Financial Crisis

Tuesday, March 10, 2009

I am 12 years removed from the banking world, but I have an opinion on the current financial crisis, and since this is my blog, I’m going to share it.

So, how did we get into this financial mess ? Greed ! Now there’s a startling revelation. TIME magazine recently identified 25 people to blame. It’s a compelling list. Certainly, we can cast blame toward regulators, government leaders, rating agencies and the consumer, but I would lay a disproportionate share of the blame at the feet of the money-center banks and the investment banks.

I worked for one of those banks for most of the 90’s and can perhaps offer an informed, if somewhat dated, perspective. This perspective predates the housing and mortgage crisis, but seeds were sown well over a decade ago that I think gave rise to the current crisis. The story I relate here was multiplied tens of thousands of times over. Nothing illegal or unethical; just out of control and short-sighted.

My role at the bank was credit underwriting and business development (more the latter), working with large multinational corporations. We were encouraged to market everything the bank had to offer, except loans. All other products besides loans were fee-based income. One such product was derivatives, which in the case of my clients back then, were primarily interest rate swaps and foreign currency swaps. These instruments were initially designed as protection against interest rate and foreign exchange volatility, essentially insurance policies. Seems kind of quaint now; even archaic. Here’s the irony – the very products designed to minimize corporations’ risks became highly risky themselves.

What happened ? Corporations, specifically their treasury departments, were seeking other income streams. Many had become profit centers. They began to see these financial instruments as ways to make risky bets with potentially large pay-offs rather than prudent hedges. The banks were only too happy to oblige. They formed teams of math geniuses whose job was to design increasingly complex derivatives to satisfy the appetite of the more aggressive treasury departments, enabling them to make these bets. So, the banks greed fed the greed of the large corporations and vice versa.

Many years ago, when the banks first dealt with interest rate swaps and other derivatives, they focused on a matched book – ensuring counterparties were on the other sides of transactions to minimize their exposures to interest rate fluctuations. Eventually banks moved away from this conservative position and began to trade for their own accounts rather than simply on behalf of their clients, putting huge amounts of capital at risk. All designed to boost profits, because core lending was unprofitable or marginally so.

Were the investment banks any different ? Not really, except they weren’t as regulated. As a result, they weren’t as well-capitalized as the commercial banks. They had less margin for error. Their cultures encouraged outrageous risk-taking, resulting in outrageous bonuses in the good years. It’s no surprise then that as this system imploded, investment banks suffered disproportionately more than the commercial banks.

How does this relate to our current mess ? The same institutions that were designing and marketing high-risk financial instruments 15, 20, 25 years ago became more and more creative and aggressive with their financial engineering in the equities and mortgage-backed securities markets. Different set of products, different buyers, but the same mindsets, same cultures, same motivation – greed. One man’s opinion.

How does this relate to Gladney or adoption or families or children ? It doesn’t. It just feels good to vent.


Nancy said...

Since you're familiar with the banking industry, what is your opinion of the bail outs? Do these help? It seems they are short term solution as someone is hoping to solve the problem, but can the bail out solve the problem? Just curious, and I don't know what to think about it.

Frank said...

The government had to intervene or we would be facing a much worse crisis. Was their intervention appropriate in terms of amounts, allocations, oversight, etc ? I don't know.