Wednesday, October 1, 2008

Is London the REAL SOURCE of the economic meltdown mess?

I spent the weekend arguing that the decline in housing prices is not the problem with our economy. It is the crazy way the financial markets tried to monetize mortgages. When cracks in the schemes of CDOs, SIVs and credit default swaps started appearing in 2005, what did banks do? They doubled down – that’s when the subprime mortgage lending skyrocketed.

Fortunately, Gretchen Morgenson came to my rescue and laid out that
exact argument on the front page of the Sunday New York Times. She wrote: “Although America’s housing collapse is often cited as having caused the crisis, the system was vulnerable because of intricate financial contracts known as credit derivatives, which insure debt holders against default. They are fashioned privately and beyond the ken of regulators — sometimes even beyond the understanding of executives peddling them.”

I would also suggest that London may well turn out to be the epicenter of the storm. It was the where the key inventors and promulgators of these schemes resided. These handful of British elite created the shenanigans that enabled the few to become so very rich that every Wall Street executive was slobbering to get in on the deals.

Take for example, Nicholas Sossidis and Stephen Partidge-Hicks. These two sold the world the idea of the Structured Investment Vehicles (SIV), and since they originated the idea while they were at Citibank, they convinced everyone that only their office knew how to set them up because they were so complicated. They even called their company Gordian Knot, an extraordinary joke turning out to be at the taxpayers’ expense. Their efforts insured BILLIONS of dollars poured into London and a renaissance in the London markets based on a house of cards began. (See: Gordian Knot: How London Created a Snarl In Global Markets SIVs Fueled Debt Boom, But Now Banks Scramble To Prop Up the Funds By Carrick Mollenkamp, Deborah Solomon, Robin Sidel and Valerie Bauerlein, WSJ | 18 October 2007)

Then we get Cassano at AIG who headed a relatively small office in London but, according to Morgenson, moved his office from the relatively vanilla deals involving the overnight rate banks charged each other for borrowing money into the mad mad mad money world of credit default swaps. In the past few years he and everyone in his office got crazy rich. And now his small office has brought down one of the largest companies in the world.

And take note that the LIBOR rate – London Interbank Offered Rate – which sets the interest rate for many adjustable rates loans in America, is regulated by just TWO Londoners as reported by Donald MacKenzie in the London Review of Books “On the Importance of LIBOR”. (There are some back up folks ready to step in due to an
emergency but these two individuals were considered too critical to the world’s banking operations to actually be named by Mackenzie.) The LIBOR rate is set when banks call in to say what it would cost for their institution to borrow money from other banks, a self-reporting system that can readily be abused.

In fact, a few months back the Wall Street Journal made some nasty claims about what was going on behind the LIBOR scenes, noting that the cost of credit between banks was skyrocketing but it wasn’t showing up in the LIBOR rate. The idea was that banks were covering up how bad things really were.

While MacKenzie doubts the WSJ position, I remain suspicious. In a story last week, the New York Times reports that “The chairman of the Securities and Exchange Commission, a longtime proponent of deregulation, acknowledged on Friday that failures in a voluntary supervision program for Wall Street’s largest investment banks had contributed to the global financial crisis, and he abruptly shut the program down.” It makes me wonder whether we are seeing the writing on the wall for any similar self-reporting system in the UK. I certainly don’t believe that the British financial industry is any more honest than the American one.

Finally, I have little doubt that these all too critical Libor lynchpins, Messrs. Cassano, Sossidis and Patridge-Hicks were all lunching. (Why don’t we have Hello! Magazine snapping near naked shots of these fellow vacationing together?) These were the top players working a tiny field of business in a very insular country with an already exclusive caste system that America chose to overthrew in our revolution.

While clearly the U.S. investment banks and their many key executives played with fire and got burnt badly, I wonder if when the dust settles we will look to London as the epicenter of so much of the mess. After all, there is also a cultural issue here. Being married to a Brit, I am always amazed by the credibility Americans give to the English. The snottier they are, the more godlike we treat them. Is this one reason why they led us by the nose into investing into their dressed-up dung?