Thursday, January 10, 2008

President of the St. Louis Fed Blames the Mortgage Crisis on Investment Professionals

The President of the St. Louis, Fed, William Poole, blameed mortgage crisis on the investment professionals stating that they were not greedy, they were shortsighted. I agree with the key mistakes that President Poole makes below, but calling the investment professionals shortsighted as opposed to greedy is rather polite. When you dangle the profit (MONEY) carrot in front of people along with the idea that the everyone else is doing it, the “long view” goes right out the window. In other words, money makes people shortsighted. As an aside there are more personal views at the end of the post. Text in bold is my emphasis. From Market Watch:

Investment professionals' "shortsightedness" led them to make fundamental errors that led to the mortgage crisis and credit meltdown, St. Louis Federal Reserve President William Poole said Wednesday.

In a speech to financial planners, Poole detailed five key mistakes that borrowers and lenders made that have pushed the economy to the brink of recession. . . .

. . . . . Poole is seen as an influential member of the Federal Open Market Committee, but does not vote on monetary-policy decisions this year. Last year, he voted in favor of all the FOMC's rate cuts. . . . .

. . . . . The bulk of Poole's speech was devoted to the need for better financial education -- not only for borrowers but also for investment professionals.

Poole said five key mistakes were made, and professionals made four of them.
"I can understand the mistakes many financially naïve borrowers made but have a hard time understanding how so many investment professionals could have been so wrong," he said in the prepared text.

"Many observers point to greed, but I prefer a different explanation. Shortsightedness rather than greed explains actions that led to losses of tens of billions of dollars and the failure of many financial firms."

Poole's list of five key mistakes:

• Borrowers took on mortgages they could not afford.

• Mortgage brokers put too many people in unsuitable mortgages. They knew, for instance, that adjustable-rate mortgages probably wouldn't be right for many borrowers if interest rates rose as the market expected.

• Investment banks jeopardized their reputations by securitizing mortgages without doing due diligence on the underlying assets, many of which were based on "inadequate or spurious information."

• Rating agencies put their stamp of approval on securitized mortgages without considering whether AAA ratings could be maintained if house prices fell.

• Investors scooped up those securities without doing adequate analysis first. "Investors too readily accepted the AAA ratings at face value," Poole said. "A reach for yield with inadequate attention to risk in another basic lesson that apparently cannot be relearned often enough.

"There are no new lessons here," he said. "The mistakes that brought us to this point have been made before."

Allow me to re-emphasize the last sentence: "There are no new lessons here," he said. "The mistakes that brought us to this point have been made before." I watched (upfront and personal) the crash of three asset bubbles, the oil patch bubble in the mid-80s, the S&L crisis in the early 90s, and the tech bubble in 2000. Trust me there is nothing new here. In fact based on my experience with past crashes I can even tell you how this one will end. Not well. Regardless of what the "powers that be" do. All the loans, toxic securities, high-priced homes, etc. (the junk in the system) have to be flushed from the system before things get better and there will be plenty of collateral damage in the process. The only real question is will there be a panic of some kind, before the orderly unwinding of all the "junk" in the system.

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