Several of my savviest readers wrote expressing disappointment and consternation with the Frontline series on the crisis, “Money, Power, and Wall Street.” The first two parts of the four part series have been released, and it’s probably safe to say that this program is far enough along to be beyond redemption.
It’s a recitation of conventional wisdom, with just enough focus on some of the numerous things the banks and the authorities did wrong so as to make it seem daring for mainstream TV. But anyone who has been on this beat will find the first two segments cringe-making (one advantage I had was that of reading the transcripts, which makes it much easier to parse the construction). Despite the obligatory shots of Occupy Wall Street protestors, displaced homeowners, and stymied officials, much of the story line is remarkably bank-friendly.
The first segment is particularly troubling. It heavily cribs from the Gillian Tett book Fool’s Gold, which to be blunt was not very well received by reviewers. Fool’s Gold discussed the development of the credit default swaps market from the perspective of JP Morgan executives and staffers, with the result that it verged on hagiography. Oh, those great, intrepid, innovative bankers who just wanted to make the world better, and maybe make a buck or two in the process.
The book at least explained that the reason for the creation of the CDS was to solve a rather big problem for JP Morgan, that it was carrying a ton of loan risk and could use a way to lay it off (the broadcast, by contrast, made it sound like this was a market just waiting to happen, as opposed to one JP Morgan, and later its competitors, cultivated).
And no one clearly explains that CDS, as currently used, are certain to produce periodic blowups of undercapitalized guarantors (the monolines and AIG are prototypical). Tett and pretty much everyone in the segment perpetuates the industry PR that CDS are derivatives. A derivative is an instrument whose price “derives” from an actively traded underlying instrument. CDS, by contrast, are the economic equivalent of unregulated insurance contracts. The pernicious feature of CDS is that the CDS protection writers (the guarantors) aren’t regulated for capital adequacy, the way other insurers are. They instead are required to post collateral to reflect the current value of the contract. But that is no guarantee that the CDS protection writer will be able to pay out. When a default or other credit event occurs, the price of the CDS spikes up, and the guarantor may not be able to make good on the new, higher collateral posting. And requiring CDS protection writers to put up enough margin to allow for “jump to default” risk would make the product uneconomical.
But none of this is explained. Tellingly, there are clips of Brooksley Born, but no mention of her failed effort to regulate CDS. It is instead presented as a benign product that JP Morgan understood (did they sponsor this broadcast? Blythe Masters gets a big promo) and no one else did:
MARTIN SMITH: Did top management at JP Morgan understand credit derivatives?
TERRI DUHON: Yes, they did. Absolutely, they did.
MARTIN SMITH: Did they at other banks?
TERRI DUHON: No, not all other banks. Certainly not.
It’s more accurate to say JP Morgan was once burned, twice shy. It took significant losses in the first test of the corporate CDS market, the bankruptcy of Delphi in 2005. That led it to pull its oars in just as the market for asset backed securities CDS was taking off. Fool’s Gold makes a great deal of noise about how JP Morgan couldn’t figure out how other banks were modeling the risks on mortgage-related CDS and presents that as the reason they were largely out of that market. That may be narrowly true, but I wonder if that sort of caution would have reigned had they not had to reassess the adequacy of their risk metrics in the wake of Delphi.
Similarly, the account hews to conventional lines in making Goldman out to be the poster villain in the CDO market, yet merely in passing, has Deutsche Bank CEO Joseph Ackermann admitting to being one of the banks that stuffed Landesbanken like IKB full of toxic debt. Crisis junkies know that Deutsche Bank trader Greg Lippmann was the most aggressive middleman in helping subprime shorts like John Paulson create and sell CDOs designed to fail (and they had their own program, Start, which was a synthetic CDO series just like Goldman’s better known Abacus trades).
Typical of the program’s attention to fine points, it manages to work in a reference to the formal dismantling of Glass Steagall without saying why it was important (answer: it wan’t, but the gutting of the rule over the preceding decade and a half was). There is also some interview material that is flat out wrong on product spreads and CDO structures. The segment provides anecdotes of the crazed subprime lending, but fails to explain how mortgage backed securities and CDOs were linked to lending (or most important, that CDOs came to drive demand for RMBS, which in turn drove demand to the worst loans). Here, Inside Job was vastly better in covering technical material (with one lapse, in confused RMBS and CDOs) and providing data in an accessible manner.
