Financial Crisis

Discussing Financial Reform at the New America Foundation

Leila Seradj — Thu, 22 Oct 2009 20:37:00 -0400

Two recent New America Foundation conferences considered the origins of the ongoing financial crisis and proposals for reforming the system.

On October 15, Senator Byron Dorgan of North Dakota discussed the requirements for financial sector reform at a conference co-hosted with the Washington Monthly. In a 1994 Washington Monthly cover story, "Very Risky Business", Senator Dorgan predicted with uncanny precision what actually happened in September 2008. Then, in 1999, Dorgan was one of eight senators to vote against the Gramm-Leach-Bliley Act, which repealed Depression-era banking regulation, cautioning at the time that deregulation "would raise the likelihood of future massive taxpayer bailouts." Now, as Chairman of the Democratic Policy Committee, Senator Dorgan supports sweeping reform of the financial sector.

Watch video of Senator Dorgan's remarks here.

And on October 13, Adrian Blundell-Wignall spoke at the New America Foundation as part of the OECD Breakfast Series. Blundell-Wignall, Deputy Director for Financial and Enterprise Affairs at the OECD and author of a recent paper in the Journal of Asian Economics, linked the explosion of complex derivatives to lax regulation, international tax arbitrage, and the persistent "equity culture" on Wall Street. Blundell-Wignall contended that some of the emergency measures undertaken last fall, including bank bailouts and unconventional monetary policy, were painful yet necessary responses to an unprecedented crisis. Yet policymakers have failed to address the fundamental problems of industry competition and corporate governance that enabled the financial calamity, most notably the "equity culture" and the "too big to fail" problem: "We've allowed some monsters to emerge in the world of banking," he concluded, "and I just don't know what to do about it."

Watch video of Blundell-Wignall's remarks, view his PowerPoint presentation, and read his recent journal article here.

Weighing in on Microfinance and the Financial Crisis

Jamie Zimmerman — Mon, 23 Mar 2009 20:24:00 -0400

Signs point to toughening times for the microfinance industry. A recent article from the Economist has echoed my concerns that selling microcredit (as a concept or a product) will grow increasingly difficult as the global economy stumbles (or crashes and burns) on the heels of a debt-led recession in the United States. Not only in the concept politically less appetizing than it was back when Muhammad Yunus won the Nobel Peace Prize in 2006, the capital fueling the industry is drying up. The similarities and differences between subprime lending that fueled the US recession and the "sub, sub, subprime" lending happening in developing countries through microfinance institutions have been debated and analyzed for over a year now. But only recently has the engine of seemingly-endless capital to MFIs around the world starting slowing, sputtering to slow chug in some instances.

The Economist article argues that the microfinance industry is more insulated from the crisis than many of my colleagues working in the sector would currently state. Just because the Grameen Bank has not faltered in this financial crisis doesn't equate to an entirely healthy sector. Moreover, the decrease in capital, and the resulting liquidity constraints and challenges institutions will face, does not represent the variety of challenges that MFIs, or the microfinance sector, could and will likely face as a result of this crisis. While I commend the Economist for putting on spotlight on this particular problem, the article fails to provide readers with the bigger picture.

Fortunately, CGAP just released last week a more thorough analysis of the potential impacts of the crisis on microfinance. The Focus Note reviews not only the challenges of the institutions, but also those of the clients that frequent these institutions to gain capital for their micro-business or, in many cases, borrow to smooth consumption over time. Essentially, the Note paints a relatively more nuanced picture of the crisis on the microfinance industry and tempers its optimism that the industry is "insulated from the problems of the global economy" (as is speculated in the Economist). On the other hand, CGAP does share my view that this crisis will bring opportunities that could result in a better functioning industry, with potentially better outcomes for the poor.

