As the financial crisis developed during 2008 and into 2009, many people believed that commercial real estate would be the next shoe to drop. It never happened. There’s more than one reason why. For example, commercial mortgage lenders are more willing to renegotiate and revise than residential mortgage lenders. This study says another reason is that real estate investment trusts have a strong presence in commercial real estate and provided a stabilizing influence. They prevented speculation in the boom period and avoided panic in the bad times.
The proof of the hypothesis, the researchers say, is that overshoots and undershoots of construction in the U.S. office building market were more moderate at times when REITs had a bigger market share. They presume that the rest of the market pays more attention to the REITs at times when their market share is bigger. To zero in on the impact of REITs’ market share, they held constant two other factors that might affect office building construction, namely the prices of buildings and the cost of construction. Similar effects were found in other commercial real estate sectors in the U.S., as well as with office buildings in Japan.
One of the hardest things about giving people sensible financial advice, especially investment advice, is competing with the story tellers and prediction experts. They’re very good at promotion and very good about pulling together a lot of facts and theory that support their extreme predictions, without addressing anything that doesn’t support their theories. This article does a good job of dissecting the predictions and failures of some of the prominent doom and gloom forecasters of recent years. While these people can be entertaining, don’t get caught in their emotional currents.
It draws viewers to TV, eyeballs to websites and buyers to books from “Crisis Investing,” published in 1980, to “Surviving the Great Depression of 1990” to “The Collapse of the Dollar and How to Profit from It” (2008).
The financial crisis and Great Recession created a bull market in doom and gloom. But nearly six years after Lehman Brothers’ collapse, the worst hasn’t happened — unless you consider a 180% advance in the S&P 500 Index a disaster. Which it was, to those who avoided U.S. stocks because they believed the doom-and-gloomers.
So, now, enough time has passed to label certain outrageous forecasts as just plain wrong and to call out the people who made them.
Former Treasury Secretary Tim Geithner has had his book about the financial crisis published. I haven’t read the book but have read a number of reviews. It seems clear that he doesn’t answer the key questions about why regulators failed to see the crisis coming and of course doesn’t address the regulators’ role in creating the crisis and making it worse. If the reviews accurately reflect the book, it does confirm my long time view of Geithner. He’s a good administrator. He could handle almost any job in good, smooth times. But he doesn’t look forward and certainly isn’t going to do anything to innovate or rock the boat. I like this review, which also links to other review.
When I left Treasury at the end of the Clinton administration, my colleagues put together tongue-in-cheek recommendations for my next job; for instance, Rubin suggested I could be Larry’s biographer. Greenspan proposed “first assistant to the deputy to the managing director of the Asian Monetary Fund,” his wry way of celebrating its nonexistence.
A major cause of the financial crisis was the unregulated nature of private derivatives. These are futures and options contracts and other contracts that are traded off exchanges. They are deals between two or more parties, usually financial firms. Firms used these to increase their leverage and make investments or bets on a range of financial assets and outcomes. It’s no secret any longer that Brooksley Borne, then head of the Commodities Futures Trading Commission, wanted to regulate these contracts in 1998 but her efforts were rebuffed by Alan Greenspan, Robert Rubin, Arthur Levitt, and Larry Summers.
What was secret until recently is exactly what happened in the key meeting between those four. Now, at least a version of the meeting is public. A set of anonymous handwritten notes were released from the Clinton Library as part of a series of recent document releases. Most media ignored them, but Bloomberg BusinessWeek has a detailed analysis of them.
Undaunted by the bruising debate, Born went ahead on May 7 with the concept release, stressing that it “does not in any way alter the current status of any instrument or transaction.” Greenspan, Rubin, and Levitt issued a statement the same day expressing “grave concerns” about the CFTC’s release. That helped persuade Congress to block the CFTC from changing its regulation of swaps.
Born resigned in June 1999. On Dec. 21, 2000, Clinton signed the Commodity Futures Modernization Act of 2000, which formalized the exemption of most over-the-counter derivatives from regulation as either futures or securities. Regulators were thus only dimly aware of the explosive growth in new products such as credit default swaps, which helped pump up the housing bubble and in 2008 brought down American International Group, then the world’s largest insurer. Interviewed in 2010, Clinton told ABC News that his economic team got it wrong—“and I think I was wrong to take [their advice].”
