized securities of the kind Bear is likely to own. As of last Friday, it was about 11 cents on the dollar.

Finally, despite the $29 billion in subsidy, JP Morgan asked for, and got, a waiver (pdf) of the Federal Reserve’s banking capital adequacy rules for the next 18 months. The implication is that once Morgan revalues the questionable Bear assets, the equity on the Bear balance sheet will disappear, and Morgan will find itself over-leveraged.

The blogosphere has changed the rules. One bright spot in this dismal account is that it is no longer possible to brush such shameful episodes aside with a day or two of anodyne testimony. The blogosphere has changed the rules. A legion of dedicated, and knowledgeable finance bloggers has been diligently digging up all the details available to be dug. Readers who would like to plunge deeper into swamp should check out Yves Smith, Felix Salmon, Steve Waldman and Alea.

But that is small comfort. The acrobatics of the Bear rescue suggest the depths of the abyss that our financial leadership has dug for us. Does anyone believe that this is the last time we will hear Fed sirens wailing in the night? And don’t we deserve a greater touch of candor on the part of officialdom? Bernanke, Cox and even Geithner, for much of his testimony, spoke of the crisis as if it was visited upon us from outer space. Is it about time for them to start pointing their fingers at themselves?

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "The Cost of Good Intentions," about the New York fiscal crisis.

Is the Worst Over?

Charles R. Morris — Mon, 28 Apr 2008 10:00:00 GMT

It would be too much to say that champagne corks were popping on Wall Street last week, but there was an almost audible sigh of relief wafting through the trading rooms. While almost no one was prepared to say that the credit crunch was over, there was a palpable sense that the violent market turmoil of the past year might finally be coming to an end.

There was plenty to be happy about. The dazzling financial pyrotechnics at the Federal Reserve over the past several weeks did indeed seem to ease some of the tensions in credit markets. Though bank first-quarter announcements are the usual dismal litany of losses and write-offs, some of the most beleaguered, like UBS, Washington Mutual and the Royal Bank of Scotland, still seem able to raise new capital. First quarter earnings at big industrial companies like IBM (pdf), and General Electric – if one ignores the results of GE’s financial businesses – were actually quite decent.

So is the worst over? Not by a long shot. We still have a long way to go.

A single number tells most of the story. Between 2000 and 2007, Americans withdrew $4.2 trillion in free cash flow from their homes – in other words, $4.2 trillion in new mortgage debt that was not invested in new housing or in paying down old mortgages. Instead, it was spent on other stuff, like new cars and plasma TVs. For the three years through 2006, the free cash flow from mortgages was more than 7 percent of disposable personal income. That’s why personal consumption could break all records at a time when real wages were falling.

But when house prices suddenly tipped into free-fall in mid-2007, home mortgage financing dried up. By the end of the year, mortgage finance flows were about half the average for the previous several years. Pathetically, credit card borrowing jumped to an all-time high in the third quarter of 2007, but dropped right back by year end, as card companies quickly tightened the screws.

In the last half of 2007, households also began a major sell-off of financial assets, like stocks and bonds. Much of that must have come from already-paltry retirement savings.

Now, take a closer look at those good results from the big industrial stocks. These are global companies. They sell all around the world, and they have learned the advantage of locating their factories, research labs and employment centers where they sell. Uniformly, revenue and profits in the United States for IBM, GE, and Goodyear have either fallen or slowed sharply. Americans benefit when American company stock prices go up, of course, but the immediately tangible payoffs – rising employment, more plant investment – will go where the sales are. Right now, America’s not where the growth is.

Mohammed El-Erian, the co-chief executive at PIMCO, a large global bond manager, recently observed that almost all the market disruptions from the credit crunch have transpired while the economy was still growing. What’s happened so far, in other words, is just prologue for when recession really bites.

House prices fell about 10 percent last year. A growing number of analysts expect another 15 percent - 20 percent price drop will be necessary to bring housing costs back in line with incomes. Some 8 million homeowners are stuck with mortgages worth more than the their homes’ market value, even as consumers are increasingly squeezed by flat wages, soft employment and back-breaking price increases for gasoline and food.

What’s happened so far, in other words, is just prologue for when recession really bites. The New York Times recently documented sharp drops in consumer spending on women’s clothing, furniture, luxury goods and airline travel, as well as a pronounced shift to lower-cost, non-branded basics from pizzas to beer. But surveys adduce plenty of evidence that consumers are still stretching to maintain spending in high-tension items -- like the video game that your kid really, really wants. In other words, recession is taking hold, but we haven’t yet adjusted to the reality.

And, regretfully, the banking crisis is far from over. Last week, the ratings agencies downgraded thousands more mortgage-backed bonds, and there are thousands yet to go. At best, only about half the mortgage-related problems are behind us. Many of the highly leveraged private equity companies taken over in the recent buyout splurge are very exposed to the consumer sector, and their debt is weighing heavily on many banks.

Smaller, regional banks may be about to join the party. Though they generally are not exposed to the kind of toxic instruments that brought Citigroup and Merrill Lynch low, they still have heavy straight real estate exposure, and are sure to start taking losses.

At this point, the Fed is finally running out of magic tricks. Banks know they are facing future losses, and are pulling in credit lines, hoarding capital for the crises on the horizon. More rate cuts by the Fed risks losing control over inflation.

For some 15 years, wise people have been nattering about America’s profligate spending and low savings. We all knew they were right. This time, winter is really coming.

America is a resilient country, and we will get through it. But the notion that we’ve paid our dues, and that good times are just over the next hill, is a dangerous hallucination.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

Fed Stirs Nightmares of Return to '70s

Charles R. Morris — Thu, 08 May 2008 13:51:45 GMT

The press release announcing the Federal Reserve Bank's latest interest rate reduction on April 30 had the ominous sentence, "uncertainty about the inflation outlook remains high." That is an unusual warning in a period of anemic growth. For anyone who can remember back 30 years, it stirs deep-seated fears.