In my opening remarks at the March 16 USAID panel on Microfinance and the Financial Crisis, I also outlined a number of challenges I either currently see or envision for the industry as the global crisis unfolds, many of which are reflected to some extent in the articles mentioned above, including decreased capital, weakening consumer confidence, increased pressure for tougher regulation, etc.. However, I foresee as serious opportunities for the industry. (Call me hopelessly optimistic, but I prefer to concentrate on opportunities whenever possible, particularly in troubling times.)

First, a debt-led global recession is indeed spurring some to cast a critical eye on debt-led poverty reduction like micro-credit. While this may be understandably worrisome for particular institutions, it's a huge opportunity for the microfinance field in general. The backlash against credit and subprime lending could very well lend itself to a microfinance industry whose health is dependent on a more diverse and balanced portfolio, particularly with an emphasis on savings. In fact, deposit-taking MFIs (who are less dependent on capital investments) are indeed the very institutions most insulated from the crisis so far. Next, the spotlight on savings is not limited to acknowledging the need for deposit-taking for an institutions fiscal health. The microfinance field as a whole is now paying long overdue attention to the other critical financial needs of the poor, namely access to effective and safe savings services. Finally, there is a growing recognition that all people, chief among them the poor and the vulnerable, need to save and create a safety net against economic shocks, rather than relying on credit alone. This is a lesson the US learned too late, but for the microfinance field, it's a very real opportunity to look at economic opportunity and resiliency in a whole new way.

(Transcripts and materials from the March 16 event, including perspectives from other panelists on this issue, can be found on the Microlinks site.)

The Next Mortal Combat Match-Up: Thrift vs. Debt?

Jamie Zimmerman — Tue, 09 Dec 2008 19:56:00 -0500

Ohio State University's Devfinance listserv, an email network for students, practitioners and researchers of development finance and economics, is one of my go-to lists for fresh debates and hot-off-the-press publications and research on all sorts of microfinance issues. Every once in a while it's also surprisingly entertaining. Take, for example, last week's pro-thirft/anti-debt post announcing a new competition to develop a thrift-focused video game (re-posted here with permission from Jane, the original author):

It's not as cool as buying a beneficent bank in Bali or doing an IPO or private placement, nonetheless it is a counterpoint to the current credit mania.

The Peter G. Peterson Foundation is sponsoring a campaign to encourage personal and governmental frugality in the U.S. One element of this is issuing what they call an INDEBTED $10,000 Challenge. It is aimed at college students and will award $10,000 to the student(s) who develop the most effective video game about the U.S. fiscal mess. I suspect they would like to see the video game promote saving.

On the one hand, the Peterson Foundation joins the Templeton Foundation in suggesting that thrift, after all, might not be such a bad idea. On the other hand, a gaggle of other foundations, government organizations, and disaster relief agencies are pushing debt as the next best thing to ice cream. Besides being highly profitable for a few -- both in low-income countries and on Wall Street -- the finance industry can also be extremely entertaining to watch!

Will the microfinance industry counter the Peterson Foundation heresy by promoting a competing video program whose end point is getting all of the poor women in the world in debt? Perhaps the prize could be a $10,000 loan (at say, a 100% interest rate) for the college student(s) who develop(s) the best debt-extolling video.

For all her sassy sarcasm, Jane reveals here a growing trend within the financial services field, not only in the United States but in developing countries around the world: a disillusion with unchecked debt as an economic empowerment or poverty reduction strategy (i.e., microcredit abroad or credit-fueled consumer spending here in the U.S.). However, the credit crisis in the US (and subsequent global financial meltdown) has also prompted microfinance and financial services practitioners to think about, and in this case, advocate for the reemergence of a once-heralded yet long-abandoned concept: thrift.

Asset Building Event: Community Banks, the Financial Crisis and a Way Forward

Mark Huelsman — Tue, 18 Nov 2008 21:09:00 -0500

Much of the discussion during our current financial crisis revolves around whether certain institutions are "too big to fail." Forgotten in the wreckage, however, is the relative success of the community bank -- the small-scale "relationship" bank where individual savers and borrowers are members of the same community. In fact, the failure rate among big banks is eight times greater than among small banks so far this year.

