Elizabeth Warren's Flawed WSJ Editorial

Yesterday's Wall Street Journal contained a very flawed and misleading editorial by Elizabeth Warren, the Harvard law professor selected by the Senate's Democratic leadership to head the TARP Oversight Panel. Here's how she begins her piece,

"Banking is based on trust. The banks get our paychecks and hold our savings; they know where we spend our money and they keep it private. If we don't trust them, the whole system breaks down. Yet for years, Wall Street CEOs have thrown away customer trust like so much worthless trash.

Banks and brokers have sold deceptive mortgages for more than a decade. Financial wizards made billions by packaging and repackaging those loans into securities. And federal regulators played the role of lookout at a bank robbery, holding back anyone who tried to stop the massive looting from middle-class families. When they weren't selling deceptive mortgages, Wall Street invented new credit card tricks and clever overdraft fees.

In October 2008, when all the risks accumulated and the economy went into a tailspin, Wall Street CEOs squandered what little trust was left when they accepted taxpayer bailouts. As the economy stabilized and it seemed like we would change the rules that got us into this crisis—including the rules that let big banks trick their customers for so many years—it looked like things might come out all right.

Now, a year later, President Obama's proposals for reform are bottled up in the Senate. The same Wall Street CEOs who brought the economy to its knees have spent more than a year and hundreds of millions of dollars furiously lobbying Washington to kill the president's proposal for a Consumer Financial Protection Agency (CFPA). "

It's obvious that Warren confuses commercial banking with investment banking and securities brokerages. Thus, she paints the entire financial sector with a brush that is largely meant for a few investment banks and the securities units of perhaps one commercial bank, Citigroup.

Warren then goes on, in her second paragraph, to conveniently omit the actions of various government actors, including Barney Frank, Chris Dodd, Kent Conrad, and former HUD Secretary Andrew Cuomo, all of whom mandated GSEs Fannie Mae and Freddie Mac to buy and securitize questionable, risky mortgages.

Private sector, publicly-held investment and commercial banks were only following the lead of Washington. But Warren doesn't choose to acknowledge this fact.

Warren then characterizes all banks which received TARP funds as needing a bailout, which is very far from the truth. Anyone alive two years ago and watching the scene unfold knows that, in order to be able to unwisely inject federal funds into a few ailing financial institutions, specifically Morgan Stanley and Citigroup, then-Treasury Secretary Paulson forced a larger number of financial institutions to accept federal money. The reason given was to not stigmatize, in the eyes of the investing public, those institutions clearly about to fail without the infusion.

What you, as a reader of this blog, ought to understand from Warren's statements in her editorial is that the appointed leader of the Congressional witch hunt that is the TARP Oversight Panel can't even get the facts straight regarding the history of events which led to the creation of the TARP.

Later in Warren's editorial, she writes,

"So far, Wall Street CEOs seem determined to stop any kind of watchdog. They seem to think that they can run their businesses forever without our trust. This is a bad calculation.

It's a bad calculation because shareholders suffer enormously from the long-term cost of the boom-and- bust cycles that accompany a poorly regulated market. J.P. Morgan CEO Jamie Dimon recently explained this brave new world, saying that crises should be expected "every five to seven years."

He is wrong. New laws that came out of the Great Depression ended 150 years of boom-and-bust cycles and gave us 50 years with virtually no financial meltdowns. The stability ended as we dismantled those laws and failed to replace them with new laws that reflected modern business practices. "

As Ronald Reagan might say, were he alive,

"There she goes again!"

First, Warren continues to use the phrase "Wall Street," to refer to large financial institutions. But that term was originally meant to apply to investment banks and brokerages. None of which now exist as large institutions. Only boutique investment banks remain.

The remaining former investment banks- Goldman Sachs and Morgan Stanley- rushed to take bank charters. Merrill was sold to BofA, while Lehman and Bear Stearns collapsed.

Leaving that topic of Warren's misinformation, it's probably unfair of her to contend that the CEOs of the nation's remaining large financial institutions, all of which are now commercial banks, don't want any regulation or the trust of their customers.

As stupid as some of these CEOs are, they're not that stupid.

Warren is correct to note that Jamie Dimon's statement should be wrong. It's not really correct to say it "is" wrong, but it should be a wrong statement.

That said, Dimon is hardly the person you'd look to for a sense of history in financial markets. He spent his formative years carrying Sandy Weill's bags. It's notable, then, to observe that Dimon's mentor created what has probably been the single worst-run integrated financial services company, Citigroup. What, exactly, did Dimon learn from that which is so valuable?

However, Warren is wrong. And in a way that Dimon wasn't in his statement.

To write that we have had "50 years with virtually no financial meltdowns" is "virtually" meaningless.

Either there were meltdowns, Elizabeth, or there weren't. Which is it?

By the way, it is "were."

Since Warren is referring to "Wall Street" in her piece, let's start with the go-go Nifty Fifty Era in the late 1960s. And it's contemporary scandal, the mutual fund collapse of Bernie Cornfeld.

Then we had the S&L crisis of the late 1980s, during which era the first CMOs were spawned.

Let's not forget the internet stock bubble of the late 1990s. Which followed the near-meltdown arising from LTCM's collapse.

Read enough?

Evidently Elizabeth Warren doesn't know any history of the sector of which she now writes with so much apparent authority.

Warren continues to the end of her article savaging "Wall Street CEOs" as being against new regulation. Which regulation, of course, is all pure good and truth. She paints the aforementioned CEOs as evil, greedy and only desirous of slipping the regulatory noose and caring not a wit for the trust of their customers.

As I've written in prior posts, these constant appeals for just one more perfect regulatory scheme to prevent the next financial crisis reflect serious misunderstandings, or total lack of understanding, of the behavior of those involved in trading and underwriting businesses.

Old-fashioned, conventional commercial lending businesses, be they consumer or business, are fairly predictable and cyclic in their mistakes. We have sufficient regulations in place to oversee those activities. What we haven't had is effective implementation of existing regulations.

As to the underwriting and trading businesses, it's a different ballgame. Volcker is correct in calling for a complete separation of these activities from federally-insured deposit-taking institutions.

What Warren, and others, fail to understand is that there is only one motive for people in those businesses: profit. It's up to their counterparties and customers, and, in fact, anyone who deals with them, to beware. No amount of regulation will ever make them "safe" with which to do business.

Best they be sequestered in their own shark tank.

Think of the worst, most risky and rapacious behavior possible in underwriting and trading securities, and you are near right in guessing the extremes to which the best professionals in these businesses will go to make money.

This will never change. Believing it can be made to be otherwise is perhaps Elizabeth Warren's editorial's most significant flaw.