Inflation is usually a by-product of overly ebullient markets. The absurd run-up in house prices during the first half of the 2000s is a classic example of an inflationary bubble. But there have been times when loose monetary policy overflowed into rapid price inflation even as the economy was slipping. The most notorious case is the devastating 1970s period of "stagflation,"’ when consumer prices jumped by double-digit rates amid a nasty recession.

The visible rise in inflation in the wake of the Fed's aggressive monetary easing is stirring nightmares of a return to the 1970s stagflation hell. The broad money supply expanded by a 12.6 percent annual rate in the first quarter. The March-to-March growth in the consumer price index was 4 percent, and an uncomfortable 2.4 percent, even after excluding food and energy costs. That’s hardly stagflation territory, but still well above the Fed’s comfort zone.

There is, in fact, little question that the Fed’s high-wire bank rescues have increased inflation risks. But the mechanisms are complicated and require some untangling.

For years, America’s biggest export has been the dollars it sends overseas to buy real goods and services – more than $700 billion, net, in 2007, only modestly down from the all-time record the previous year. The huge buildup of dollars in foreign hands pushes down the value of the dollar in currency markets, and drives global price increases in dollar-denominated goods like oil.

More subtly, the build-up of dollars fuels inflation in states, like most of the Asian exporters and most of the Gulf states, that try to keep their currency value "pegged to the dollar. When Washington lowers interest rates, they are forced to do the same; otherwise their higher local interest rates would attract currency traders and push up their exchange rates relative to the dollar. America's second biggest export after dollars, in short, is local inflation.

The best defense against imported dollar inflation is to let the local exchange rate rise to its economic level. Countries resist doing so for a variety of reasons. China isn’t yet ready to disrupt its U.S. trade bonanza, while the Saudis fear being left on their own to deal with fractious local Shiites. But even the steadfast Chinese are showing signs of cracking. Some Chinese goods are being priced in euros rather than dollars, while cost inflation at home is starting to work its way into Chinese export prices. Having sent its inflation abroad for so long, the United States is now importing some of it back.

The devastating run-up in oil prices is partly the result of a real shift in demand, as consumers in newly wealthy markets like China and India discover the joys of driving. But it is also, substantially, a monetary phenomenon. The president of the Organization of Petroleum Exporting Countries recently said that a 1 percent fall in the dollar works through0 as a $4 rise in the price of a barrel of oil.

But subtler unintended consequences of the Fed’s monetary easing are also driving oil markets. Oil companies normally sell futures – in which buyers contract to take oil at a specific price at a future date – to stabilize revenue streams. Since futures buyers are protecting oil companies against price drops, they usually get contract prices somewhat lower than current-market or ‘spot’ prices.

Over the last few years, however, Wall Street has been advising their wealthy clients to diversify their holdings into commodities, especially oil. Speculative oil futures buying by outsiders has pushed futures prices higher than the spot markets – an unusual position called "contango." With high futures prices and low interest rates, it now makes sense for speculators to sell oil futures and lock in their profit by buying the oil now and storing it for future delivery. As a consequence, the rapid run-up in crude oil prices has been accompanied by increases in inventories, which is very unusual. Interest rate-driven oil speculation, in short, is making the oil squeeze worse (pdf).

The price of grain, the world’s most important food staple, has been rising at about the same clip as oil prices. It’s hard to blame the grain price run-up on the Fed, since it seems mostly a reflection of real supply constraints. The same emerging market consumers that are buying cars are shifting to richer, meat-based diets that require far larger grain inputs.

But the nutty U.S. corn-based ethanol program is a big contributor too – despite the farm lobby’s insistence to the contrary. (Corn-based ethanol offers little or no advantage in energy and climate terms over gasoline.) The World Bank points out that from 2004 through 2007, global maize (corn) production increased by 51 million tons, but virtually all of it – 50 million tons – went to the U.S. ethanol program. All other maize consumption rose by 33 million tons, causing a drop of about 30 million tons in global stocks. More unintended consequences (pdf).

The biggest difference between the 1970s and the current price run-up is that workers aren’t getting any of the inflationary upside. In those benighted days, workers usually had cost-of-living escalators, so their pay kept pace with expenses. Now, worker productivity is rising, but hours worked and real incomes are falling.

For Wall Street, that’s the ideal inflation firewall.

U.S. Still a Manufacturing Super Power

Charles R. Morris — Tue, 20 May 2008 04:00:00 GMT

Bloggers from the left and the right are attacking both of the likely presidential candidates, Sens. John McCain (R-Ariz,) and Barack Obama (D-Ill.), for their complacency in the face of American "deindustrialization."

The anger is fueled, in part, by the absurd expansion of "Wall Street" over the past decade – the investment banks and hedge funds that have pulled down mega-profits by pumping up the credit bubble, now gooily imploding all around us. According to the government’s Bureau of Economic, the financial sector accounted for more than 40 percent of all corporate profits in 2007. A disproportionate share of those profits accrued to the upper one-hundredth of 1 percent of the nation’s taxpayers, accentuating a degree of financial inequality not seen since the Gilded Age.

There is plenty there to stir righteous fury. But first some facts, so we can throw the hand grenades in the right direction.

To start with, the United States is the world leader in manufacturing output by a huge margin. The American share of world manufacturing peaked immediately after World War II, when it was the only game in town. But it has never fallen lower than 30 percent, and has grown significantly since 1980, with some very small share slippage in the 2000s.

