CNBC's "House of Cards" Program On Financial Excess- Part 2

Friday's post on David Faber's CNBC special program dealing with the global effects of securitization of subprime mortgages drew record views- over 300. And almost 200 more yesterday. As I watched the first half of the program this morning, I noticed that Faber was credited with 'reporting' on the story, but someone else wrote and directed the piece.


The names of two key figures appearing in the program are Kyle Bass, the Texas-based hedge fund manager whose fund earned approximately 600% in 18 months by betting against the mortgage/housing industry, and Ira Wagner, the head of structured product development at Bear Stearns.


Bass bought credit default swaps on various companies involved in the mortgage industry, which, of course, turned out to be a highly profitable bet. He related chilling conversations with various executives at financial houses and rating agencies involved in the evolving mess.


For me, as, I'm sure, for other viewers and observers of the industry in the past few years, two particular exchanges stood out.

First, Bass learned from rating agency personnel that their ratings were based on assumptions of constant 6-8% rising home values in perpetuity. This, of course, is totally unreasonable and unsustainable. Thus, Bass realized that the CDOs were literally overrated. And somehow shorting or betting on a decline in their value would be a reasonably safe move.

Second, Bass reported that a managing director at one of the investment banks involved in mortgage-backed security origination, and head of whole loan trading, was so young that he had been in graduate business school during the last financial market downturn. I believe Bass was referring to the 2001-03 bear market, so he implied that the MD had only about five years' experience. This MD stated, in reply to a question from Bass about the nature of cyclicality in the volumes of CDOs being originated, that the volumes would not end, and the company was pumping out questionably-valued, unseasoned CDOs with AAA ratings to European and Asian investors as fast as possible, leaving none on the investment bank's balance sheet.

Again, Bass knew this, too, would end sooner or later.

But, in re-viewing the program, perhaps the most interesting scene, for me, was Faber's questioning of former Fed Chief Alan Greenspan on his ability to have halted this merry-go-round of securitization of subprime mortgages.

When I first saw the program, I felt that Greenspan was covering his ass by alleging that there was nothing he could have done.

However, upon a second viewing, I feel differently, as I mentioned to my business partner this morning while discussing the interview.

What Greenspan implied by his answer was that his independence as Fed Chairman and, in fact, of the Fed in general, would have been at risk, had he stepped in to halt the origination of subprime mortgage origination.

To fully understand this, one has to go back to Paul Volcker's tenure to understand that Congress routinely has threatened the independence of the Federal Reserve System, which it created as a populist alternative to a single central bank, when and if it does not seem to be sufficiently lubricating national finance with the growth of the money supply.

Thanks to William Jennings Bryant's advocacy of American farmers' cry for coinage of silver, to devalue dollar-denominated debts by inflating the money supply at the turn of the century, the Fed system was designed to give each of the country's regions a Reserve bank, and, thus, a say in money supply management. It was a populist solution which would lessen the chances of another J. Pierpont Morgan-led rescue of the US financial system as occurred in the Panic of 1907.

Much later, in the waning days of Hubert Humphrey's life, the hapless liberal Democrat's misguided Humphrey-Hawkins Full Employment Bill was passed, mandating that the Fed maintain equal focus on two objectives: appropriate money supply growth consistent with low inflation, and full employment. The former, of course, is often at odds with the latter.

And it was this issue to which Greenspan was referring, by implication. If he had tried to rein in subprime lending by more vigorous bank examination and quashing of these activities, Congress would have hauled him up before some committee to explain his actions, which would have dampened economic growth, particularly at the expense of home ownership by lower-income groups.

This Greenspan was unwilling to do.

One only has to read this post to see why.

Thus, while many of the actors in this sorry saga were guilty of knowingly doing inappropriate things, they were allowed to do so by the complicit consent of the Fed, bowing to Congress' desire for more homeownership among the poor.

Congress wanted this mess, and now, they look for scapegoats among the businesses they asked to execute it.

In retrospect, I think Greenspan was pretty brave being as near to explicit as he was in explaining his actions during the boom in unseasoned, unwise, low-downpayment mortgage lending and securitization.