This Thursday November 20th, the Asset Building program and the Washington Monthly will explore ways to encourage the health and number of small-scale financial institutions as a means of thwarting the tendency toward excessive consolidation in financial services and restoring a mutuality of interest between borrowers and lenders. Our own Ellen Seidman and Phil Longman will discuss the role of these institutions in climbing out of our current economic mess and preventing more trouble down the road. They will be joined by Doug McGray (Fellow, New America), Joshua Rosner, (Managing Director, Graham Fisher & Co), and Jan A. Miller (President & CEO, Wainwright Bank & Trust Company).

We hope you join us for what promises to be a lively discussion. Click here to RSVP.

Greenspan Admits Flawed Assumptions on Deregulation

Sam Sherraden — Thu, 23 Oct 2008 18:54:00 -0400

Alan Greenspan, Federal Reserve Chairman from 1987-2006, admitted before the House Committee onGovernment Oversight and Reform that he made mistakes as Fed chairman. Greenspan said the "flaw" in the assumptions he had over four decades was that lending institutions themselves were best able to protect the interest of their shareholders. The testimony marked a dramatic shift from a previously defensive position regarding his terms as chairman.

Meanwhile, the major ratings agencies, Moody's and Standard and Poor's, are undergoing thorough investigation by Congress as internal conversations about ignoring risk to make profits are revealed.

Snapshot asks, should regulators be making assumptions about the ability of financial institutions to manage their own risk?

The Mainstream Comes On Board--CRA Didn't Cause the Current Mess

Ellen Seidman — Wed, 15 Oct 2008 16:44:00 -0400

Those who, like me, believe that CRA not only did not cause the current mess but has been a positive force, are gratified that the mainstream press has finally started to pick up the theme. For example, this morning the New York Times ran an editorial pointing up both the fallacies of the anti-CRA argument and the good CRA has done. And last week Forbes carried a piece by Luis Ubinas, the new President of the Ford Foundation, pointing out that the crisis was caused by risky mortgages (by risky, non-CRA-regulated lenders), not risky borrowers, and in particular not poor borrowers.

Perhaps even more important for countering the effects of the "blame CRA" campaign in middle America, the McClatchy papers have distributed a news item blasting the myth, noting, "What's more, only commercial banks and thrifts must follow CRA rules. The investment banks don't, nor did the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans. These private non-bank lenders enjoyed a regulatory gap, allowing them to be regulated by 50 different state banking supervisors instead of the federal government. And mortgage brokers, who also weren't subject to federal regulation or the CRA, originated most of the subprime loans."

Ubinas' piece builds on an extremely timely and compelling study by the Center for Community Capital at the University of North Carolina. The study is also referenced in the Times editorial. Using matched samples of sub-prime borrowers who got well-underwritten, conventional, fixed-rate loans from banks and credit unions and those who got adjustable rate loans with prepayment penalties from brokers, the study found that the borrowers with good loans had significantly lower default rates than those with the bad loans. And nothing else accounted for the difference. As the study states: "all other characteristics being equal, borrowers are three to five times more likely to default if they obtained their mortgages through brokers. When the feature broker-origination channel is combined with the adjustable rate and/or prepayment penalty, the default risk is even higher."

So, enough already. Let's put the blame where it's due: on bad products sold by people with no interest in repayment to investors who didn't understand what they were buying in an unregulated market run amok. Good products sold by lenders with an interest in success to borrowers who understood what they were getting did much, much better.