When a country’s manufacturing productivity grows rapidly its manufacturing employment invariably shrinks. The so-called "emerging" countries -- like China, Brazil and India -- have enormously expanded their shares of output over the past decade, but the big share losers have been the European Union, Russia and Japan. China is now the world’s third largest manufacturer, while Japan is still No. 2. U.S. manufacturing output is about five times that of China.

How can that be? Look at the trade numbers! Look at jobs!

Start with trade. Manufacturing output is usually measured by a method called "value-add;" and it’s especially important in understanding the China phenomenon. Assume A is a car manufacturer who sells nearly finished cars to B, who paints them and ships them to dealers. While B’s gross revenue is the dealer price of the car, his value-add is only what he’s earned for the painting and shipping, since all the rest is remitted back to A.

Much of China’s exports are like B’s – goods for which Chinese workers provide the last processing and finishing steps, while other countries supply most of the value-add.

China assembles and ships iPods, for example, but almost all of an iPod’s value-add, and profits, go to Apple for the software, and to other international companies for chip sets, disk drives and additional high-tech components. But trade data is drawn from prices at customs. So China gets credit for $150 in exports for each iPod it ships, even though 99 percent of the revenue goes to other countries.

What about workers? By one recent estimate, China has 80 million manufacturing production workers, or nearly six times as many as in America. But that is a measure of Chinese backwardness.

When a country’s manufacturing productivity grows rapidly its manufacturing employment invariably shrinks. U.S. manufacturing employment peaked at about 19.4 million workers in 1979; but was down to 13.9 million workers at the end of 2007, the lowest level in more than 50 years, even as its output was steadily expanding.

The same trends are already evident in China, which has been shedding manufacturing jobs even faster than the United States has, as it struggles to move up the technology curve. Low-wage hand assembly isn’t the road to world dominance.

Shrinking work forces and soaring production are hardly new phenomena. America is also the the world leader in agricultural production, but fewer than half of 1 percent of its workers are employed in agriculture.

So why all the focus on manufacturing jobs?

The main reason jobs, and especially manufacturing jobs, are such an issue in the United States, is that the productivity drive has meant downsizing millions of workers, and treating most of them badly. That exposes a deep contradiction at the heart of the American system.

Of all the advanced countries, U.S. companies are by far the most flexible in responding to change. Employers have immense freedom to dismiss workers, or to restaff with different skills, to keep pace with competitive challenges. But perversely, of all the advanced countries, it has chosen to be the roughest on dismissed workers, and to provide the least reliable social safety net. Investors, private equity companies, CEOs, can therefore happily reap the profit and incomes from improved productivity, while leaving their former workers to reap mostly fear and insecurity.

Health care is the most striking example, since for working-age Americans, health insurance is available almost exclusively through employment. The rapid "human-resources adjustments" of market-responsive companies therefore entail near-absolute cutoffs of health insurance. Unemployment benefits and retraining opportunities are, similarly, miserly in the extreme.

But the inequities are now too palpable to ignore. If America is to retain its admirable economic flexibility, the social contract requires major revisions and soon.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

The Other Subprime Loans

Charles R. Morris — Tue, 03 Jun 2008 22:06:14 GMT

Wall Street has suffered two sharp downturns in the first two trading days of June. It's a disappointment after all the cheering for the market’s positive performance in May.

Monday’s worries were mostly about the financials, especially the struggles at Lehman Bros. and Wachovia. The shocker on Tuesday was General Motors' announcement that double-digit declines in the SUV/light truck categories would lead to big production cutbacks and shutdowns of four factories.

GM’s problems had been foreshadowed a few weeks ago when Ford’s CEO, Alan Mulally, rescinded his promises of near-term profitability because of a steep May dive in sales of SUVs and pick-up trucks. The bigger vehicles are the U.S. companies’ profitability sweet spot, so the market’s collapse is tantamount to financial disaster. Even the Japanese companies like Toyota and Nissan that have made big commitments to the high-margin big-car category will take serious profitability hits.

Why is this a surprise? The Ford Expedition, for example, is a four-ton behemoth that, with a full plate of options, rings up a sales sticker not much below the median yearly incomes of American households. With $4 pump prices, the Expedition drinks a buck’s worth of gas every 3.5 miles. The real question is why they’ve been best-sellers for so long.

The truth -- usually missed in the fog of faux-analysis -- is that these are not normal times. Fundamental changes are afoot. But no one knows how long they will take, or what might come out on the other side.

The SUV and the suburban McMansion are the linked symbols of American consumerism. And it turns out that the same folks who cooked up a housing boom out of subprime and "Alt-A" mortgages, also invented a subprime auto loan industry. People swamped with mortgage debt could still pile on loans to equip their four-bedroom/game-room split-levels with the right kind of wagon or two.

Readers can figure out the rest of the story. Subprime auto lending, much like subprime home lending, was another unintended consequence of the gusher of money the U.S. Federal Reserve Bank opened up after the recession of 2001-2002. As banks and auto finance companies ran out of good borrowers, they reduced credit standards and eased payment terms to suck more and more borrowers into the net. Just as in home mortgages, the riskiest loans were packaged into blue-ribbon-rated securities and sold off to investors too greedy or stupid or inexperienced to notice.

Now delinquencies are rising sharply, subprime auto loan investors are in full flight, and a quarter of car owners are "underwater" – they owe more in car loans than their cars’ resale value. The mothballed SUV factories are just another monument to the credit crunch, like the rows of empty condos on Miami Beach.

The solid growth of the 1990s was investment-driven, as corporate America integrated a host of startling new technologies into their everyday business processes. But it was also a decade of unusually favorable American karma. The baby-boomers were in their high-productivity, high-saving 40s and 50s. Forty years of government-led investment in Internet and related technologies were finally bearing fruit. Almost the entire world was happily on a dollar standard. The real costs of economic inputs, like energy, were mostly falling.

