Can someone shut these banking industry narcissists up?
The one and only time I met Steve Schwarzman was in 1986, when he and Pete Peterson had just started the Blackstone Group. I was a manager (meaning a mid level working oar) at McKinsey. We had teed up a deal and were assisting our foreign client in hiring an investment banker. This transaction was sufficiently sexy that Felix Rohatyn wound up working on it personally.
But what did we get when we presented the idea to Peterson and Schwarzman? We explained why we came to see them. We got 40 minutes (I kid you not, I checked my watch) of name-dropping by Peterson, of all the senior folks he knew in our client's country. But that wasn't why our client came to see him; had he bothered to listen, the matter at hand was in the US.
Then he and Schwarzman spent the next 20 minutes talking about Blackstone, and they make it abundantly clear how jealous they were of leveraged buyout king Henry Kravis (at the time, Peterson and Schwarzman were mere advisor types, their wealth creating opportunities were far more limited than if they had oddles of investor and bank money to play with).
So in effect, they spent an hour telling us that they really wanted to be doing LBOs, that was SO much better paid than M&A, they wanted to grow up to be Henry Kravis, but since they hadn't raised the money to do that yet, then yeah, our client's deal might be worth their while in the interim.
I have never seen a pitch meeting (and this had been arranged at the senior levels of the firm) devolve into such a naked display of personal greed. The two partners who were there with me, neither one of them naifs, were as appalled as I was. As much as I have seen a lot of unprofessional conduct in my life, this still ranks as one of real doozies.
So nothing about Schwarzman since has surprised me. His Washington Post op-ed today, "Lawmakers' rush to punish banks threatens recovery," attempts to defend the new world order of finance uber alles, is every bit as appalling in its own way as that brief encounter I had with him 25 years ago.
His article starts with the "We're having a recovery!" meme, citing the 5.7% fourth quarter GDP growth, and improving output statistics overseas. But the US GDP results were largely inventory-driven. The improvement in reported unemployment was largely the result of a change in statistical methods. There have been some mildly encouraging signs, like an increase in the length of the workweek. But there has been, and continues to be, a substantial gap between financial market performance, which is still pumped up by super cheap money, and the still weak real economy. For the vast majority of the public, there has been no recovery.
But this is where Schwarzman starts with his defense of the indefensible, namely, that the banking industry should get a break:
We have also learned, however, that bank lending is still contracting in the United States and Europe, especially for small and medium-size businesses. Unless we reverse that trend, this incipient revival of the global economy could well sputter to a halt.
Yves here. Before we get one step further, it is important to note that the last survey of loan officers pointed to low loan demand, as well as tight credit conditions. Back to Schwarzman:
Blackstone is a major client of many of the largest banks around the world. And if there is one common theme that I have heard in conversations with senior bank executives over the past several months, it is that their fundamental business model is under siege. They are uncertain about the amount of equity capital needed to run their enterprises. They are uncertain about the amount of reserves required for various business lines. They are uncertain about the potential new requirements for special reserves they will have to retain in good times to use in bad times. They are uncertain about the ongoing level of taxes they will be paying. They are facing various proposals for what are described as new fees, which are the equivalent of new taxes. They are facing proposals to limit the number of businesses they will be allowed to be in and thus are contemplating having to shrink their banks and divest themselves of otherwise profitable assets. They are facing restrictions on what they can pay their people and are facing the possibility that many talented employees will leave for other financial institutions outside the public eye.
These uncertainties have severely hampered banking executives' ability to plan how to run their businesses or even know what their businesses may include. Predictably, bankers are reacting to this unprecedented uncertainty by becoming conservative and cautious. The result is that there is less lending and less credit available.
Yves here. Notice what is missing? Do we have a single mention, or even an allusion, to the financial crisis? He has airbrushed out the excessive risk taking, predatory behavior, looting, and excessive leverage played, and that in turn was the result of over two decades of effort to free financial firms from restraint and oversight. Damned right their business models are "under siege". That's what happens when a populace mobilizes to respond to bandits.
The industry's inability to see, much less admit, any culpability, and hence the need for root and branch reform, is pathological. The reaction of the bank chiefs, at least as depicted by Schwarzman, is utter denial. It's as if someone who drove his car at 150 miles an hour, lost control, plowed through several houses but miraculously survived (only by virtue of going to the head of the line in the emergency room). He is miffed that what is left of the wreck has been impounded and he is forced to go to the police station and explain himself, and might have to pay fines, have his driver's license suspended, or face other restrictions as a result of his reckless and destructive conduct.
And notice how the banksters are depicted as victims. There's no mention of the fact that their business models aren't working because the industry itself tested them to destruction. Securitization, which had become a crucial mechanism for everything from residential and commercial real estate to credit card and takeover loans, is in the deep freeze because investors were burned. As much as Schwarzman and the banks he is shilling for would have you believe otherwise, the difficulties in large measure result from aggressively redesigning their firms around "innovations" like credit default swaps that might have been salutary if used in only in carefully selected circumstances, but weakened their foundations by allowing them to operate with too little equity and too much leverage (note I am very skeptical re the genuinely productive uses of CDS, but I am willing to be persuaded otherwise).
