I’ve never been a big believer in the predictive power of the reversion to
mean theory, but at the same time it stands to reason that after a reasonably
sensible outing last week, Ben Stein would hand in an utter
shocker of a column this week – and that the NYT would slap it on
the front page of the business section, too, under what Yves Smith describes
in an email to me as "the classic ‘God’s light from the heavens’ shot that
you see in religious material targeted to the lower middle class". I shall
studiously avoid, however, the subject of what this implies about the divinity
or otherwise of Stein’s Word: there are some places I simply will not go.
Stein starts off by giving us "the good news" about the economy.
(Actually, he starts off by giving us the good news about Taco Bell, which is
that its Taco Supreme is tasty. So I guess if you’re having your house foreclosed
upon, you know where to go.) This good news consists of five things. The first
is an eternal verity: "almost all mortgages are not in default". Does
Stein have a clue how stupid this is? If you get a mortgage, one of two things
tends to happen: you either pay it down, or you don’t. If you pay it down, then
you are not in default. If you don’t, then eventually the bank forecloses on
you, and the mortgage isn’t a mortgage any more. So at any given point in time,
the vast majority of mortgages are not going to be in default. Which doesn’t
mean that a lot of the more recent ones won’t go into default when they reset,
of course.
Stein’s second piece of good news has been true for decades: "almost all
workers in the labor force who care to work are not unemployed". (But note
the qualifier in there.) And the third is false: Stein says that homeownership
rates are at all-time highs. But the second-quarter
data put homeownership rates at 68.2%, down from 68.7% in the second quarter
last year; the peak actually came in 2004.
The fourth piece of good news is that the Dow is doing well. I’ll let Dean
Baker handle
that one. And the fifth is that junk bonds haven’t gapped out a lot –
something which is anybody holding speculative-grade mortgage-backed securities
will be overjoyed to know. (Oh, wait, Stein has managed to find a junk-bond
index which doesn’t include asset-backed securities, which is where
all the trouble has been. Well, apparently the market in $10 million New York
City condos has never been hotter either. Does that mean house prices aren’t
falling?)
Stein’s main point is that reality is fine; it’s just the media which is making
things look bad. "Newspapers (which often sell on fear, not on fact) talk
frequently about a mortgage freeze," he says. Although if you do a Google
News search on "mortgage freeze", you find exactly one newspaper
article: this one, by Stein. Meanwhile, he says, and I swear I am not
making this up, "there is still a long waiting list for Bentleys in Beverly
Hills". Well in that case there couldn’t possibly be
a housing crisis!
"This country does not look like a country in economic trouble,"
concludes Stein. Well, maybe if you live in Beverly Hills and you have lots
of money invested in the stock market, then that might seem to be the case.
But Stein doesn’t seem to consider that most Americans might not fall into that
category.
After getting the good news wrong, Stein then proceeds to concede a certain
amount of bad news – and, of course, he gets that wrong, too. First he
feels compelled to demonstrate that he has no ability at all to comprehend why
crashes and corrections might be frightening:
As everyone knows, we have a housing correction on a large scale. True, it’s
a correction from a high level, but it’s still a big correction.
Ahem. It’s the corrections "from a high level" which are precisely
the ones that people should be most worried about. If prices have risen
a lot, that’s reason to be more scared, not more sanguine. But I think that
maybe Stein may have been distracted of late: he describes the economy as "lusciously
huge". Let’s just say that Googling that term at work is contraindicated.
Stein then diagnoses "a stupendous wave of fear washing over Wall Street"
about leveraged loan commitments – one which is so stupendous, indeed,
that he reckons it will end "very, very soon". I guess that a stupendous
wave is an everyday occurrence to a Californian like Stein: what we really
need to worry about is the "tsunami of fear" (yes, really, go check
for yourself if you don’t believe me) about – wait for it – conduits.
Now I know that there’s been a lot of talk about these things in the past week
or so. But a "tsunami of fear"? Is Stein shopping a screenplay about
the Credit Crisis of 2007? "Jack, I’ve just picked up on my Bloomberg seismograph
that there’s been a huge subprime earthquake just off the Azores, which means
a tsunami of fear will be headed straight for Wall Street! And it’s
travelling along a conduit!!"
Stein describes conduits as "basically incredibly risky and foolish instruments,"
which is not true. And his diagnosis of what made them risky is particularly
weird: he complains that in an SIV, "money is borrowed short to be lent
long". Well, yes, this is called maturity transformation, and it’s the
foundation on which the entire banking industry is based. Without it, capitalism
would go nowhere fast. And it’s something which is not confined to banks, either:
there are thousands of companies with well-established CP programs, all of which
are playing exactly the same game. The problem with the SIVs is not that they
lent long, it’s that they invested in highly-rated structured products which
turned out to be much riskier than they thought.