Investment-led growth tipped into a tech bubble when even experienced investors turned giddy in the late-90s tech boom. In recent American history, it is an unusual episode of an investment-led bust.

As business licked its wounds, the Fed was happy to let consumers take over. Consumer debt grew strongly during the 1990s, by about 6 percent a year in current (pre-inflation) dollars. Household debt rose from about 85 percent of disposable personal incomes in 1990 to approximate equality by 2000. But in the 2000s, the debt engines went into overdrive. The annual rate of household debt growth jumped to almost 12 percent by 2003, and has averaged more than 10 percent since the start of decade.

By the end of last year, household debt had ballooned to 136 percent of disposable incomes. From 2003 through 2005, net home equity borrowing not reinvested in housing accounted for more than 7 percent of disposable personal income.

Now the whole consumer-driven, debt-fueled sprint for growth has smashed into a brick wall, leaving a mountainous tangle of bad loans and big trade deficits.

A lot else is going wrong at the same time. The baby-boomers are turning into senior citizens; the dollar is in collapse; critical input costs, like energy, are rising sharply, and military spending has jumped to new levels, even as U.S. forces are under severe strain. If there is such a thing as an American karma, it has taken a decidedly wrong turn.

It is understandable that officials like Fed chairman Ben Bernanke and Treasury Secretary Henry Paulson are almost solely focused on avoiding an even bigger crash. Wall Street and the investment community, after all, will be swallowing at least $1 trillion in losses and writedowns within a concentrated period of time.

What’s missing is any sense of what should come next. All the rescue efforts are aimed at helping the American public carry on borrowing and spending, keeping the consumer boom alive, gliding by the crisis as if nothing has changed. That is not a strategy. It is grasping at life buoys, or, in Metternich's phrase, "propping up a corpse," for want of any better ideas.

There are big questions ahead. The textbooks say that when a country is saving too little and spending too much, you raise interest rates. But can we do that without destroying our hopelessly overleveraged banks? Each year Washington borrows $700-800 billion abroad to finance its overspending. The collapse of the dollar suggests that those days are coming to an end. How do we wean the country away from its consumption binge? What we will do with all those store clerks and mortgage brokers?

We are clinging to the sides of a deep, dark, hole. The Fed and the rest of officialdom are turning somersaults to help us hang on. But at some point, we have to start building ladders to get out.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

Financial Weapons of Mass Destruction

Charles R. Morris — Tue, 10 Jun 2008 13:27:29 GMT

Warren Buffet calls credit derivatives "financial weapons of mass destruction." When his company, Berkshire-Hathaway, Inc., took over an insurance company in 2002, it took him four years to unwind its portfolio of credit derivatives -- at a cost of $400 million. Buffet didn’t entirely follow his own advice, however, because in the first quarter this year Berkshire-Hathaway took another $500 million loss on credit derivatives.

Why worry about credit derivatives? One reason is that the "notional value" of the most important credit derivatives, credit default swaps, or CDS, is now $62 trillion. That’s trillion, with a "‘T," and it is more than the whole world’s gross domestic product. Numbers that big automatically make people nervous, especially when they see the canniest investors like Buffet taking losses.

CDS are the fastest-growing financial instrument of all time, because they fill a real need. Stock markets have long had efficient methods of re-balancing risk. For example, if you have a large stock position, and are worried that it will fall, you can buy options that will limit your possible losses, without the expense of actually selling the shares.

But bond markets, other than Treasuries, are primitive compared to stocks. There are no options markets for corporate bonds. So if you were worried about your holdings, your only recourse was to sell them. Markets in mortgages and bank loans are even less developed.

Enter CDS, often called "credit insurance." Suppose a bank, or pension fund, is worried about its exposure on a portfolio of bonds. It can enter into a CDS with another investor to shift the risk of defaults. The bond owner makes a regular stream of payments to the protection seller over the life of the swap; in consideration for the payments, the protection seller promises to make good the losses to the bond owner if the bonds default.

The beauty of the CDS is that if the payments are calculated correctly, the protection seller is in the same position as if he actually bought the bonds, but without putting up the cash. The payments he receives will mirror the bonds’ interest coupons and market risk premium, and he will profit as their market price rises and falls. (If the value of the bonds rises, the cost of protection will drop. So he can eliminate his risk by buying protection on the same bonds and pocketing the difference between the premium he pays and those he receives.) If the bonds actually default, of course, he’s out the principal value of the bonds, less any expected recoveries, just as if he owned them.

So CDS are a wonderful invention. They make it possible to create "synthetic" bond portfolios quickly and cheaply. The extra efficiency should increase liquidity and lower interest costs. A win-win, it sounds like, all around.

The scary parts are in the gritty details. To begin with, the payoffs from a winning CDS tend to be large. If you’ve sold protection on a $10 million portfolio of bond X, and X defaults, you owe your counterparty the full principal of the bond less the likely recovery. In normal times, recovery rates might be 50 percent, but in recessions, they can drop to 20 percent. In any case, protection sellers will be on the hook for lots of cash.

And for a market involving such huge amounts of money, it is still very informal -- with deals getting done by email and fax, often with shaky documentation. Big banks play the role of dealers, matching up trading parties, but from that point the details are left to the counterparties.

Until recently, swap parties could sell off their positions without informing their counterparties. Since swaps might be traded many times, someone who thought she had protection might not be able to track down her counterparty when it was time to collect. Deal terms can also be complex. At least three large recent defaults are in court, because protection sellers refused to pay, on the grounds of alleged contract violations by their counterparties. As defaults spiral up, CDS close-out disputes could become a litigation goldmine.