Blogger Exclusive with President Clinton: Wall Street vs. Main Street on the Eve of the Clinton Global Initiative

Jamie Zimmerman — Tue, 23 Sep 2008 13:40:00 -0400

Last night, I was one among 15 progressive bloggers invited to an informal and intimate meeting with President Bill Clinton to discuss the 2008 Clinton Global Initiative, the annual massive convening of world leaders, celebs, corporate executives and progressive NGO activists to make commitments to solve some of the world’s greatest challenges. Told the meeting would last 30 minutes and to limit our questions (“if there is time for any”) to this year’s CGI commitment areas, I wasn’t expecting much more than fluffy rhetoric and quick sound bites on each of this year’s issues -- education, energy and climate change, global health and poverty alleviation. But, President Clinton took his first question early -- “Will the financial turmoil in the United States be a distraction from efforts to advance CGI commitments?” Indeed. This question ended up dominating an hour-long discussion of the causes and effects of the current financial crisis, and what needs to be done about it.

The President gave us a crash course in 2008 Financial Crisis 101: In his view, the turmoil has been caused in large part by three factors. First, the financial system was transaction-based which resulted in over leveraging. Second, investment banks were not subject to the same level of oversight as commercial banks. And third, the money injected by Greenspan in 2001 to avert the tech bubble from bursting when into investments that were too narrow – real estate. By the early 2000’s real estate investments dominated the market and increasingly money was chasing opportunities in housing, leading to subprime mortgage lending and derivative futures.

But Fannie and Freddie aren’t off the hook here either. These institutions “socialized the risk” of real estate investing, “but privatized the profits.” And the lack of regulation and oversight of these institutions, coupled with “bi-partisan coddling of misconduct for too long” contributed to this mess we’re in now.

Here’s an interesting counterfactual he posited: If President Bush had ratified, instead of killed, the Kyoto Protocol when he came to office, it would have created investment opportunities and incentives to create new sustainable energy technologies and products. Housing wouldn’t have been investors’ only cash cow.

A moot point, perhaps in the immediate future (more on his comments on the environment and energy soon), as a quick response to the crisis is critical if we want any chance of averting a downward spiral of collapses and bailouts. And speaking of bailouts, what does the President think of the $700 billion package?

The package is necessary to deal with the crisis on Wall Street, but what about the crisis on Main Street, that faced by millions of everyday Americans who are losing their homes, who can’t pay their bills, who are worried about paying for healthcare, education and the value of the 401(k)s? In Clinton’s view, it’s not sufficient. For taxpayers to fork over 700 billion dollars, he said, they should expect in return:

A moratorium on foreclosures for two years,
The creation of a Loan Homeowners Corporation (model after the one created during the depression that saved million of homes and actually turned a profit for the government) and
A plan to pay back the taxpayers over time, through profit-sharing or other measures. Without an appropriate “Main Street” response, this package may fail.

But what does this have to do with the CGI convening’s this week? Obviously, the financial turmoil will impede next President’s (and perhaps other world leaders) ability to use of soft-power spending (on foreign assistance/poverty eradication efforts). But President Clinton is not convinced that this crisis will distract leaders from confronting important global issues. Instead, he wonders if - with the current crisis’ reminder that none of us are immune to economic and social troubles - will make the world more resolute in our search for solutions.

*Note: I will be blogging from the CGI all of this week. Stay tuned for more on the meeting with President Clinton, as well as coverage of commitments and sessions on poverty eradication, asset building and financial services for the poor *

Stop Calling it the Subprime Crisis!

Reid Cramer — Thu, 18 Sep 2008 14:27:00 -0400

I think it is pretty safe to say that we can stop calling it the subprime mortgage crisis. I went to an event at the Hudson Institute this week with this title. Robert Edelstein from UC Berkeley had a good presentation which provided an informative review of the issues but the dramatic events of this week were making understanding the crumbling system more of an historic exercise. Many of the actors in the play were already being played by understudies and the script was being rewritten on the fly.

Sure, the earliest indicators of pervasive financial distress began when the performance of subprime loans started to sour last year. But I think it is safe to say now that the financial turmoil which is unfolding in real time extends well beyond the subprime mortgage market. It never really made sense to begin with anyway since the fall of home prices from their precipitous heights was hardly unexpected, especially in the areas where the run-up had been so steep. Increasing default rates should have been predicted as a nature course of events when the housing bubble eventually popped. This sound has been heard of before. It is a dynamic that has been studied and observed. Yes, gravity is just a theory but we still know that the apple will eventually fall.

