In March Treasury Secretary Timothy Geithner delivered a pointed warning to European finance ministers against tough new regulations for hedge funds and private equity funds. Gordon Brown, the British prime minister, strongly echoed Geithner. The complaints are both framed in free-trade terminology—as if the Continent were trying to exclude inexpensive, high-quality British and American steel.

Bear in mind that the financial terrorists who blew up the global economy little more than a year ago were mostly American and British financial institutions. European banks helped out too, but they joined the party late, and often got stuck with most of the losses. Since the eventual taxpayer tab may run to $10 trillion or more, a tough regulatory response should hardly surprise.

What’s disheartening is the blatancy of Geithner and Brown’s shilling for favored constituents. Most hedge funds and private equity funds are American or British, so their governments leap to do their bidding. What if President Felipe Calderón complained of America’s hostile attitude toward Mexican drug cartels?

It’s worth reminding ourselves what the financial crisis was about. In 2001, then–Federal Reserve Chairman Alan Greenspan joined President George W. Bush in a campaign for federal tax cuts, disproportionately tilted toward the very wealthy. Then in the wake of the 2001–02 recession, Greenspan drove interest rates down to their lowest levels ever, and kept them there, to make it easier for banks to lend.

Both those measures put huge new pots of free cash in the hands of the very rich. Real investment—in things like new machinery or new roads—stayed pretty flat, however. Instead the money flowed into financial instruments, and especially into hedge funds and private equity funds, which claimed to earn much higher returns than those available to hoi polloi.

Private equity funds used to make money by buying underperforming companies or other distressed assets and actually fixing them. It was hard work and often financially risky. But with all the free cash floating around in the 2000s, you could dispense with the grungy “fixing” part. It was easier to just pile up debt and take the money home.

Consider a once-thriving European cell-phone company, TIM Hellas, that was snapped up in 2005 by two private equity funds, one British, one American. The buyout price was €1.7 billion. The funds put up €450 million of their own money, and borrowed the rest on Hellas’s books. So on day one, Hellas had gone from cash-rich to debt-poor, and its healthy profits had turned to losses. The next year, the company floated another €1.9 billion in debt, €1.5 billion of which was paid directly to the fund partners. For their efforts in self-enrichment, moreover, the funds charge the company yet another €2 million in annual fees. In other words, Hellas has been looted, and is now in danger of folding. Although the funds call themselves “investors,” they are really malignant parasites, feeding on hosts until they die.

There is no single category of hedge funds, but many were deeply implicated in buying and distributing the complex financial instruments like CDOs (don’t ask) that let banks spray toxic subprime mortgages, or auto loans, or consumer debt throughout the land, then collect the poison in pretty boxes and gift-wrap it with AAA ratings. Unsuspecting “sophisticated” investors, like Danish school boards and Mississippi pension funds, happily snapped up the pretty boxes. And the savings so diligently gathered for worker pensions or school textbooks were siphoned away into the pockets of distant bank and hedge-fund executives.

In other words, the financial system in the last decade was a machine for redistributing wealth upward. It worked well, too: in both England and America, from 2002 through 2006, nearly three-quarters of all income growth went to the top 1 percent of earners.

Working folks were blinded by the easy availability of money for big houses, big cars, and electronic toys from China. But like the employees of Hellas, they’ve discovered that the rich took all the cash, leaving only mountains of debt behind. And now they’re losing their jobs besides.

When the Obama administration came into office, the rallying cry about the financial meltdown was “Never again!” On their face, the European proposals seem targeted at exactly the destructive, highly leveraged deal-making that was such an important cog in the 2000s klepto-machine. Indeed, the fact that bankers hate it so much suggests that the Europeans are on to something promising. So it’s sad and shocking to see the highest officers of the land meekly take their places in the bankers’ chorus.

About the Author

Charles R. Morris, a Commonweal columnist, is the author of The Two Trillion Dollar Meltdown (Public Affairs), among other books, and is a fellow at the Century Foundation.



Commenting Guidelines

  • All

The velocity of money when not measured against what is prudent becomes a merry go round where the up and down of what comes in and goes out goes faster and faster creting an illusion of well being. The people on the lower end are the unsophisticated riders and at the higher end the much better off run the circus. Yes, getting on the merry go round is entertaining and fun but much short lived. The lesser are thrown off and about and the circus owners leave with their profit.  Sachs Goldman bought blocks of financial securities to sell. They suspected in 2007 as any small town lawyer knew that the real estate market was out of whack. So they sold their securities and what they kept they bough insurance to hedge against any loss. When the market went down the isnurance compaines had to pay the stock bought at the higher level to Sachs and Goldman. The profits from the stock prior to devaluation more than made up for the insurance to hedge the price of their securities after they fell in value. Of course, the question is to what extent did they take advantage of their customers. How could someone earing $50000 a year buy a $500000 house?  Yet despite my warnings, a secretary bought a condo in Florida which has lost at least 40% of its value.  Should a tbar owner be held liable if he creates an environment where the patrons become uncontrollable. Some would say that if you want to sell more alcohol, you should encourage unrestricted buying and selling and the price of rioting drunks is well worth the profit.  SAchs and Goldman could argue that it was the drunks that got hurt and others will argue that the barowner should have been better regulated. A regulated market slows down the merry go round and maybe that is the way it should be.  RICHARD BORDA.