The biggest problem, however, is so-called "counterparty" risk. Most financial instruments of CDS scale, like Treasury futures, are traded on exchanges, like the Chicago Merc. Once brokers match a Treasury future trade, the Merc steps in as the counterparty for both the buyer and the seller. The exchange insists on daily collateral-postings. If you make a loss because you sold a future that’s rising in price, you have to post additional collateral; if the future price drops the next day, you get that portion of your collateral back. In short, iron-clad procedures ensure that the exchange always has enough cash to settle up with the parties when contracts close out.

CDS, however, trade "over the counter," without a central exchange. While most counterparties insist on some initial collateral, the arrangements are inconsistent, and updating of positions is haphazard. Perhaps a third of the ‘long’ players, or protection sellers, moreover, are hedge funds, typically very highly leveraged. While they love selling protection for the cash income, if they are faced with a spate of default payouts, they could easily default themselves.

The biggest banks are now cooperating to set up a central CDS clearing system, but many suspect it is just a tease. The murkiness of the current system allows them to extract an estimated $10 billion in annual brokerage fees, which would surely be at risk in an efficient, transparent trading environment.

It was fear of just such a falling-domino cascade of CDS failures that forced the Federal Reserve to intervene so vigorously to prevent a collapse at Bear Stearns. The firm’s end-of-year SEC reports show that it was a guarantor on $2.5 trillion in "credit derivatives,"’ most of them, presumably, CDS.

If Bear had gone under, all those guarantees would have immediately defaulted. The price of default swaps would have increased across the board, and banks would have started making collateral calls on hedge funds with positions like Bear’s. Hedge funds that didn’t have sufficient collateral would have joined the domino cascade. Panicky brokers scrambling to liquidate their most exposed positions could have crashed the fragile CDS trading machinery.

There was a real risk of a global financial thrombosis that could have taken weeks to unravel. The potential losses are incalculable. Nor are the rescues necessarily over. Lehman Bros. is on many people’s short lists of the next to go.

That is what’s scary about CDS markets. So the Fed probably had no choice but to intervene in the Bear case to forestall a possible catastrophe. What is not forgivable is that the major global regulatory bodies have allowed things to come to this point, and that the Fed even had a policy of cheering it on.

But more unforgivable yet would be the lack of a strong regulatory response to ensure that it doesn’t happen again.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

Wall St. Still Hasn't Learned

Charles R. Morris — Mon, 23 Jun 2008 12:58:47 GMT

Lehman Brothers, Inc., released its second quarter earnings last week, reporting a loss of $2.8 billion ($4.1 billion before taxes). The losses were caused by writedowns and failed hedges on the same kind of toxic mortgage and leveraged-loan securities that have been wreaking havoc on bank earnings throughout the world.

Lehman is one the storied names on Wall Street, with a history that stretches back more than 150 years. After a rocky period in the 1980s and 1990s, it became one of the more sure-footed banks under its CEO, Richard Fuld. It was one of the few major players in mortgage markets not to sustain heavy losses in 2007 -– and it underscored its superiority by ostentatiously raising its dividend at year end.

Lehman surprised the market again by announcing decent earnings for its first quarter. Many analysts had anticipated Bear Stearns-style problems. But then market confidence was rattled when the first quarter profits turned out to based on questionable, if perfectly legal, accounting tactics.

The fact that Lehman is now finally coming clean is, therefore, encouraging. Even more so is the sharp reduction in its leverage -- from about 32:1 down to 20:1. Leverage is measured by dividing equity into total assets, and Lehman improved on both ends of the formula. Writedowns and asset sales reduced the firm's total assets, but it also managed to raise $6 billion in new equity capital.

But the scary part here is that Fuld has reassured the stock market that he has no intention of sitting on such conservative leverage. Much of the new capital would be devoted to re-leveraging, in order to generate the double-digit returns financial sector investors believe they are entitled to.

That suggests that Wall Street and its investors still don’t get it. The whole credit crunch has been about excessive leverage. Most American adults understand the realities of leverage from their experience with home mortgages, but few really appreciate the extremes to which Wall Street has pushed the game.

Start with the basics. You’re a trader, and you buy $1 million worth of mortgage-backed securities, at the modest leverage of 5:1 – you put up $200,000 of the firm’s money and borrow $800,000 from banks. If the mortgages rise in value by 10 percent, you make 50 percent return on your equity; but if they fall 10 percent, half your equity is gone, and the firm has to stump up another $80,000 to maintain the agreed leverage ratio (The position is now worth $900,000; subtracting the $800,000 bank loan leaves only $100,000 in equity. The $80,000 restores leverage to 900:180 = 5:1).

But there are lots more ways to rev up leverage. Consider "structured finance:" A bank or hedge fund buys up mortgage-backed securities or other assets, and pools them into CDO, or "collateralized debt obligation," that is cut into five or six horizontal slices. The top slice, which may comprise 80 percent of the CDO bonds, gets first claim on all cash flows, so it has the lowest risk. The bottom layer, perhaps 5 percent of the bonds, is the "equity layer." They get the highest returns -- but also are on the hook for the first 5 percent of losses.

Since a 5 percent loss in the CDO wipes out the entire equity layer, those bonds come with "embedded" leverage of 20:1. Assume again that you’re a trader playing with 5:1 leverage, but this time you buy a CDO 5 percent equity layer. Multiply your 5:1 leverage times the security’s embedded 20:1 leverage, and your true leverage is 100:1. Just a 1 percent loss on the CDO wipes out all your equity in the deal.