However, I have no problem with calling what we are experiencing a mess. I just think it is a bit unfair to lay the blame at the feet of subprime borrows. Even the unscrupulous purveyors of subprime products should not be entirely blamed. In theory, risk-based pricing has the ability to get people into good loans and good homes than they otherwise would be able to do, but all too often it lead to getting people into good homes and bad loans, that they either did not need to be in or could not afford to stay in. Certianly many subprime lenders had a business model that was offensive. And yet regulations were lack, the risks they faced were low, few people were paying attention, and they were told there was nothing wrong with the profit motive.

Unfortunately, despite our need to find resolution in assigning blame, I believe there have been too many culprits at work. Clearly a role was played by the lenders, the banks, the formerly Government Sponsored Enterprises of Fannie and Freddie, the accountants, the insurers, and just about all of the major players in the global financial system. Perhaps we will look back in hindsight and marvel that our national system for financing homeownership became one of the foundations for conducting global finance. The drive to create financial products such as mortgage-backed securities that could be sliced, diced, and sold got away too far ahead of the ability to estimate and understand their underlying value, risk, and ultimately price.

As we watch the financial unraveling, the complexity of the arrangements is maddening. Steven Pearlstein makes a useful attempt to explain the current state of things in today's Washington Post. He calls it a category 4 financial storm. It seems to me, though, that most of the experts are just as confounded as those of us reading the new stories. What I do know is that the roots of the problems were structural. They emanated from the policy choices we made to govern financial markets. These choices should be revisited structurally as questions of governance and government (our U.S. federal government) will have to establish the new rules for the market which provide protection and security for consumers, small investors, and big investors alike. The era of small government and deregulation is over.

Bad Times for Bankers

Sam Sherraden — Mon, 02 Jun 2008 21:45:00 -0400

Three of the largest U.S. investment banks, Morgan Stanley, Merrill Lynch, and Goldman Sachs, had their credit ratings lowered by S&P on the concern that further writedowns lay ahead. Since the beginning of 2007, banks worldwide have written down some $387 billion and raised over $270 billion in new capital. Commercial banks also had a turbulent day with Wachovia's Chief Executive Ken Thompson ousted and Washington Mutual's Kerry Killinger stepping down from his position as chairman (he will retain his position as the CEO).

Snapshot asks, do you agree with the ratings agencies that financial institutions will face further trouble in 2008? Will it be less, more, or equal to trouble they faced in the past few months?

BNP Paribas - Financial Crisis: Banks in the Midstream
Bloomberg - Morgan Stanley, Merrill, Lehman Ratings Cut by S&P
Fitch Ratings - Securities Firms: 1Q08 Peer Data
Fitch Ratings - Subprime Mortgage‐Related Losses

Is London Loosing its Edge?

Ian McAllister — Wed, 07 May 2008 18:35:00 -0400

A proposal by Gordon Brown's government to up the taxes paid by resident foreigners and demand greater transparency in their offshore dealings has many fearing an exodus of London's international financiers. This comes at a time when increasing numbers of businesses in London are also moving their headquarters to countries with lower taxes. Layoffs by banks in the wake of the subprime crisis are further damaging the City's reputation as a vibrant financial center. A loss of foreign residents and international business would be devastating for a city that has emerged as New York's greatest rival for global preeminence.

Snapshot asks, could New York reclaim the top spot if London falls?

The Times - Nondom Raid will Lead to Capital Exodus
Financial Times - Big Companies Consider Domicile Status
International Herald Tribune - Job Losses Feared in British Financial Sector
Financial Times - City Job Vacancies Down by a Quarter
Bank for International Settlements -Intl. Financial Centers: A Network Perspective