The next segment is even more troubling. It treats the crisis as if it started with the failure of Bear Stearns, when that was the third of four acute phases, and was in full There Was No Alternative mode. It repeated the thesis I believe, but I’ve never seen confirmed, that it was concern over Bear’s CDS exposures that led to the bailout. It also says that Hank Paulson thought Bear was an isolated case, which would explain why the officialdom went into Mission Accomplished mode rather than trying to get to the bottom of the CDS exposures, pronto (We pointed out in March 2008 that Lehman, Merrill, and UBS were next on the list. If we could see that, that meant it was bloomin’ obvious). But it ignores the fact that the Fed first offered a 28 day loan, which it then changed to overnight and the original loan also would have tided Bear over into having access to a new Fed facility. I’m not convinced that Bear would not have made it, and no one has ever explained why the Fed retraded the deal.
Incredibly, this segment also presents the idea that Obama was seriously interested in and campaigning on the economy. Huh? Obama was stumping on the issues of 2006. It also presents other pro-Obama propaganda in the form of the meeting McCain called to discuss the financial implosion-in-progress, which Obama wound up dominating. This has just about zero relevance in explaining the crisis, and strongly suggests that there were multiple agendas in producing this series.
But worse is the Lehman-AIG meltdown. The markets were tanking! The world was about to come to an end! The authorities had to Do Something! No mention of the Fed’s zillions of special facilities (or previous interest rate cuts). Instead we get the TARP, and the story makes much of Congress critters sounding miffed at being asked to act over a weekend (as opposed to sign off on a soi disant bill that was all of three pages demanding $700 billion while putting the Treasury Secretary above the law). It also fails to mention the Treasury bait and switch, that while the bill did give the Treasury remarkable latitude, it was sold as being used to buy toxic assets (which we said at the time would never work under the parameters Treasury set forth), not a direct bailout to the banks.
We also get the lame excuse for Doing Nothing after Bear (“we lacked the authority”) when the officialdom had no compunction about bringing the banks to heel in October 2008 (note that there are several layers of kabuki here: as we described at the time, Paulson threatened the banks to take the TARP before revealing the terms, and the banks were quietly pleased when they learned how favorable the deal was. So the “forcing” was theater so the ones who wanted to pretend they didn’t need it could keep that story up. But even if this wasn’t a lot of play acting, this threat illustrates the sort of thing regulators have at their disposal but have become timid about using).
DICK KOVACEVICH, Chmn., Wells Fargo, 2005-09: I don’t know how much further we went before I was interrupted by Hank, who said, “Your regulator is sitting right next to me. And if you don’t take this money, on Monday morning, you will be declared capital-deficient.” I was stunned.
Aside: I also wondered if Wells Fargo sponsored this program. There was gratuitous statements by Wells that they were better lenders (not true if you limit it to banks, we’ve commented often on Wells’ sanctimoniousness).
The show defended the false dichotomy of bailout or disaster, when there were other options. Comments like these were throwaways, not taken up in a serious way:
SHEILA BAIR, Chair, FDIC, 2006-11: If the government hadn’t intervened, those counterparties would have taken huge losses, so there was some leverage there. At least tell them, you know, “You’re going to take 10 percent.” That just— that would have helped. But there was just willingness to kind of throw lots of money at the problem. And I don’t— I think we threw more money at the problem than we needed to. Absolutely….
ROBERT REICH, Secretary of Labor, 1993-97: They don’t have to modify any mortgages. They don’t have to put limits on their own salaries or their own compensation or their own bonuses. They don’t have to do anything differently than they were doing before. They don’t even have to agree to major regulatory changes. Basically, they are sitting fat and pretty and happy.
So thus far, we have some populist decorating of a profoundly pro-Establishment account. Yes, the system got really out of control, but whocoulddanode? It just got SOOO complicated no one could understand it, not even those super well paid top Wall Street executives. There isn’t a single mention of ideas like looting, bogus accounting (remember the fictitious Lehman balance sheet, or Merrill’s CDO-hiding Pyxis, or the $40 billion of Citi CDOs that appeared out of nowhere?) or abuses in other areas (like swaps sold to municipalities all over the world, or rapacious privatizations, the auction rate securities blow up, or chain of title abuses). Nah, it’s just a bunch of fundamentally good ideas taken too far. And they really expect you to believe that.