Or suppose that the firm that creates the CDO can’t sell the equity layer bonds right away, so it holds them in its trading books. If , like Lehman, it’s leveraged 20:1, its true leverage will be 20:1 times the embedded leverage of 20:1 in the bonds. That’s 400:1, so just a quarter of 1 percent loss wipes out all its equity in the deal. That’s the math driving the never-ending stream of bank writeoffs. Since the third-quarter of last year, total bank losses have risen past $400 billion, with no end in sight.

Commercial banks -- FDIC-insured "depositary banks" -- have regulatory limits on their leverage, so they have been losing their traditional lending markets to price-cutting by highly-leveraged investment entities like investment banks and hedge funds. By 2007, three-quarters or more of lending emanated from these "non-banks." A good chunk, however, also came from the disastrous off-balance-sheet entities, like SIVs (don’t ask) that the commercial banks created to evade the leverage rules.

The Federal Reserve has recently estimated that the so-called "shadow bank" assets, at some $10.5 trillion, are now higher than all regulated bank assets. At the same time, the "shadow" and regulated banking sectors are deeply intertwined. Remember how our trader kept borrowing to ratchet up her positions? A lot of those loans would have come from regulated banks acting as "prime brokers" for the shadow system. The regulated banks, that is, have been taking their turn at sucking the hookah pipe, and learning that second-hand smoke can kill you too.

The fact is that de-leveraging will happen whether or not Fuld or the other investment banking barons want it to. The credit bubble has pushed indebtedness so high that legions of borrowers -– home owners, commercial developers, private equity companies –- can’t pay back their loans. Like most of Wall Street, Lehman’s books are still stuffed with commercial and residential mortgages, leveraged loans and tens of billions in securities with no market prices, all asset classes in free-fall.

So why believe Lehman now? A couple of months ago, after all, Fuld was telling the world that Lehman didn’t need any more equity, only to find himself scrambling madly for new equity just before the quarter’s close to avoid joining Bear Stearns in the display rack of pickled corpses of former firms.

De-leveraging is a necessary prerequisite to a real recovery. The brunt of federal policy to date, however, has seemed directed at keeping the squirrel cage running at high speed -– trying to help consumers carry on borrowing and spending, taking questionable assets onto the Federal Reserve Bank’s balance sheet, instead of accelerating the burnout of accumulated excesses.

The current administration has long slipped into crippled-canard-dom. But this year’s election winners need to come into office with clear programs for cleaning up the mess while somehow cushioning the worst impacts on ordinary folks. Let's hope that they are up to it.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

The Continuous Housing Free Fall

Charles R. Morris — Mon, 07 Jul 2008 18:01:45 GMT

Financial markets have finally internalized the brutal fact that house prices still have a long way to fall. The full-year price drop in 2007 was 8.5 percent. From January through April of this year, the most recent data available, prices fell by another 8.2 percent -- a remarkable rate of acceleration.

Can they fall further? Unfortunately, yes. By conventional ratios of prices to rental values and prices to incomes, they may still be 20 percent too high.

Falling asset values have a way of turning free-market avatars into raving Socialists. For example, the housing rescue bill currently working its way through the Congress has Bank of America’s fingerprints all over it. But while the rescue bill gets all the attention, much bigger bucks are already in play.

Start with the "Government-Sponsored Entities," or GSEs – Fannie Mae, Freddie Mac and the Federal Home Loan Bank Board. These are private-sector stock companies created by the federal government, and they enjoy certain tax and other privileges. While they have no legal claim to government support, everyone believes that the government is the de facto insurer of their debt.

Fannie Mae and Freddie Mac, which are by far the biggest of the GSEs, are a mess -- both financially and operationally. Freddie is leveraged 50:1, which means that it has two pennies of capital supporting every dollar of risk exposure. It is desperately in need of new capital. Now it claims to have lined up an additional $5.5 billion; but it has been forced to delay the closing, because it hasn’t been able to register the shares with the Securities and Exchange Commission.

Fannie and Freddie had once been exempt from SEC registration. But after a series of early 2000s accounting scandals, Congress insisted that they register. Fannie has done so. The fact that Freddie is still stuck in the process suggests continued accounting issues.

Collectively, Fannie and Freddie lost more than $5 billion in 2007, and Fannie had another blowout $2.5-billion loss in the first quarter. Freddie had a far smaller first-quarter loss, but the improvement is almost all accounting gimmickry. Fannie has completed its capital raise and, though still shaky, it has substantially lowered its leverage ratio. Until Freddie completes its capital raise, it is a pure financial basket case.

Almost as soon as the credit crisis hit last summer, however, Fannie and Freddie were quietly anointed as the twin engines of a bank bailout. The numbers involved are big. In the fourth quarter of last year, the annualized rate of home mortgage borrowing was about $600 billion, a sharp drop from previous years. But the GSEs’ rate of mortgage lending jumped to $1.2 trillion, or twice as much.

The same thing happened in the first quarter of this year. Home mortgage borrowing dropped to only $321 billion annualized, but the GSE lending was again twice as much, $655 billion annualized. Where did all the extra money go? To absorb existing mortgages from banks, of course – a fine example of the charitable works supported by taxpayer dollars.

The Federal Reserve Bank has been doing its part here. Over the past six months, it has created a plethora of lending programs that essentially provide banks with Treasury securities in return for illiquid paper -- like subprime mortgage-backed bonds. A good guess is that of the total of $500 billion in bank assets absorbed by the Fed, about $200 billion, are backed by subprime mortgages.

These are instruments that sell for, at most, 60 cents on the dollar on the open market -- if any buyers can be found. But the Fed takes them off bankers’ hands at 98 cents on the dollar. The silk tie and vintage wine industries need help too.