Unfortunately Mr. Morris fails to indict those who set the stage for the sub-prime mortgage market and actually forced banks and mortgage companies to issue mortgages to borrowers who were not financially sound or credit worthy. Who was the force behind the sub-prime fiasco, the US government through HUD, Fannie Mae and Freddie Mac. Let's review:

"Every effort has been made to place the blame for the mortgage/housing crisis on anyone President Bush, greedy bankers, predatory lenders, et al, and everyone except the truly guilty, the politicians behind the social engineering program, "home ownership is an entitlement" by the federal government.TheTimeline to today's disaster starts here:1977- The Carter AdministrationThe Community Reinvestment Act becomes the United States federal law designed to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods.1992-The Clinton Administration The New York Times published the following article outlining the further implementaion of the 1977 law.Fannie Mae Seeks to Ease Home Buying By KEITH BRADSHER, Published: March 10, 1994 "The organization that stands behind many of the nation's mortgages is taking broad steps to make home ownership easier for lower-income Americans, particularly recent immigrants and minorities, people involved in the effort said today. Under the new rules, banks would have more flexibility in lending to people who already owe a considerable amount of money or who cannot afford a down payment equal to 20 percent of the price of a home".  "President Clinton is tentatively scheduled to attend the announcement. The Administration is urging that loans be more broadly available to poor and lower-middle-income Americans."  "In addition to changing its guidelines, Fannie Mae plans a national educational campaign that will seek to teach recent immigrants and minorities how to obtain mortgages. The campaign will be aimed particularly at immigrants in a dozen "gateway" cities where the percentage of home ownership has been declining.  The long-term goal is to broaden the economic and ethnic diversity of homeowners. About 70 percent of white households now own their homes, compared with 40 percent of black and Hispanic households. "Two Million Excluded Mortgage experts have estimated that up to two million American households are excluded from buying homes now because of conservative mortgage lending standards. These include Americans with minor blemishes on their credit records, for such things as changing jobs repeatedly or failing to pay utility bills on time. Most mortgage experts assume that even people who fall behind on other bills will struggle to make mortgage payments lest they lose their homes." !999 The Clinton Administration IN 1999 the New York Times warned that Fannie and Freddie were taking on additional risk at the insistence of the Clinton administration and predicted the eventual meltdown and bailout in an economic downturn.: "This is from the New York Times September 30th, 1999. Headline: "'Fannie Mae Eases Credit To Aid Mortgage Lending'  by Steven HolmesIn a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders. The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring. Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits."  '''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. 'Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.' Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market. In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's." The role of HUD during the Clinton administration is documented in a lengthy article in the Village Voice: Andrew Cuomo and Fannie and Freddie How the youngest Housing and Urban Development secretary in history gave birth to the mortgage crisis By Wayne Barrett Tuesday, August 5th 2008The full article is found at:http://www.villagevoice.com/2008-08-05/news/how-andrew-cuomo-gave-birth-...2003- The Bush AdmiistrationIn 2003, the Bush administration recommended significant regulatory overhaul of Fannie Mae and Freddie Mac. However, the Democrats opposed that proposal, fearing that tighter regulation could sharply reduce financing for low-income hous ing, both low and high risk. Under immense lobbying pressure from Fannie Mae in association with Congressional Democrats led by Rep. Barney Frank, Congress did not introduce any legislation aimed at bringing this proposal into law until 2005.   "In 2006, the Federal Housing Enterprise Regulatory Reform Act of 2005 (first put forward by Sen. Chuck Hagel) where he pointed out that Fannie Mae's regulator reported that profits were "illusions deliberately and systematically created by the company's senior management". However, this legislation too met with opposition from both Democrats and Republicans. This bill was passed by the House, but was never presented to the Senate for a vote. 

The blame being heaped upon Fannie Mae and Freddie Mac is not only undeserved, but an overt effort to remove these institutions completely. The mortgage melt down was not a function of the effort to offer lower down payment mortages to cash strapped borrowers. 90 and 95% loans have been around for 40 years with private mortgage insurance covering the difference between 80% loan to value and 90 or 95%. In addition we have for over 50 years been offering no down VA loans to veterans and 3% down loans under FHA. The causes of defaults under all those high loan ration programs are usually loss of employment or financial catastrophe within a local community. The high ratio loans are resold by local lenders to Fannie and Freddie so local lenders can lend again to new borrowers.

What really happened in the melt down crisis was the huge number of loans originated by fly by night mortgage brokers and greedy national banks that were NOT sold to Fannie or Freddie but repackaged and sold directly to investors at large by cooperating financial investment banks. These loans did NOT have to meet the usual underwriting standards of Fannie, Freddie, FHA or VA. Hence the large number of no document, windshield appraisal, no credit check, and even 120% lending with wrap around seconds - the entire sub-prime toxic waste of the mortgage industry. Please do not blame the regulator for this mess. It is the unregulated banks such as Country-wide, WaMu, Merrill Lynch, Indymac and others of their ilk that deliberately caused and fomented this huge debacle. Time for them to come clean.

Add new comment

You may login with your assigned e-mail address.
The password field is case sensitive.

Or log in with...

Add new comment