Financial Crisis

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  Then, in 1999, Dorgan was one of eight senators to vote against the Gramm-Leach-Bliley Act, which repealed Depression-era banking regulation, cautioning at the time that deregulation "would raise the likelihood of future massive taxpayer bailouts."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.

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.

 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.

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.

 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?

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."

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. 

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.

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?

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?