00:00:14
I think the heart of this problem was
00:00:16
the real estate bubble um that uh
00:00:20
started uh in 2002, 2003, 2004.
00:00:27
Uh there were a number of reasons for
00:00:29
this. Uh one of course is is the low
00:00:32
interest rates uh that existed and by
00:00:35
the way I don't think it was all
00:00:36
Greenspans uh to blame Greenspan for
00:00:39
those low interest rates. I think there
00:00:40
were a lot of uh really uh international
00:00:43
forces that in play that that drew that
00:00:45
interest rates down. Uh but what that
00:00:48
that did is made people very hungry for
00:00:52
yield to uh uh get higher yields, get
00:00:56
the type of interest rates that they
00:00:58
were getting uh before uh the break
00:01:02
downward in in interest rates. And with
00:01:04
home prices rising,
00:01:07
uh people suddenly began to think, well,
00:01:09
let's go to the mortgage market um that
00:01:11
are collateralized that are backed by
00:01:14
homes. Homes seem to be sound
00:01:16
investments. Home prices had rarely if
00:01:19
ever gone down in nominal terms if you
00:01:22
look at the historical record. So it
00:01:25
seems that loans that were backed by
00:01:27
homes were ones that you should get. Now
00:01:30
of course if you want to get a higher
00:01:32
interest rate uh you just don't take the
00:01:34
conventional loans that are backed 20%.
00:01:37
You got to take those loans of borrowers
00:01:39
that are not quite as good. Uh take
00:01:42
loans of 90%. take loans of 100%. Not
00:01:47
only were the interest rates higher, but
00:01:49
the fees were higher for delivering
00:01:53
these loans. And so s was born the
00:01:57
market for subprime and what's called
00:02:00
alta a mortgage instruments not just in
00:02:04
the billions but in the hundreds of
00:02:07
billions that found ready buyers out
00:02:09
there that said I want higher yields
00:02:12
than the 1% uh that I get on my money
00:02:15
market. remember Fed funds was down 1%
00:02:17
for a year and a half or even the three
00:02:19
or 4% I can get uh on on government
00:02:22
bonds now investment banks made a lot of
00:02:26
money out of packaging these poor loans
00:02:29
these subprime loans selling them out
00:02:32
there um they could have and they should
00:02:35
have sold them very quickly I mean it is
00:02:38
there's one thing about getting the fees
00:02:40
from processing is the other thing about
00:02:42
holding them but many of them decided to
00:02:44
hold them in addition because they were
00:02:46
good investments.
00:02:48
All right? And they did so with ever
00:02:52
Okay, I guess we're turned off here.
00:02:53
Everinccreasing
00:02:55
leverage.
00:02:57
So they were buying these subprime
00:03:00
they were holding creating these
00:03:02
subprime mortgage uh securities
00:03:06
um that was backing this this real
00:03:08
estate. They were getting high interest
00:03:09
rates. they were they were getting high
00:03:11
free fees and they were levering this by
00:03:14
20 to1 30 to1 and even 40 to1. Now that
00:03:18
doesn't give you much of a of an error.
00:03:21
If the price of those instruments just
00:03:22
goes down a few percent you're going to
00:03:25
get into deep trouble. Now that is
00:03:30
precisely what happened is that back
00:03:34
last February they noticed that these
00:03:36
subprime mortgages were not paying the
00:03:39
delinquency rate went way up and all of
00:03:42
a sudden they said this this is not
00:03:43
worth the price and the investment banks
00:03:46
were found to be holding a lot of these
00:03:49
some tried to get rid of them but some
00:03:52
said just a minute here
00:03:55
if I look at the market the market's
00:03:57
down a lot I think it's down too much. A
00:04:01
few of the investment banks then
00:04:03
decided, we have the expression double
00:04:05
down. You know, I'm going to double my
00:04:07
bet. I think these things are too far
00:04:09
down. I'm going to borrow some more
00:04:11
money and buy even more of them. And of
00:04:13
course, what happened is that they
00:04:15
continued to go down afterwards. Now,
00:04:20
this is the main cause of why these
00:04:22
firms had to be liquidated. And we take
00:04:25
a look at at Meil Lynch. It wasn't
00:04:27
liquidated. it was sold into into Bank
00:04:29
America. It wasn't because people
00:04:31
weren't using their brokerage
00:04:32
facilities. It wasn't because they
00:04:33
weren't using uh their investment advice
00:04:37
or any of the other functions of of
00:04:39
Merill. They they were using those. The
00:04:42
problem was the balance sheet. They had
00:04:46
bought these bonds. They didn't get rid
00:04:49
of them because they thought the price
00:04:50
was too low.
