Wednesday, September 24, 2008
Criminalizing optimism
Oh, goody. Another headline-grabbing business failure begets another FBI investigation in search of "fraud."
The FBI is investigating Fannie Mae, Freddie Mac, Lehman Brothers Holdings Inc and insurer American International Group Inc and their senior executives for potential mortgage fraud, CNN reported on Tuesday.
The FBI did not provide specifics but said the inquiries were part of a broader probe, CNN said.
The bureau is trying to determine whether anyone in those financial institutions, including their senior executives, had any responsibility for providing "misinformation," CNN reported.
This is such a bad idea. Nobody makes a huge pile of bad loans -- or issues credit default swaps to guarantee derivatives thereof -- because they deceive other people. They make bad loans because they deceive themselves. Will the FBI be able to find a few ambiguously stinky emails among the billions that no doubt reside on the servers of AIG, Lehman, Fannie and Freddie? No doubt. Is it always possible after the fact to say that an executive was too optimistic, perhaps to the point of fraud? Of course it is -- he would not have made the crappy loans otherwise. The question is, do we really want all public companies to be run as if the consequences of failure is criminal prosecution? If you answer "yes," then you are saying that we should abandon the American propensity for risk-taking that has, in the main -- occasional bailouts going back to Alexander Hamilton notwithstanding -- made us the land of opportunity.
CWCID: Glenn and Megan.
8 Comments:
By 
, at
Wed Sep 24, 09:09:00 AM:
If, as in the case of Raines, they took on more and more of these loans in order to pad their reports and increase their bonuses, then an FBI investigation to make sure.
The question is, do we really want all public companies to be run as if the consequences of failure is criminal prosecution?
Doesn't SoX somewhat do this now?
By 
TigerHawk, at
Wed Sep 24, 09:26:00 AM:
Yes, it does, and that is its worse effects.
If we want as a country to protect ourselves against all losses, then we will have no gains, either. What sort of world would that be to live in? How risk averse do we want to get?
The problem, of course, is that even an investigation can be ruinous to a public company, especially if it is in a "trust" business. Directors and executives therefore (generally) run their businesses to some point that is more conservative than the line drawn by the last high-profile investigation. When the FBI or the Justice Department starts going after mere financial failures, it tells everybody to be that much more careful. Well, you can be too careful, and I am terrified for the next generation that we are heading in that direction.
By , at
Wed Sep 24, 10:17:00 AM:
Tigerhawk ... c'mon man, we know you're a lawyer. The answer is 'yes', but not to shut off all risk-taking or create disincentives so severe that we kill business.
The inside guys I know tell me unequivocally that the big boys knew how bad these loans were. But there was an insatiable appetite to produce more of them because there was so much money to be made. At what point did people actually believe abandoning the traditional model of lending for increasing riskier loans to people who couldn't buy a used car from a jip-joint? In many places, you could buy on piggyback/80-10-10, or no income verification, or negAm, or pick a pay. There is no earthly reason to believe that living above ones means was sustainable, unless access to credit remained easy, and home values continued to soar such that you could take a new HELOC to fund your payments.
The government needs to stabilize but not try to fix this market, and find a way through favorable rates of return to encourage new money into the system. To make it work, we need some hardnosed lending rules, because in the end, the bank is lending the government backed dollars, not the depositors monies, since FDIC is backing the accounts.
Look up Clayton in CT ... I think they were doing appraisals, and cut a deal months ago with the Feds for protection. The system had so much fraud at so many layers it's just astonishing that no one stepped in with real oversight to stop this runaway train.
I know you're in a public company, and Sarbanes is bullsh*t to an honest guy, but what other than the fear of personal ruin (disgorgement, leg shackles, having an inmate gleefully state "I've never beaten the sh*t out of a former billionaire ... I'm gonna enjoy this") can stop the dishonest men running these companies?
By , at
Wed Sep 24, 12:51:00 PM:
To make it work, we need some hardnosed lending rules, because in the end, the bank is lending the government backed dollars, not the depositors monies, since FDIC is backing the accounts
Sounds great, except all the major bank failures so far have been investment banks, which don't have depositors.
By , at
Wed Sep 24, 12:59:00 PM:
Randian ... so far, because for a long time Fannie and Freddie would take almost anything, and roll it into CDOs, or whatever they're called. At some point, the really bad stuff stayed on the bank books because it failed compliance and just couldn't get thru the filter.
Look under the covers at WaMu and their exposure to sub-prime, including from their former sub Long Beach. Look under the covers at GMAC Mortgage. Look under the covers at Wachovia.
I've read that WaMu's exposure alone could bankrupt FDIC.
By , at
Wed Sep 24, 01:38:00 PM:
Didn't the Russians execute managers that failed to meet government defined goals?
By Mrs. Davis, at
Wed Sep 24, 02:37:00 PM:
The question is, do we really want all public companies to be run as if the consequences of failure is criminal prosecution? If you answer "yes," then you are saying that we should abandon the American propensity for risk-taking that has, in the main -- occasional bailouts going back to Alexander Hamilton notwithstanding -- made us the land of opportunity.
Let's split the difference. Lehman and AIG, private companies. No investigation. Fannie and Freddie? Not so much. In fact, I'd favor Bills of Attainder for them.
By Escort81, at
Wed Sep 24, 03:03:00 PM:
TH - Your point on risk is well taken. We don't want to discourage risk taking in the real economy, where you, as a medical device executive, work -- there are technological risks, marketing risks, FDA regualtory risks, etc. You have to help manage these risks prudently and be able to raise capital in a comptetive environment to fund your projects. Not all of your projects will pan out, and of course some will have no return of capital, but some will be (hopefully) grand slam home runs, so the portfolio approach is the correct one. Also, with regards to your point about an investigation hurting a company, think I would look at Stryker (a company in your industry) as one that has been subject to many different kinds of official inquiries over the past number of years and continues to crank out quarterly profits -- so, while it is certainly a "distraction" (to borrow my favorite Obama term), it is not a death sentence.
Risk in the financial engineering economy is something I view a bit differently. I think Paulson is on the right track when he says how shocked he was at the inadequacy of the regulatory structure when he arrived at Treasury. He may not be the most telegenic guy, but as CP has posted elsewhere (and as one of my PU roommates who knew him well at GS would say), he knows what he is doing. We need a new and appropriate regulatory structure for financial institutions that fits the modern finance business, and yes, regulates the nature and extent of risk that those institutions can take. We have lived with margin requirements for purchasing common stocks for over 7 decades in an effort to limit systemic risk of the general investor public buying stocks with too much borrowed money, and it became a well-regarded part of the rules of the road since before we were born. Synthetic margin at financial institutions can be similarly regulated, right up until the point in time when, through Darwinian evolution of the financial ecosystem, smart people think up ways of a new kind of leverage that will require a slightly altered set of regs.
I am not as troubled by the notion of the FBI poking around the bones of Lehman et al. Let the investigation proceed and see what the evidence points towards. To John's various points, Could it be that the fraud occurred primarily at the local level with a mortgage origination, and not at the institutional level where the notes were securitized?
Who is the rube, Wall Street or Main Street?