There haven’t been many headlines from Europe recently. The financial crisis seems to be in the past, and European stock markets generated nice gains the last few years. But that’s only the surface analysis. In fact, European leaders haven’t done anything except stabilize the continent at depression levels. Growth is very modest. Unemployment still is very high and generating a range of social problems. The structure of the continent’s governing structures make it difficult to enact any policies that will do more than provide stopgaps to the serious problems. Stratfor.com updates the situation.
There’s a growing consensus that the European Central Bank needs to implement something similar to the quantitative easing policies of the U.S. and U.K. The ECB isn’t allowed to buy bonds the way those two central banks have. More importantly, a German court is reviewing a case in which it could sharply restrict the powers of the ECB, making it extremely unlikely that the ECB would be able to pursue aggressive policies. If the court does rule that way, it could change public perception enough to cause another panic and crisis.
Much like the U.S. Supreme Court, upon which Germany’s highest court was partially modeled after World War II, the German Federal Constitutional Court is the final interpreter of constitutional law. Accordingly, it has the last word on the legality of any treaties, agreements or actions undertaken by Germany at the European level.
The court already has challenged German involvement in some of the more creative legal acrobatics undertaken by the European Union. These include the establishment of the EU emergency bond-buying plan known as the Outright Monetary Transactions program. In that case, the German Federal Constitutional Court proceeded with caution and referred the case to the European Court of Justice. But there are strong indications that it could be more aggressive in future cases. A rejection of government moves in a landmark case, such as one involving potential German participation in a strengthened quantitative easing program, could derail the Continent’s recovery.
Charles Keating, the leader of the savings & loan scams of the 1980s, passed away last week. Not too many people remember the damage that was done by the S&P crisis and how few of the lessons from that crisis were remembered. Instead, new scams and frauds occur with regularity. Here’s a good review of Keating’s actions by a many who tried to regulate Keating and regularly was confronted by politicians Keating had purchased through campaign contributions.
The Savings and Loan debacle was the test bed for the epidemics of accounting control fraud that drove our subsequent financial crises. The debacle was the only one that was “successfully” contained before it could cause a financial crisis. The debacle was widely described at the time as the “worst financial scandal is U.S. history,” so the phrase “successfully contained” is obviously one that could spark disbelief. The critical modifier is “before it could cause a financial crisis.” The S&L debacle did not lead to even a mild national recession. It did hyper-inflate regional real estate bubbles that pushed parts of the Southwest region into a serious economic decline. The Enron-era frauds substantially contributed (in conjunction with the related collapse of the dot com bubble) to a $7 trillion fall in market capitalization and the fraud epidemics hyper-inflated the largest bubble in history and drove a Great Recession that is projected to cost over $20 trillion in lost production. The S&L debacle, therefore, allows us to understand not only went wrong, but also how to prevent things from going wrong.
Many people wonder why after all the losses in the financial crisis so few people faced criminal prosecution. One answer is that incompetence and mismanagement aren’t crimes. But there are some instances of questionable public disclosure and other acts that could be crimes. Here’s a good example of why even those cases don’t result in prosecutions. Sometimes the prosecutors aren’t very good. Sometimes prosecutors find it to their benefit to settle cases for money instead of taking the risks of losing at trial. By settling they get to announce all the fines they collected and bad guys they pursued.
According to the complaint, Bank of America executives wrestled over whether to tell investors about the mounting Merrill losses. On Nov. 13, 2008, Bank of America’s general counsel, Timothy J. Mayopoulos, and the bank’s outside lawyers from Wachtell, Lipton, Rosen & Katz decided that the numbers would have to be disclosed in a Securities and Exchange Commission filing, according to the complaint. Then, they consulted with Joe Price, the bank’s chief financial officer, and decided to reverse their decision.
On Dec. 4, the complaint alleges, Mr. Price knew that the losses had breached the threshold that Mr. Mayopoulos had laid out as the benchmark for requiring disclosure. The shareholder vote went ahead without any filing.