00:04:52
And all of a sudden, they found their
00:04:54
balance sheets underwater. When you look
00:04:57
at a market basis,
00:05:00
that is the problem. It's not a problem
00:05:03
so much with the services they were
00:05:05
selling. Certainly the subprime
00:05:07
services. No one's going to buy the
00:05:09
subprime loans anymore. And that was a
00:05:11
source of increase in income to the
00:05:13
investment banks in 2004, 56,7.
00:05:17
But only one part of the increase. I
00:05:20
mean there was a lot of international
00:05:22
uh activity. There was a lot of IPOs. In
00:05:26
other words, there was a lot of activity
00:05:27
going on that caused an increase in
00:05:29
their profit. But the subtitle was one
00:05:31
of them. If they got rid of them, if
00:05:33
they had sold them, just originally sold
00:05:35
them, they would be in a very strong
00:05:37
position today. You probably read about
00:05:39
Goldman Sachs. One of their divisions
00:05:41
actually bought them and held. Another
00:05:43
division said, "These things are bad.
00:05:45
Let's short them and sell them." the
00:05:48
division that sure didn't sell them made
00:05:50
enough profits to offset basically the
00:05:53
loss in the value on the other division.
00:05:56
That is one of the reasons why Goldman
00:05:57
Sachs ended up in one of the best shapes
00:06:00
of of uh of all of them. But what we see
00:06:03
now is I mean Dick Fo Leman Brothers
00:06:07
they were all masking the decline. They
00:06:10
didn't want to admit how far down these
00:06:12
financial instruments and in some cases
00:06:14
as I think Joe was going to talk about
00:06:16
the property that they held particularly
00:06:18
on Lehman had gone and when Wall Street
00:06:21
and traders saw how far down it went
00:06:25
they said whoa you are insolvent you
00:06:29
don't you know you your balance sheet
00:06:31
has negative net worth you know you're
00:06:33
going to have to go into liquidation
00:06:37
now want to talk a little bit about why
00:06:40
did the Fed bail out some of these
00:06:45
institutions and not others and that's
00:06:48
very interesting too what's the
00:06:49
difference between Sters and Leman not
00:06:51
very much maybe we should say six months
00:06:55
where Sterns was in March and Lehman
00:06:56
here is in September
00:06:59
um Lehman had access to certain
00:07:02
facilities that were not in play when
00:07:05
barristers went under particularly the
00:07:08
primary dealer credit facility that the
00:07:11
feds put in place just the day before
00:07:13
they folded uh Bear Sterns into uh JP
00:07:17
Morgan. Uh there was more time for them
00:07:21
to adjust their position. There was more
00:07:24
time for them to finance the
00:07:26
counterparty risk that was there.
00:07:30
And let's face it, it's an election year
00:07:32
with elections six, seven weeks away.
00:07:35
there was increasing criticism of
00:07:37
bailing out the big guys over here and
00:07:40
and uh I think the Fed began to get
00:07:43
sensitive and said listen Lehman doesn't
00:07:45
provide systemic risk we can let them go
00:07:50
under. They did the same thing at the
00:07:53
beginning for AIG
00:07:55
but AIG works out differently. This all
00:07:58
played out today. Uh AIG is much bigger
00:08:03
than Lehman. AIG insured hundreds of
00:08:07
billions of dollars of these mortgage
00:08:11
securities,
00:08:13
not just 20 billion, 50 billion, a
00:08:16
100red billion as Lehman did. The whole
00:08:20
credit default swap market, which I'm
00:08:23
not going to go into, but it's grown
00:08:24
into the trillions of dollars would have
00:08:26
been thrown into chaos
00:08:28
had AIG gone under. That was the
00:08:31
pressure on the Fed today. At first they
00:08:34
bought saying I'm, you know, we'll let
00:08:35
AIG go. As the day went on, they began
00:08:40
to realize maybe we cannot do that. I
00:08:42
wrote this morning that it was much more
00:08:44
important for the Fed to solve the AIG
00:08:47
problem today than to lower the Fed
00:08:49
funds by 50 basis points. Um, when they
00:08:52
didn't lower them by 50 basis point, the
00:08:54
market went down a 100 points. When
00:08:56
there was a rumor that the Fed had made
00:08:58
a deal with AIG, it went up 250 points.
