No Free Pass for Wall Street

In "Warning Signs Were Clear, Just Not in Washington," Washington Post Writers Group commentator David Ignatius correctly criticizes politicians and regulators for failing to heed ample evidence of impending disaster that preceded the current unraveling.

Unfortunately, by targeting only those who are directly charged with looking after our interests, he ends up giving the financial community (and others, like the mainstream media, for example) something of a free pass.

In truth, while a very small number of operators did see and prepare for what was coming down the pike, most of Wall Street not only missed the boat -- think of all the multi-billion-dollar writedowns we've seen lately -- but actually made things far worse for all concerned because of their baseless and likely self-serving assurances that whatever problems were cropping up would remained "contained."

In my view, Washington, Wall Street and many others share the blame equally for this sorry saga (though it's not surprising that some would wish to use what is unfolding now as a way to score cheap political points). Anyway, below is Mr. Ignatius' commentary:

So where were all the politicians who are now saying, "Hurry up! Fix it!" about the looming recession, back when the economic mess was brewing? But you know the answer. Most of them were focusing on other issues. And now that the slowdown has begun, it may be too late to blunt some of its effects.

That's one of the dirty little secrets about economic policy: The response to a crisis is often too late. Policymakers are slow to recognize that a problem is brewing, and then slow to take action. As a result, the lag in policy often has a pro-cyclical effect - a stimulus package that juices the economy after the recovery has begun, or a cut in interest rates that encourages more lending well past the time it would do most good.

What's infuriating is that the problems in the housing market were clear to everyday folks long before they registered with the geniuses at the Federal Reserve and the Treasury Department. In fact, that's why we are heading into a recession now - because consumers and business managers realized last fall that there was something seriously out of whack in the housing sector, and began trimming their spending and investment. The result is the pattern we are now seeing, of declining retail sales and rising unemployment.

Here's what neophyte Fed Chairman Ben Bernanke said back in May, when warning signs about a mortgage squeeze were already flashing red: "The effect of the troubles in the subprime sector on the broader housing market will likely be limited." Sorry, but that was not the correct answer.

Wall Street traders saw a housing crunch coming, and the smart ones were aggressive enough to profit from it. The Wall Street Journal last week profiled a hedge fund manager named John Paulson who has made between $3-billion and $4-billion over the past year betting that the shaky structure of subprime mortgage loans would topple.

"This is crazy," Paulson is said to have told his colleagues, as he looked at the imbalances in the U.S. economy back in 2005. "Where is the bubble we can short?"

Goldman Sachs, too, recognized that there was trouble ahead in the housing market. In late 2006, Goldman's chief financial officer, David Viniar, decided that the bank should reduce its holdings of mortgages and mortgage-backed securities and buy insurance against further losses.

And what was Goldman's former chief executive, Henry Paulson - now in Washington as secretary of the Treasury - doing about the looming crisis when his former partners were reducing their exposure? Sad to say, very little.

Even journalists saw this one coming. In December 2005, Kirstin Downey, who covered housing at the time for the Washington Post, wrote an article headlined: "Mortgage Stress Seen for '06; Delinquencies on Subprime Loans Seen Likely to Spike, Report Says." She continued to write warnings about the subprime mess through 2006.

Steven Pearlstein, a financial columnist at the Post, wrote some of the sharpest warnings about what was ahead. In a prescient March 2007 column about the gimmicky loans that fueled the subprime disaster, he wrote: "What we have here is a failure of common sense."

Now congressional Democrats and the Bush White House are jostling over the size and shape of an emergency stimulus package to reduce the damage of the coming recession - with presidential candidates shouting out their advice from the wings. It reminds me of Hurricane Katrina, with frantic action after the disaster has begun but little precaution beforehand.

Economists, who have a theory for everything, have come up with an explanation for this chronic tendency to delay until it's too late, and then scream for action. "Procrastination and Impatience" is the title of a paper published in December by the National Bureau of Economic Research. After conducting elaborate experiments, the three authors concluded: "Our results lend support to the hypothesis that subjects who have a preference for immediacy are indeed more likely to procrastinate."

So there you have it: Our political process is a self-frustrating machine. Our politicians want immediate action, but only after they have delayed to the point that it will be ineffective. Our Fed chairman wants to shower the economy with money, but only after bankers have gotten too nervous to lend it. With this one, nobody can say that people didn't see the crunch coming. The policymakers just didn't do anything effective about it, back when it would have made a difference.

Comments

[Rocky]

The political class was more interested in preventing gay marriage and expelling Larry Craig from the Senate than worrying about the developing real estate bubble. It's easy to stir up stupid voters about gay marriage. It's a lot more difficult to explain a developing real estate bubble to the masses. Now we all have to pay the bill. But a few people will end up filthy rich after this is all over. At least one hedge fund trader has made an absolute fortune shorting AMBAC stock in recent months.

[Tim]

Rocky, those old chestnuts like flag burning, gay marriage and even abortion are not working in this economic environment. Even the sheep have to eat.

[Rocky]

Unfortunately, a lot of economic damage has been done already and a lot of people are going to get hurt. Even the soup kitchens are having troubles finding enough surplus food to give out to the poor.

[roger pasa]

No free pass a good article.99% of economist & politicians are endowed with brain dysfunction & unfortunately there is no viagra pill available for that.What is needed in the good old USA is a massive brain recall

[Jes]

Can someone explain to me why Bush's proposed tax cuts, or the various candidates' proposals to get money in people's hands, is seen as a good idea? We're in this mess due to overspending. Dumping money into the economy might ease the pinch temporarily, but then what? Do it again? Or are we spending addicts going to suddenly reform and become financial prudent? Perhaps I'm looking at it too simplistically, but it certainly looks like offering a drunk another beer.

[dearieme]

Where were the warnings from the Universities' Economics Departments and Business Schools? They seem largely to have been asleep.

[Lady from Middle America]

I wish I wasn't quite so anonymous so everyone would know that I've never been one to spout Bolshevistic claptrap. However, I think all we need to do is follow the money and see who is profiting at various times of the economic cycle. I can't help but think that would clear up a lot of the mysteries surrounding why certain actions are taken by the Ruling Elites during times of crisis.

[interested]

Lady f M A, given the self-serving way these R Es protect and enhance their investments, please tell me more

[Thomas Shawn]

Fascinating that Bush got into bed with liberals to promote homeownership at the very apex of the housing market.

The in utero murder of millions of children is not an old chestnut.

[farang]

dearieme:

I was unaware that using basic detective investigative procedure was "Bolshevistic claptrap."

Larned me sumpin' nu taday.

[farang]

Hey Thomas Shawn:

"Liberals" got into bed with Bush? Pray tell, what "Liberals" would this be?
Better yet, please describe in your own words what a "Liberal" stands for, ok? That should be fascinating.

And yes, bringing up divisive issues to distract the masses from Fraud and scams, including abortion, IS an old chestnut.

Welcome, it is always enlightening to see ignorance up close and personal.

[Lady From Middle America]

Farang and Interested, I'm not anywhere's close to being a trained economist, a "larned" money person or investigative journalist, nor do I pretend to be. I guess I was trying to say, in my own clumsy way, is that normally I'm not one to say "those imperialist capitalistic dogs are destroying the masses" or to find a conspiracy behind every rock. I'm just trying to find the answers like everyone else.

Farang, I was not trying to imply in any way that anyone questioning the status quo is a Bolshevik. You'll have to excuse my lack of eloquence.