Stein then goes on to place all the blame for pretty much everything on the
CEOs of Merrill Lynch, Citigroup, and other, unnamed, money center banks. This
is how he sees the genesis of SIVs:
They tried to juice returns in a low-interest-rate world by maneuvers so
dicey that the maneuvers would not survive scrutiny and had to be hidden on
off-balance-sheet entities, sometimes outside the country.
Well, either that, or else the whole point of the SIVs was that they would
have triple-A credit ratings – stronger than the banks themselves
– which would allow the conduits to access the CP market at very low rates.
And by "sometimes outside the country" Stein doesn’t mean shady offshore
vehicles in Bermuda, he’s talking about London.
And then Stein attempts a neat acrobatic feat. After telling us that the economy
is hunky-dory, and that companies are going great and have no problems raising
debt capital, he then tells us that many banks have suffered "immense losses"
on their lending. Now, how can all those loans have gone bad even as the economy
is doing fine? It all comes down to the fact that "prudence was not used
in the last several years at some of our most esteemed money houses".
Prudence. What does he mean by that? "As I have said for 20 years, it’s
basic when you are lending to subprime borrowers to take substantial reserves
for likely defaults. Obviously, this was not done."
He’s been talking about subprime borrowers for 20 years? The subprime
mortgage business barely existed 20 years ago. And in any case, the
whole reason why there’s such a mess in the mortgage market right now is that
it didn’t make any sense for the banks to take reserves against subprime mortgage
default, because they didn’t own any subprime mortgages. Instead, they
bundled them up, tranched them down, and sold them to institutional investors.
If Stan O’Neal or Chuck Prince had started taking reserves against mortgages
they didn’t hold, I doubt they would have stayed in their jobs very long. When
mortgage-backed securities started performing much more badly than anybody thought
they would, the repercussions for Merrill Lynch and Citigroup were nasty indeed.
But the problems came from the MBS market, which is dominated by bond investors
– not banks – who historically were much more worried about
prepayment risk than about default risk. What Stein is saying here is that the
banks who sold mortgage-backed bonds to investors should have started putting
away money against the risk that those bonds would go really, really bad –
so bad, indeed, that there would be systemic consequences which would redound
back upon the banks themselves. And, it seems, Stein thinks they should have
been doing this even as they were underwriting the bond issues in the first
place. I fear to think what Eliot Spitzer would have thought of that.
Stein then graces us with his analysis of The Entity. According to Stein, this
super-conduit is but a hint of things to come:
It’s the thin edge of the wedge: what may follow is to have a government
fund to buy the slightly less fragrant parts of the portfolio. Indeed, that
would seem inevitable to me.
I do so wish that I could take Stein up on his bet here. Whatever
happens, the US government is not going to start setting itself up as a buyer
of last resort for impaired mortgage-backed securities, and it certainly
isn’t going to "pay full price" as Stein implies in his next paragraph.
Stein by saying that "the losses are nothing compared with the losses
in the tech debacle" – I guess he owned a bunch of tech stocks in
2000. But he accuses bank CEOs of behaving unethically, without any evidence
at all beyond the fact that the SIVs were off balance sheet – something
which was known and understood and completely transparent. Enron-style SPVs
they were not. And he demands that the SEC bring suit against the big banks,
and that there be "criminal investigations from other law enforcement authorities".
Yes, criminal.
There’s nothing criminal going on here. In fact, it’s quite obvious what happened,
how it happened, and why it happened. All of the links in the chain are right
there in broad daylight, and none of them are criminal in nature.
But Stein’s already back onto his paranoiac talking points: "we stockholders
and taxpayers foot the bill, of course". No, you don’t. You just said that
stocks are at all-time highs: I don’t see stockholders footing any bills at
all. And taxpayers haven’t bailed out anybody, least of all the banks. (There
might be some help for subprime borrowers, but that’s a different issue.)
In Stein’s black-and-white world, evil, unethical criminals run large banks
and become billionaires thanks to lax regulation and government bailouts. Would
that it were so simple. In fact, this crisis came about due to the actions of
many different players, from hedge-fund managers to credit rating agencies.
The banks played their part, but it wasn’t nearly as central as Stein is making
out – and it certainly wasn’t illegal. It’s always fun to play "blame
the banker". But it’s also, in this case, stupid.