Financial Crisis: Quotes from a Columbia classroom

The last couple days have shown that there are fundamental problems with the way we finance everything in this country. David Leonhardt’s column in the Times is a thoughtful summary of the long-term changes that need to take place to make sure this doesn’t happen again. No bailout, he writes, can solve the problems of regulators thinking Wall Street can police itself, or households taking out “wishful-thinking loans” they can’t afford.

While no one official has put forward a new long-term financial strategy, people seem to be agreeing about some fundamental issues in this crisis. (And some of them were saying these things years ago. Why didn’t more people listen?)

Here are some comments from a lecture by a professor teaching a class in international finance at Columbia University. I’m not naming the prof, since the classroom — even though it is effectively open to the public and had about 150 students — is only a semi-public place and not a press conference, but I’m sure plenty of folks will find these comments interesting. This prof has years of experience in the finance world.

  • “The last time I felt like the bottom was falling out [like this] was October 19, 1987.”
  • The roots of this crisis were ten years ago. Despite all the complex balance sheets that seemed to cover risky debt, something was ignored: “There is a fundamental concern that if you want to sell something [debt], it means you don’t want it anymore.”
  • What people thought about Bear Stearns: “These balance sheets look suspicious, but you know, they [Bear Stearns analysts] are just so smart! But then they play 20 straight days of golf and smoke marijuana in public …. Hmm, maybe they’re not so smart.”
  • “These guys [i-banking leaders] are not that smart, they’re not in touch and they don’t know what they’re doing.”
  • Bear Stearns has been hyped as a bailout more than it actually was. “The press calls it a $29 billion bailout. But … it’s not obvious that the Fed is going to lose money on this.”
  • “A world without i-banks: is it one we want to live in? I have personally thought for a long time that the existence of these banks is fraught. Individuals can trade stocks without Lehman. Investment management — you can get that without Lehman…. Sales and trading — that’s why God created hedge funds. They have built-in incentives, they are unregulated and the investors can afford to lose.” [LGD aside: Not sure I agree with this last one, but I don’t know enough yet to argue with someone who has decades of experience.]
  • “These behemoth i-banks combined all these things under one roof. Not only did they breed conflicts of interest, they are hard to manage — look at the changeover of leadership.”
  • “I don’t know why AIG insured so many subprime loans. My guess is that when they first did it, it made a profit, and they continued. It was a titanic error of judgement.”
  • “I predict that Goldman will be bought by the end of the year…. But maybe they’re so special that they’re really unique.”
  • “I kind of think it’s a good idea to have fewer stand-alone i-banks, but I don’t think they should all go down at once like this.”

REGULATORS…. Mount up!

We need a fiscal Nate Dogg and Warren G to take control of these wild days on the Street.* But this time they need to be on Wall Street, not 21 and Lewis.

I have to admit to feeling a kind of sick glee watching the coverage of Lehman’s demise this week, and I’m not alone. Wall Street observers are saying this is a necessary step in realizing the full depth of the financial crisis.

Of course, the glee is unfounded, right? Isn’t it terribly naive to feel this way, since this crisis is going to rattle the economy thoroughly, and eventually directly affect me, along with everyone else?

The thing is, the Lehman disintegration is just a symptom of a crisis that has been brewing for much longer, so the glee is more about the depth of the crisis coming to light, and not about all the lost money.

Also, while I feel sorry for anyone who lost jobs or big money in the last few days, this is something of a case of the chickens coming home to roost. Long before summer 2007, I heard stories of people piling into houses in poor neighborhoods to try to pay their way out of subprime mortgages and keep their homes. Meanwhile, the hot housing profits in the credit markets were built on the use of these mortgages and the derivative schemes that made them seem viable. The geniuses in private equity who came up with these ideas operated outside the constraints and oversight of regulation — I guess because the government trusted them, as rich people (rich=competent and good, right?) and because no one fully understood the mechanisms they were using. Now, the house of cards has collapsed.

It goes without saying, at this point: These capital markets need regulation, just like any market where greed can trump prudence. Which is probably any market under the sun.

So as soon as the bailouts and bankruptcies blow over, we need action from lawmakers, preferably under the guidance of a president who is not an idiot.

Regulators, mount up.

*In case you lived in a cave in the early 90s, Warren G and Nate Dogg sang the hugely popular 1994 hit, “Regulate”, in which Nate Dogg describes saving his friend from muggers — “regulating” — on the streets of Long Beach.