What happened. What now.

Commercial and investment banks used their size and money to make campaign contributions that allowed them to evade any meaningful effort to impose common sense and transparent risk controls in the public interest, known as regulation. One of the first regulations attacked dated from the Great Depression. This was the Glass-Steagall Banking Act, a law designed to separate commercial and industrial banking. Banks, commercial and industrial (the latter known as investment banks) could now combine operations to create products in fundamentally unstable ways.

Markets are ruled by two emotions: fear and greed, and these institutions got greedy, very greedy. They created financial products that served no real purpose, other than to generate profit for the bank. To keep customers (their only regulator) from understanding the bank’s true intent, they made these products horribly complicated. These products were, in part, simple bets. These bets were layered on top of each other until only the product designers had any hope of realistically estimating what little value actually existed in the products.

Commercial and investment banks came to act as if they understood that giving these products a veneer of social utility would help them hide their true motivation, so they tied a small fraction of these bets, now known as “derivatives,” to subprime lending and passed the bundle off as the invisible hand of the free market at work.

How Does This Impact Blacks

Financially, Blacks are worse off now than they were, on average, ten years ago. Subprime lending products allowed white banks to engage in highly negative and discriminatory practices. Such practices “intentionally assigned black customers subprime mortgages while giving whites better rates.” This leads to higher mortgage loan payments for black versus white borrowers. Given this reality, efforts by media outlets to blame the crisis on minority borrowers reveals a stunning level of racism. This negative campaign further fuels race-based resentment that will grow, as the economy continues to weaken, to a very dangerous level.

What to do now

We need to replace the elites that controlled the financial marketplace, both firms and people. This means a blanket prohibition covering the firms that created the crisis, and includes anyone working in a operational or senior level at any failed GSE, bank, insurance company or investment bank/brokerage house.

Public Private Investment Program (PPIP)

Treasury released details concerning the Public Private Investment Program (PPIP), the Administration's approach to dealing with "legacy assets", or the real estate loans and securities that caused the current financial crisis.

The approach relies, in large part, on the market. Unfortunately, these are the same institutions that created the problem. The issue is this: as the Fact Sheet Treasury released describing the PPIP Program notes,

"the financial system is still working against economic recovery." (No kidding.) As we noted in April, 2008:

"With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic."

Further, the solution outlined by the Administration relies heavily on the assumption that "these assets create uncertainty around the balance sheets of.. financial institutions." This is a false assumption: the behaviour of financial managers created the uncertainty. While we are not "in despair", as is, apparently, Paul Krugman, we recognize that any "solutions" that do not explicitly address the ethics and behaviour issues are, well, problematic.

The lack of recognition is problematic because it leads away from the long term solution. For example, the Fact Sheet states "excessive discounts embedded in some legacy asset prices." There are no excessive discounts. In this, Mr. Krugman is correct. Prices are what they are at a given point.

Further, we note a discussion about the "lack of clarity about the value of these legacy assets." There is no lack of clarity. Market participants are discounting asset values because of the fraudulent and highly unethical business practices used to create and distribute these assets.

Given the above, we can ask if the approach outlined by Treasury will, in fact, address the challenge. Three principals are outlined:
1. Private Sector Price Discovery
2. Shared Risk and Profits With Private Sector Participants.
3. Maximizing the Impact of Each Taxpayer Dollar

Private Sector Price Discovery is problematic. The fraudulent and unethical business practices used to create and distribute these assets will tend to interfere with price discovery. In addition, there is the asset selection problem: banks and investors will determine which assets to price. See our earlier comments. Better to have a regulatory agency do so.

Shared Risk and Profits With Private Sector Participants. The fact sheet notes that "Treasury and private capital will provide equity financing and the FDIC will provide a guarantee for debt financing issued by the Public-Private Investment Funds to fund asset purchases." This is fine, except that to participate you must have "capacity to raise at least $500 million of private capital, a minimum of $10 billion (market value) of Eligible Assets currently under management and experience investing in Eligible Assets." Sounds reasonable. It is not, since these requirements do nothing to address the core issue: fraudulent and unethical business practices. Better to have a solid ethics test that requires eligible firms to show that they testified in Federal Court on behalf of investors or perhaps that statistical models created by the firm signaled the probability (or even the possibility) of system-wide economic and market failure.

"Maximizing the Impact of Each Taxpayer Dollar" simply means that the Federal Government will multiply dollars provided by the private sector. In itself, this is appropriate.

All in all, we like this plan, and think it is another in a series of positive steps taken by the Obama Administration. This crisis will take time to work through. There will be a number of starts and stops. This is a bear market, and the best way to escape a bear is as follows:

"..do not run - slowly back away, always watching the bear, and do not turn your back on that bear. Make yourself look as large as possible, and as confident as possible."

We could not agree more.