Or consider the Federal Home Loan Bank of Atlanta, which might be dubbed "Countrywide East." Home loan banks provide liquidity to mortgage lenders by advancing cash in exchange for mortgages. Nearly one-third of the Atlanta bank’s lending, or $46 billion, has been to Countrywide Financial -- perhaps the most notorious of predatory lenders. Since its mortgage portfolio is in a state of collapse, it was recently picked up for peanuts by Bank of America. But the Atlanta bank was sufficiently confident of the integrity of Countrywide that it maintains no loss reserves against its Countrywide loans.

But that’s ok now, since BofA just bought Countrywide, right? Er, no. The merger proxy makes clear that BofA doesn’t accept any liability for Countrywide’s debts.

Which brings us to the Congressional bailout bill (pdf) -- which is set to provide $300 billion in new money so the Federal Housing Admin. can exchange expensive, inflated mortgages for traditional fixed-rate mortgages at more realistic values.

Good idea. But the catch is that the banks will choose the mortgages they want to exchange. Despite some toothless language to prevent "adverse selection," what mortgages do you think the banks will be volunteering? Any bets on the loss rates? 50 percent? 60 percent? Did we mention that the FHA lost $4.6 billion last year, so it is already in Fannie and Freddie red-ink territory?

The final rub-your-nose-in-it charade is the claim, supported by the Congressional Budget Office, that the new bailout program will make money for the taxpayer. How will it manage that feat? By imposing charges on Fannie and Freddie!

In other words, as Fannie and Freddie careen toward insolvency, they are charged with financing a new bailout program, which will just be added to the taxpayer’s final Fannie and Freddie insolvency. If Enron had been as ingenious, they would still be in business.

The sad fact is that all these programs, well-meaning as many are, are hopeless. House prices doubled from 2000 through 2005 – an unheard of 12+ percent per year rate of increase. There were no demographic or economic drivers for the housing boom. It was cooked up entirely by the banks from financial fakery and outright fraud. And they extracted enormous rewards from their misdeeds.

There are many ways to help homeowners without saving the banks -– like forcing the conversion of toxic mortgages into market-value rental contracts in bankruptcy courts. Instead, we could well waste trillions, with no result except to create a zombie industry based on false prices that will delay a true recovery for years.

We did much the same thing in the early 1980s, when the problems in the savings and loan industry first surfaced. A decade later, it all went onto the taxpayer books at 10 times the cost. History repeats itself, as Marx said, the first time as tragedy, the second as farce.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

Mortgage Giants in Critical Care

Charles R. Morris — Mon, 11 Aug 2008 17:00:00 GMT

Both Fannie Mae and Freddie Mac , which have been almost single-handedly keeping the U.S. home mortgage markets afloat, announced their first half-year results last week. If they were cancer patients, the doctors would transferring Freddie into hospice care. Fannie is probably terminal as well, but is in better shape and might have a fighting chance.

Illustration by: Matt Mahurin

Fannie and Freddie are "government-sponsored entities," or GSEs. (There is a third GSE, the Federal Home Loan Bank system, that has been almost the sole support of Countrywide Bank over the past several years.) Fannie and Freddie don’t originate mortgages directly, but create liquidity by either guaranteeing mortgages for other lenders or buying them up for their own balance sheets.

The chart below shows the lending and guarantee activity for the GSEs for the five quarters through March, 2008. For comparison, it also shows the volume of ABS, or "asset-backed securities," that are a good proxy for private, unguaranteed mortgage activity. By 2007, almost all such mortgages were packaged up and sold to investors as ABS, while most ABS were backed by mortgages.

Source: Federal Reserve Flow of Funds Report (June, 2008)

The chart shows how the GSEs leaped into the breach when the private mortgage markets collapsed in mid-2007. By the third and fourth quarters, they were virtually the sole support of the markets, but were digging deeper and deeper financial holes. The first-quarter 2008 tightening shown in the chart continued in second quarter. Both Fannie and Freddie say it will do so for the foreseeable future.

Why are they in such trouble? Fannie and Freddie were created to lubricate the home mortgage market by buying mortgages from lenders; wrapping them with a guarantee, and packaging them up as tradeable securities sold to long-term investors -- like pension funds and foreign central banks.

The guarantee works because there are strict rules about the credit quality of the mortgages they buy. "Conforming," or guarantee-eligible, mortgages must be well-documented, conservatively structured and held by borrowers with good credit. Default rates are low, so guarantee fees are modest.

Together, Fannie and Freddie guarantee $4.1 trillion in mortgages. The business is profitable, but not egregiously so, and almost everyone agrees that it works fine.

What got them into trouble is their other business, that wags call their "$1.6 trillion hedge fund." Because global investors assume that Fannie and Freddie debt is "implicitly" guaranteed by the government, they can borrow at below-market rates. After all, their executives reasoned, if Goldman Sachs can make so much money trading for their own account, why shouldn’t they? They had stockholders, they sincerely lusted after Goldman-scale paychecks and the implicit government guarantee would let them tap almost unlimited capital.

So, between the two of them, they have now borrowed $1.6 trillion to build positions in mostly mortgage-backed assets, including good dollops of risky subprime and Alt-A mortgages, and "structured" mortgage-backed securities. So, of course, the housing market collapse that is destroying careers and balance sheets all over Wall Street is wreaking havoc at Fannie and Freddie.

Freddie is already a walking corpse. It ended the half with its balance sheet leveraged up 68:1, or more than twice as high as Bear Stearns just before its collapse. And that’s only if you assume their books are truthful. Though that’s unlikely.

One item deep in their financial footnotes is especially ominous. Accounting valuation rules usually classify mortgages and mortgage-backed securities as "Level 2" assets. While they don’t have daily market prices, like IBM stock, they can be usually valued by a combination of "observable" market values and internal judgments.

