LOS ANGELES — Congressional approval of the $700 billion financial-system “bailout” earlier this week has failed to calm the jitters of five prominent financial professionals, who said they remained vexed by both a paralyzed banking system and the possibility of prolonged recession during a Tuesday evening conference in Los Angeles.
Fear and foreboding remained the dominant mood at the conference convened by the University of Southern California (USC). “I don’t worry about the stock market,” said economist Richard Green, chair of the USC Lusk Center for Real Estate. “I’m worried about [bankers] who are not willing to lend money,” he added. He cited the widening spread, or surcharge, charged by banks on short-term loans to other banks, which has risen in the past year from 0.65% above the cost of funds to a prohibitive 4%.
While each of the experts cited different causes for the near-breakdown of the banking and capital-distribution system, their diagnoses turned out to be surprisingly similar. Economist Raphael Bostic, a professor at the USC School of Policy, Planning and Development, blamed what he called “multi-party” investments like mortgage-backed securities, typically made up of hundreds of separate mortgages, none of which are known to “end-user” investors.
In a similar vein, Brad Hintz, an equity research analyst for Sanford Bernstein & Co. and a former CFO of Lehman Brothers, blamed securitization itself, which “broke the link between the guy who made the loan and the guy who holds the loan,” he said. The situation is potentially corrupting for loan originators, he added, because originators are not held directly responsible for lax underwriting, especially after the rise of subprime mortgages in 2004 and after.
Investment manager Robert Rodriguez, CEO of First Pacific Advisors, described the current market meltdown as a “debacle” due to “excessive leverage” and “bad monetary policy.” He also pilloried both investors and regulators for ignoring warning signs of financial weakness in government-sponsored enterprises Fannie Mae, Freddie Mac and insurance giant AIG.
Those warning signs were visible many months before those firms were rescued by direct government investment, Rodriguez is convinced. “The investment community failed to do their jobs and the regulators failed to do their jobs,” Rodriguez said.
Larry Harris, the Fred V. Keenan Chair in Finance at USC Marshall School of Business and a former chief economist of the U.S. Securities and Exchange Commission, blamed “complexity,” notably in investments like mortgage-backed securities and derivatives, which introduce “layers of intermediation” between the investor and the underlying asset that gives value to the investment.
“Each step along the way seems reasonable,” he says of investments with complex structures, yet the information about the underlying assets ends up “fuzzy,” leaving investors unable to tell whether investment sponsors had made good or bad decisions.
What, then, is the best prescription for ending the crisis? Wirth recommended more “transparency,” meaning the investor needs more information about the underlying value of the assets propping up her securities or derivatives. Harris seconded the need for transparency. “The only way to deal with fear is to remove uncertainty,” Harris said.
Rodriguez is skeptical the bailout is the right medicine for the illness. The bailout, he concluded, “will not work because it’s the wrong diagnosis,” said Rodriguez. “A flu shot will not cure the mumps,” said the lender. A contrarian on the bailout, Rodriguez said that firms should be allowed to fail to “clear the market” of bad debt.
Investors eventually must have the courage to invest in securities and real estate, and lenders need to trust one another enough to extend short-terms loans, according to USC’s Bostic. “We need to trust in the system,” he said, “because the system is based on that [trust].”