And he fails to mention the 800 lb. gorilla in the room, the biggest reason for banks not lending: that they still have lots of unrealized losses. That leads to considerable risk aversion and the need to hang onto liquidity buffers. The "under seige" story is a convenient excuse to divert attention from the yawning hole on their balance sheets and blame correctly critical outsiders instead. For instance, the Congressional Oversight Panel anticipates another $200 billion to $300 billion in losses on commercial real estate. Similarly, I participated in a lunch with Josh Rosner and Chris Whalen earlier in the week. They went on at considerable length how much further banks had to go in writing down bad loans, how the industry marks were wildly unrealistic in some of the most obviously troubled categories (HELOCs), and that even a mild increase in short term rates would be very problematic.
But to Schwarzman would have you believe that the reluctance of banks to lend is due solely to government (and by extension, public) interference and hostility. He continues:
This country, of course, needs fundamental reform of our financial regulatory system, as I, and many other financial institution executives, have publicly advocated for a considerable period. But we are debating this hugely important issue in an inflammatory political atmosphere in which key participants seem determined to single out the banks for special retribution in reaction to the financial crisis.
Yves here. Please, this is laughable. How many executives have called for fundamental reform (and how do you define "considerable period"?). For the most post, the proposals offered, like the one Schwarzman penned last year, have more to do with consolidating oversight mechanisms and practices, and offer little in the way of substantive measures (for instance, Schwarzman called for consolidation of off balance sheet vehicles. While that is a welcome and needed measure, the FASB released its exposure draft on this topic on September 15, 2008, for a sixty day comment period. The odds are high that as of the date of his November 2008 op ed, this proposal looked likely to go through. So is lining up with a pretty certain to be done deal the same as being an advocate of "reform"? Not in my book. Note nowhere does his list include more equity for banks and broker dealers (a sure negative for his business), and it argue for an abolition of mark to market accounting for hard to value assets, when the abuses of recent approaches (the use of Level 3 accounting, or "mark to make believe").
Now we go to the next bit:
It is important to remember that a variety of actors helped create the financial crisis. From our government, there was congressional pressure to expand homeownership by lending to borrowers who would not otherwise qualify for traditional mortgages. . As a result, Fannie Mae and Freddie Mac dramatically expanded their activities to accommodate this objective.
Yves here. Making Fannie and Freddie the focus of blame for the growth of subprime is overdone. The agencies were under severe restrictions as to balance sheet growth from the outbreak of their accounting scandals in 2002 and 2003 though late 2005. The GSEs lost market share in mortgage origination when suprime and near prime mortgages were taking off (note I am not denying that they played a role, merely focus on them). Back to the article:
Federal Reserve monetary policy reduced the cost of lending and encouraged borrowing. Private market participants may have used excessive leverage in some transactions. Regulators permitted dramatic increases in leverage at investment banks, and billions of dollars of debt stayed off some banks' balance sheets. There was failure at virtually every level of regulatory oversight, including, critically, minimal controls over mortgage brokers, who encouraged many subprime borrowers to contract for houses or take out additional loans that they could never afford. Many banks lowered lending standards for various other commercial, residential and consumer loans while reducing their reserves for bad debts. Rating agencies bear a heavy burden of responsibility for assuring investors that securitized pools of subprime mortgages could get the highest AAA rating, when in reality they were highly speculative risks. Banks underwrote and sold these AAA securities around the world without a sober, objective examination of the underlying risks. Many of the purchasers of these securities failed to perform even the most rudimentary independent due diligence.
Yves here. The comments re lax regulation again misplace blame. Why was oversight so weak? Because the industry fought tooth and nail to have it that way. As the old saying goes, it's like shooting your parents and asking for sympathy because you are now an orphan. While the rating agencies should join in any perp walk, but the article is again wide of the mark on the "complex securities." Those AAA tranches often would up being retained by the banks themselves because, if they were hedged, the results were very flattering to trading desk P&Ls and trader bonuses (and yeah, the hedged failed for predictable reasons, but no one has tried to get the money back). And the vast majority of the value of those deals was in those same AAA tranches. The other parts were flogged very aggressively around the world, often picked precisely because they were incapable of understanding them, much the less evaluating them.
Back again to the piece:
To single out banks for blame is dangerous to the economy. If, as a result of this anger, credit becomes unavailable, particularly for small and mid-size businesses, in the amounts needed to fuel economic growth and job creation, then at best the economy will slow and, at worst, we will find ourselves in a dire situation, to which we all will have contributed. We need sobriety, rationality and civility in the discussions on the regulation of financial institutions so that the banks can return in a robust manner to their central role in funding the economy. We are on the road to an economic recovery. Let's stay on it.
Yves here. This could not be further from the truth. What helped produce durable, well though out securities reform was relentless, public exposure of the abuses by the Pecora Commission, which kept public ire at a high enough level to maintain pressure for the development of complex legislation. The fact that Roosevelt threw his support behind financial reform in general and Pecora in particular was another important impetus. It led some bankers to break ranks on enough issues (for instance, smaller securities firms and the Rockefeller interests backed Glass Steagall; famed speculator Joe Kennedy proved an effective reformer as the first chairman of the SEC) to allow for expertise to be devoted to crafting sound measures, rather than obstructionism and Potemkin reforms.
The last thing the public should do now is turn down the heat on bankers. We have just been through the greatest looting of the public purse in history. We cannot relent until we understand how it happened and have put new rules in place to prevent its recurrence. People like Schwarzman need to understand that the populace is increasingly understanding that what has been depicted up as reform is mere industry serving pablum. Even if Schwarzman is incapable of seeing it, continued pressure will lead some of his colleagues to recognize that they need to embrace change or else wind up in the dustbin of history.