When the market for complex securities backed by high-risk mortgages collapsed last year, many banks shifted their holdings down to "Level 3," which allows you value solely by "internal models." In real life, that means almost any way you please. Accounting standards bodies led a concerted drive to move such assets out of Level 3 back up to Level 2, for greater transparency.

Freddie has gone the other way. During the first half of the year, they moved $154 billion of securities backed by high-risk mortgages from Level 2 to Level 3. A reasonable guess is that they’re carrying them at 80 cents on the dollar, or thereabouts.

But these are the same class of instrument that Merrill Lynch recently cleared off its books for 22 cents on the dollar. At a minimum, Freddie may be sitting on another $30-$50 billion in losses. Freddie ended the half with only $13 billion in equity supporting $879 billion in assets. If a beam of sunlight hits those Level 3 assets, the walking corpse instantly shrivels into ashes.

Almost laughably, Freddie plans to solve its problems by raising another $5.5 billion in capital -– or will as soon as its investment bankers tell them the time is "propitious."

Don’t hold your breath. Freddie’s total stock market value is now only about $3.8 billion. What percent of a $3.8 billion company do you sell to raise another $5.5 billion? And, oh, by the way, their chief executive, Richard Syron, was paid $20 million last year.

Fannie has been pulling in its horns faster than Freddie and raised substantial capital in the first half of the year. Their overall leverage is now only about 22:1 -- or about a third of Freddie’s. But their future is still bleak. Like Freddie, their stated equity includes huge deferred tax assets, which they may never realize. Normal bank accounting rules would assign much lower values.

Fannie has absorbed $6 billion in net losses so far this year, and expect losses in that range to continue for the rest of the year. The losses should continue well into 2009, but they hope at a lower level. A normal company could not survive.

Is a rescue on the way? Congress recently authorized the Federal Reserve and the Treasury to lend as much as they want to bail out Fannie and Freddie. That is the topic for Part II of this article.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

Mortgage Giants Need Dose of Reality

Charles R. Morris — Tue, 12 Aug 2008 13:09:42 GMT

Last week’s announcements of first half results from Fannie Mae and Freddie Mac exposed the dire straits they are in. By its own rosy fair-value accounting, Freddie is already insolvent. Fannie is in better shape, but a string of heavy losses may have left it fatally weakened. Since both anticipate falling house prices through 2009, their futures grow blacker by the day.

A collapse of Fannie and Freddie would be a huge blow to an already-comatose housing market, so Washington is in full panic mode. Last month, Congress and President George W. Bush pushed through emergency legislation authorizing Treasury Sec. Henry Paulson to supply federal cash infusions of up to $300 billion to the mortgage giants, in almost any form he chooses.

Illustration by: Matt Mahurin

Paulson says he has no current plans to use that authority. But there is no possibility that he could allow a default on senior Fannie and Freddie debt. It is widely held by foreign central banks, and U.S. officials, including Paulson, have consistently reassured holders when doubts about the reality of the guarantee have surfaced.

But if the government is forced to bail out Fannie and Freddie, many other important decisions would have to be made. How do you treat the shareholders, or subordinate bond holders? How much can you curtail Freddie and Fannie without trashing the economy? Do we need a Fannie and Freddie at all? A fundamental question is why is the government propping up house prices amid a glut of unsold houses.

The bitter truth is that by conventional measures, like the ratio of house prices to rentals or to incomes, prices are still too high. Home prices nearly tripled over the eight years from 1998 to 2006, but have so far fallen only by about 18 percent.

There is a growing consensus that prices will fall by another 15 percent or so. The projections made by Fannie and Freddie economists, though they use different market indices, anticipate proportionally that level of decline -- bottoming out toward the end of 2009. Even generous federal refinancing programs for home mortgages make little sense when prices are dropping. Working people would be better off renting instead of being chained to falling assets.

Officially, we classify residential housing as an "investment." Sometimes that’s true. The shift of the nation’s economic center to the technically dynamic Southeast and Southwest in the 1980s and '90s was possible only with vast new housing and infrastructure construction.

But the "McMansions" at the heart of the 2000s construction boom look like economic millstones, their wraparound entertainment centers and multiple bathroom-spas monuments to conspicuous consumption. Big houses on large lots are energy hogs – both heating and driving – and impose heavy additional costs extending local sewage, sidewalks and other amenities.

A cold-eyed view of Fannie and Freddie suggests that they’ve long since outlived their usefulness. This is a country with low personal savings, extraordinarily wasteful consumption habits and big deficits in pensions, health care, roads and airports. Yet the new housing bill raises their permissible guarantee ceiling from $417,000 to $729,750 -- as if bigger houses were a national priority.

A realistic approach to a collapse of the mortgage giants might be: Federalize their outstanding senior debt, upholding the implicit guarantee. Recognize all their likely losses in fell swoop, which will wipe out current shareholders. (The taxpayer owes no obligation to investors who let their company run rampant.) Then create a new federal entity, with a high-quality board of directors, to run off the existing business in an orderly way, perhaps over the next 5-10 years, to minimize market disruptions.

The total effect would be to increase mortgage rates, and force new buyers to build more savings to become mortgage-eligible. Consumption of big-ticket furniture and electronic appliances would probably drop. None of those is a bad thing.

From 2000 through 2007, the United States spent 105 percent of what it produced. The resulting trade deficits have put some $5 trillion into the hands of foreigners, so the dollar has been falling and commodity prices spiking. Worse, a huge share of the overseas dollar trove is in the hands of states like Russia, China and the Middle Eastern petro-kingdoms -- which have little love for the United States, and often shadowy ties to terrorism.

Everyone knows that we have to change our ways. The way we deal with Fannie and Freddie will show how serious we are.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”