The minutes from the Fed meetings of 2008 are something of a gold mine for those who want to plug in the details of how the debt problems became a major calamity that spiraled almost out of control. A really good compilation is this piece from The Atlantic. It pieces together news events and the Fed minutes, starting in 2007, and shows how the majority of the Fed was worried about inflation when we were on the verge of a deflationary spiral. It’s good reading. Good title, too.
Now, the Fed actually did a good job in this first part of the crisis. It aggressively cut interest rates from 5.25 percent in September 2007 to 2 percent in April 2008. And it midwifed a deal for Bear Stearns—taking on $30 billion of its crappiest assets—to prevent an all-out panic. By April, Bernanke was justified in saying that “we ought to at least modestly congratulate ourselves.” The TED spread had come down from end-of-the-world-terrible to merely terrible levels. And though unemployment had risen to 5.4 percent, that wasn’t too bad when you considered that housing had already fallen 20 percent from its 2006 peak.
It looked like we might muddle through with something like the 1990 recession: a shallow, but long, slump, with a weak financial system, but no panic. This is the three-chapter story of why that didn’t happen, the story of the three Fed meetings that took place during the summer of 2008, whose much-anticipated transcripts were finally released last week.
Since the financial crisis, former Federal Reserve Chairman Alan Greenspan’s been researching and writing. Mostly he’s been trying to learn what he didn’t know back when he was head of the Fed. He wrote a couple of books and some articles. Most recently, he was interviewed by the Harvard Business Review. There are a lot of interesting points in the article, including the observation that he didn’t have time to learn and do research as Fed chairman and has learned more since leaving the Fed than he did during the previous 10 years.
I can recall a lot of people at the Federal Reserve raising all of these issues. I was sitting there 18-and-a-half years, getting an extraordinary amount of advice from everybody under the sun. Every day for most of the period from let’s say late 1980s basically through the end of my term, I would get almost every week people predicting that the world was coming to an end. That the economy was going to crash. “There are imbalances. There’s too much debt. There’s too much speculation.”
After a while you begin to say that this stuff is random, because you have this same thing going on on the other side. But in retrospect, what everybody reads is five or six guys who did get it right.
You know, when [Eugene] Fama and [Robert] Shiller got the Nobel, in the New York Times, they have Fama saying about Shiller’s forecast of a decline in housing prices, “Aw yeah, he’s been saying that for years.” [Greenspan asked me to check that, and the actual line from the article was pretty close: “Asked in 2010 about those who warned that housing prices would crash, he responded, ‘Right. For example, Shiller was saying that since 1996.’”]
Jon Hilsenrath of The Wall Street Journal read the Fed’s minutes from 2008 and came up with a list of officials who distinguished themselves (winners) and those who don’t look so good in retrospect (losers). Some of the losers were named by Hilsenrath because in retrospect they seemed to be wrong in their assessments of the economy and policy preferences. Others made the losers’ list because of personal qualities in the minutes that didn’t appeal to Hilsenrath. It’s an interesting piece and serves as a good summary of the minutes.
After Mr. Dudley gave a detailed presentation on Jan. 29 2008 on troubling risks in the bond insurance business – a precursor to AIG’s collapse and New York Fed-led bailout the following September – Mr. Geithner was asked by a colleague if he was in touch with the bond insurers. He responded vaguely: “We have not been in touch with them directly to get a sense about their risk profile and so forth.” Instead, he said, the New York Fed was conferring with their New York state regulator and offering it advice.
Later at that January meeting he offered this assessment of financial conditions: “In the financial markets, I think it is true that there is some sign that the process of repair is starting,” he said, pointing to capital-raising by financial firms and “pretty substantial improvement in market-functioning.” He did say later that he remained worried about a “dangerous self-reinforcing cycle” in markets which raised recession probabilities, a point he emphasized often during the year in a call for the Fed to action. Still Fed Vice Chairman Donald Kohn felt the need to gently push back in that case in January: “The repair process that President Geithner referenced among financial institutions strikes me as very fragile and quite incomplete.” Bear Stearns collapsed several weeks later.