00:09:01
So, it did respond much better to that
00:09:05
situation. Um, they're going to have to
00:09:07
make some sort of deal on AG. We hope
00:09:10
AIG is is the the last one. Um, and I
00:09:14
think it is. If you take a look at the
00:09:15
impaired balance sheets uh on the books.
00:09:19
Others have some problems. I think
00:09:22
that's the last big one.
00:09:25
Finally, a few words about results.
00:09:28
Who's getting bigger? um the commercial
00:09:31
banks. Why? Well, not of course we're
00:09:33
buying marrow, you know, they're they're
00:09:35
they're absorbing bare sterns, but very
00:09:38
importantly, they have direct access to
00:09:42
the Fed, the ultimate source of
00:09:45
liquidity in the markets. Um all these
00:09:49
other dealers, yeah, they can borrow,
00:09:51
maybe they can, but it is the primary
00:09:53
responsibility of the Federal Reserve to
00:09:54
make sure of the integrity of the
00:09:56
commercial banking system. and they will
00:09:58
lend as much as necessary to make sure
00:10:02
that all the deposits are safe.
00:10:05
This means the banks are going to get
00:10:06
bigger. Over the last 50 years, they've
00:10:09
lost business to the investment banks
00:10:11
because people say, "Oh, we don't need
00:10:12
banks. We can go directly to the public.
00:10:14
The public is willing to give us money."
00:10:16
Well, now risk premiums have ballooned
00:10:18
upward. A lot of these deals are going
00:10:21
to go through the banks now, the
00:10:23
investment uh bank division of the
00:10:26
banks. And of course, when times get
00:10:28
back to normal, these investment banks
00:10:30
might be spit out again. Now, we're
00:10:32
we're seeing a change in the players. Uh
00:10:34
Leman was bought by American Express,
00:10:36
then spit out. I mean, this is uh you
00:10:39
know, they're going to be mixed in, spit
00:10:42
out over time. But the immedi immediate
00:10:45
situation obviously is an increase in um
00:10:50
the commercial banks. Let me let me end
00:10:52
with this because I'm sure we're going
00:10:53
to get into some of these with with with
00:10:55
discussion.
00:10:57
Um,
00:10:59
as I pointed out in my article, uh, Wall
00:11:01
Street Journal today, um, there's still
00:11:04
huge demand for, um, financial services,
00:11:09
not quite as much as there was a couple
00:11:11
years ago because the subprime market,
00:11:13
which was very profitable and obviously
00:11:16
ballooned from nowhere, you know, back
00:11:18
in in the early part of this decade,
00:11:20
remember, and I banks were very profit
00:11:22
profitable before we even heard of a
00:11:24
subprime a mortgage. They didn't
00:11:26
absolutely need them. They just got more
00:11:28
profitable as a result of of of issuing
00:11:31
the issuing those. But the demand for
00:11:34
financial services is going to grow.
00:11:37
Internationalization,
00:11:38
international flows of credit are going
00:11:40
to be bigger than ever. What we're going
00:11:42
to see is a downward adjustment now and
00:11:45
then we're going to go back to the trend
00:11:47
line that has really been going over the
00:11:48
last 20 25 years. And I see no sign of
00:11:52
of breaking up. So we are repackaging
00:11:55
and in one way let me just say that how
00:11:58
much better off we were than Japan which
00:12:01
suffered a terrible real estate collapse
00:12:03
in 1989 1999 never admitted their
00:12:08
problems. They stayed for a whole decade
00:12:10
in a slump as a result. No one admitted
00:12:13
the loans were bad. They kept them on
00:12:15
the books forever hoping they would pay.
00:12:18
They had a frozen banking system. I know
00:12:19
Dick Herring knows a lot more than I do
00:12:22
about this subject. and I talk about it,
00:12:23
but we are now making transparent what
00:12:28
these instruments are worth. We're doing
00:12:31
the type of reorganization that is
00:12:33
necessary. Uh we're going to get healthy
00:12:36
as a result of this far faster than
00:12:39
Japan did and uh and uh these financial
00:12:44
service jobs are going to continue to
00:12:47
grow. Thank you.
