David Einhorn on the Financial Crisis, Government Complicity and Why Rating Agencies Aren't Much Better Than USAToday

Working deep inside Wall Street these past eight months or so, I've had a privileged vantage point from which to observe some of the most tumultuous quakes in the industry in a generation -- and arguably in a century. (Given the near-catastrophic, and still potentially catastrophic nature of those changes, one might legitimately argue with whether 'privileged' or 'punitive' would be the right word to describe my seat in the proverbial bleachers on this one. Since I'm still being paid -- for now -- I'll stick with the former, if only because it has been quite an education.)

Readers without a direct interest in the inner workings and accounting arcana of the financial services industry though, should take a gander at David Einhorn's ten-page pdf/speech: "Private Profits and Socialized Risk". [emphases added in the excerpts below] H/T: Bob Weber.

On the credit-rating agencies:

The market perceives the rating agencies to be doing much more than they actually do. The agencies themselves don't directly misinform the market, but they don't disabuse the market of misperceptions -- often spread by the rated entities -- that the agencies do more than they actually do. This creates a false sense of security and in times of stress this actually makes the problem worse...

It is hard for me to see how the rating agencies survive this debacle with their franchises intact.

On the failure of Bear Stearns and how the SEC has enabled the entire mess:

Rather than looking at its own rules which permitted increased leverage, lower liquidity, greater concentrations of credit risk and holdings of no ready market securities, the SEC is conducting an investigation to see if any short-sellers caused the demise of Bear by spreading rumors.

Of course, Bear didn't fail because of market rumors. It fell because it was too levered and had too many illiquid assets of questionable value and at the same time depended on short-term funding.

On how none of us are really spectators in this

...before Bear Stearns failed... I [had] planned to speculate that regulators believe all of these [major investment banks] are too big to fail and would bail them out, if necessary. The owners, employees and creditors of these institutions are rewarded when they succeed, but it is all of us, the taxpayers, who are left on the hook if they fail. This is called private profits and socialized risk. Heads, I win. Tails, you lose. It is a reverse-Robin Hood system...

As night follows day, it is certain that in the absence of tremendous government regulation, this bailout [of Bear] will lead to a new and potentially bigger round of excessive risk-taking...

On the counter-party credit system

In effect, [with Bear] the government appears to have guaranteed virtually the entire counter-party system. The message is that if you are dealing with a major player -- anyone in the "too big to fail" group -- you don't have to worry about that player's creditworthiness. In effect, your risk is with the U.S. Treasury...

...regulators should consider dismantling the counter-party system... require the posting of all derivative trades, clearing them through a central system and regulating margin requirements...

Sobering stuff, with a few funny bits (check out his water-vs-Coke analogy), along with some interesting long- and short- stock picks near the end. I urge you to read it all. The reason I post it here (a scenario- and big-picture-oriented blog) is that it will eventually touch pretty much everything in the global economy. Ignore it at your peril. Understand it and you'll at least be able to tell the difference between a two-by-four and a rock when it hits you (and all of us) in the back of the head.

Comments

[blandspace]

I complain because I am on the short end. If I was on the highend I would probably act the same way. The nature of greed.