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"There is a lot of amnesia that's emerging, apparently," former Federal Reserve Chairman Alan Greenspan told the Financial Crisis Inquiry Commission on Wednesday. He's appalled that we don't remember the Alan Greenspan who fought for more regulation and led a crusade to stomp out predatory lending.
And we don't. Because he didn't. Greenspan's testimony, along with cameos by former Treasury Secretary Robert Rubin and Citigroup (NYSE: C ) executive Tom Maheras, are classic examples of soaking up adulation and nine-figure paydays during the run-up of a bubble only to plead ignorance after it pops.
Exhibit A: Alan Greenspan
Throughout Greenspan's two-hour testimony, committee members persistently asked why the Fed sat on its hands while subprime lending ran wild.
Greenspan's rambling reply was that he and the Fed actually tried to warn everyone of its hazards and even attempted to do something about it to no avail. He backs up his regulator-in-chief stance by noting:
In 2001, we issued our "Expanded Guidance for Subprime Lending Programs." This guidance warned regulated institutions that loans designed to serve borrowers with impaired credit "may be prone to rapid deterioration in the early stages of an economic downturn," and imposed requirements for internal controls to protect against such risks.
This took me off guard -- it didn't sound like something laissez-faire commander Greenspan would say. So I looked up the report and quote in full context and found this:
Although subprime lending is generally associated with higher inherent risk levels, properly managed, this can be a sound and profitable business. Because of the elevated risk levels, the quality of subprime loan pools may be prone to rapid deterioration, especially in the early stages of an economic downturn. Sound underwriting practices and robust effective control systems can provide the lead time necessary to react to deteriorating conditions, while sufficient allowance and capital levels can reduce its impact.
All the report says is that subprime can be safe and sound provided it's done in a safe and sound manner ... which it isn't, wasn't, and never will be. Subprime and "sound underwriting practices" is oxymoron to the extreme. Like a prudent round of Russian roulette.
But more importantly, the report Greenspan mentions is simply a guidelines statement. The word "should" is mentioned 58 times in the report, and specifically states, "we expect institutions to recognize that the elevated levels of credit and other risks arising from these activities require more intensive risk management." Just expect banks to behave, bow to your Ayn Rand shrine, and call it good.
At any rate, we know how Greenspan felt about subprime when he used blunter language. In 2005, he wrote:
Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s.
But apparently we're the ones suffering from amnesia.
Next, Greenspan tackled credit derivatives. Brooksley Born, the former chairwoman of the Commodity Futures Trading Commission who was famously ostracized for her derivatives warnings a decade ago, asked Greenspan to comment on AIG's (NYSE: AIG ) fatal use of credit default swaps (CDSes). His answer is a spectacle of denial:
[AIG] was selling insurance. They could just as easily have sold and gotten into the same trouble by issuing insurance instruments rather than credit default swaps. My understanding is the reason they did that is because there were [different] capital requirements, but that is not an issue of the credit default swaps per se.
No, that's exactly the issue per se. Banks love credit default swaps because they can gamble their brains out behind closed doors without setting aside a penny to cover losses like regular insurance products. Had CDSes been regulated like insurance, issuers like AIG would have only been able to sell them to investors actually insuring something (not "naked" swaps that are purely speculative), and regulators would have forced issuers to set aside enough money to cover probable losses. But they weren't, and taxpayers paid dearly.
Exhibit B: Robert Rubin
Next in the hot seat was Rubin, a former Goldman Sachs (NYSE: GS ) boss who became Treasury secretary under President Clinton. While in office, Rubin was instrumental in repealing Glass-Steagall regulations, which paved the way for the creation of Frankenstein financial behemoths -- particularly Citigroup. After leaving Washington in 1999, Citigroup named Rubin chairman of the executive committee, where he was paid $126 million over the next eight years -- call it $43,000 a day. Rolling Stone columnist Matt Taibbi gets the award for explaining this relationship: "they don't call it bribery in this country when they give you the money post factum."
Rubin's defense for Citigroup's misery boils down to the claim that he had no operational duties, and didn't realize the bank was choking to death on toxic mortgages until it was too late. He was more of a highly paid face, and "wasn't a substantive part of the decision-making process."
Others disagree. In November 2008, The Wall Street Journal reported that "Mr. Rubin was deeply involved in a decision in late 2004 and early 2005 to take on more risk to boost flagging profit growth." The New York Times quotes a former Citi executive as saying, "Rubin had always been an advocate of being more aggressive in the capital markets arena. He would say, 'You have to take more risk if you want to earn more.'"
And earn more he did, which gets to the heart of the matter. When you're making $15 million a year as the head of the executive committee, you're not an innocent bystander. You're responsible for the outcome whether it makes you look good or not.
Exhibit C: Tom Maheras
This one's short and sweet. Maheras, who ran Citigroup's toxic-asset campaign, was asked by the committee what led him to pile on so much risk. The reason, he claims, was that's what the pros told him to do. "Based in part on a careful study from outside consultants …" he explained, "the company decided to expand certain areas of our fixed income business that we believed at the time offered opportunities for long-term growth."
He went on. "Even in the summer and fall of 2007, I continued to believe, based upon what I understood from the experts in the business, that the bank's [CDO] holdings were safe."
It's worth asking: If Maheras wasn't an "expert in the business," why was he running the business? And if he wasn't an expert, why was he paid $97 million -- ninety-seven million -- during the three years before Citigroup disintegrated? Makes you wonder what kind of money the experts made.
Suck it up and say it like it is
I'd like to have sympathy for these people. But every time we hear their side, it's the same story. They didn't know. They were blindsided. It was someone else's fault. They tried to warn, but no one would listen. What's sad is they were the first to accept full responsibility for the bubble's success on the way up, but largely claim ignorance now that the cat's out of the bag. I'd call that hypocrisy.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.