04/09/2012 11:30 am ET | Updated Jun 09, 2012

You Can't Trust the Wise Men of Finance

I have my doubts about the the wisdom of our entrusted Wise Men in understanding the past in order to predict the future.

Fed Chairman Ben Bernanke told a George Washington University class last week ( I saw it on C-Span) that the 2008 financial crisis took place because "nobody was looking at the whole system."

Almost simultaneously former Treasury Secretary Robert Rubin was telling another GWU group, televised on C-Span, that "no one saw the Long Tail coming," meaning that no Wall Street leader, no economist, no legislative committee, no regulator, could predict the perfect storm of all investment assets collapsing at the same time.

I beg to differ. Here, from a piece I wrote on June 18, 2007 -- more than a year before the Lehman Brothers bankruptcy -- I was talking to a whole mess of well-connected people about what danger we might be in.

Gail Fosler, President of the Conference Board, told me in March, 2007: "This is a bubble which could be as large or larger as the financial crisis we saw in the late 1990s."

Gary Schinasi, an IMF economist, warned me that "There could be a tsunami of credit evolving into a perfect storm. When positions unravel liquidity evaporates quickly and systemic issues impact innocent bystanders."

Fitch Ratings predicted a debt bubble driven by credit derivatives swaps exploding.

Tim Geithner, then president of the New York Federal Reserve Bank,( March, 2007) warned of a "greater risk of systemic financial crisis due to excessive leverage and hedge funds doing 60% of the trades in credit derivative swaps." But he never instructed the major money center banks like Citigroup to immediately and massively reduce the assets on their balance sheet, no matter the price obtained.

J.P. Morgan Chase's derivative research department was every week publishing reports advising their clients their opinion that some sub-prime mortgage backed bonds were in the process of losing 80% of their value. I know this is true because I saw and read these documents and reported on them.

A small band of investment banks, led by Goldman Sachs, Morgan Stanley and Barclays created in 2006 their own private index, the ABX, to enable them to hedge their positions in derivatives, and to make billions by selling short these dangerous securities they had created. They understood quite succinctly they would be faced by a meltdown, a "perfect storm," a "Long-Tail."

Last week, I was shocked that Bernanke told his class at GWU that "it was a bad choice to rescue AIG... because it made it safe for a big firm to fail." This is absurd, since AIG, the largest insurance company in the world, failing, would have threatened the dozens of banks and other financial institutions around the globe who were its counter-party on hundreds of billions of transactions and loans. Only chaos would have resulted.

Nor do I have confidence that the Financial Stability Council, which includes every regulatory agency like the SEC, the Treasury, the CFTC, the FDIC etc, will see in advance the dangers and coalesce on quick bold policy to rescue the system. Moreover, this Stability Council, can only SUGGEST. It cannot insist on action and produce it.

Rubin is on stronger ground recommending that there be both margin required on all derivative position -- and additional capital be prescribed as the quid pro quo for holding many tens of trillions of derivative contracts on their books. If the Volcker rule that limits gambling by banks gets gutted, you will know to start biting your nails again.