Who’s to Blame for the Collapse of the Financial Markets?

British newspaper Sunday Times has published a very interesting article on the international insurer AIG. The piece elaborates extensively about the firm’s underwriting methods and creation of the multi-sector CDS portfolio – which seem to have had no correlation between fees paid and the risk assumed. According to  Christopher Whalen, managing director of Institutional Risk Analytics, “AIG’s foray into CDS was really the grand finale….Towards the end, it looked much like a Ponzi scheme, yet the Obama administration still thinks of AIG as a real company that simply took excessive risks. In other words, there was never a chance AIG would honor its contracts: its income was nowhere near enough to cover the payouts.”

The article also touches on the firm’s furore over bonuses – calling it “a convenient distraction from the real causes of the crisis.”

The article also argues that while until now the economic crisis has been seen as a giant intellectual errors, the dishonesty in the collapse of the global economy and the financial markets is on a scale that is almost too vast to comprehend.”There are conflicts of interest in American finance and politics that make our own, dear House of Lords look like beginners” the article said. “There are frauds so large, and so long-standing, that it can be hard to see them for what they are. And all these things were allowed to thrive in an intellectual atmosphere that tolerated no dissent.”

From Sunday Times: “Why did no-one see it coming?” asked Queen [Elisabeth] last November, on a visit to the London School of Economics. Well, they did, ma’am. Charles Bowsher, head of the US government’s General Accounting Office, testified as long ago as 1994 that “the sudden failure or abrupt withdrawal from trading” of large dealers in derivatives “could cause liquidity problems in the markets and could also pose risks to others, including… the financial system as a whole”. It took another 13 years, but that is exactly what happened.

One regulator tried to act on Bowsher’s warning, but she was silenced. Brooksley Born, who monitored the futures markets, tried to extend her remit to unregulated derivatives. Alan Greenspan and Robert Rubin, the then Treasury secretary, persuaded Congress to freeze her already limited power, forcing her departure. Rubin had come into government from Goldman Sachs; when he left he went back to banking, and pushed for Citigroup to step up its trading of risky, mortgage-related investments. For his advice, he earned over $126m (£84m) and then, as Citigroup collapsed, became an adviser to Barack Obama. After Greenspan stepped down from the US central bank in 2006, he became a consultant to Pimco, the world’s biggest bond fund, where his insights have been praised by his boss. “He’s made and saved billions of dollars for Pimco already,” said Bill Gross last year. Greenspan is also an adviser to Paulson & Co, a hedge-fund group that has made billions from the collapse in American housing.

The lightness of touch reached a level that defies belief. America has an Office of Risk Assessment, set up in 2004 to co-ordinate risk management for the main regulator, the Securities and Exchange Commission (SEC). Jonathan Sokobin, its director, says it is charged with “understanding how financial markets are changing, to identify potential and existing risks at regulated and unregulated entities”…. By early 2008, this office was reduced to a staff of one…We had gotten down to just one person at the SEC responsible for identifying the risk at all the institutions. The $596-trillion market in unregulated derivatives, including $58 trillion in credit-default swaps, was being watched by one person. That’s when he wasn’t looking at the rest of the corporate world, of course.

“From 1973 to 1985,” says Simon Johnson, a former chief economist at the IMF, “the financial sector never earned more than 16% of [US] corporate profits. In the 1990s, it oscillated between 21% and 30%, higher than it had ever been in the post-war period. This decade, it reached 41%.” The whole point of financial companies is to allocate your savings to those who can use the money best. If they are taking 41% of the profit in an economy, something is out of balance. These figures reveal an enormous transfer of wealth.

emphasis added

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