I read somewhere that the crisis on the financial markets was partly due to a change in a law signed by President Clinton. The (previous law) Glass-Steagall Act prohibited a bank from offering investment, commercial banking, and insurance services. The (new) Gramm-Leach-Bliley Act (established in 1999) allowed commercial and investment banks to consolidate. This makes the market less transparent but whether and how it has contributed to the crisis remains unclear.
A crisis offers a moment of reflection. Although many don't learn, people tend to wonder what went wrong at least to avoid the same mistakes in the future. But it is hard to find a single cause as the financial world is way too complex.
But if there was to be a single cause I would imagine it to come from one person, or to put it more precisely: from one productive role in the economic system. This is a person you can trust. He or she has a track-record and it is someone people know. It's about closing the sale to end up with the transaction.
Transactions are the basis of an economic system. Some of those transactions involve financial means other physical means like collateral. Every transaction requires a buyer and someone who sells. It is the latter where the problem starts in case of the financial crisis.
The chain of events go like this. The first transaction is done “around the house. " It is the real estate broker that sells the house to the customer. The broker knows that this person may have a problem financing the mortgage, but he shakes hands with the customer; “If I can arrange you a loan, you will buy this house!" “Yes, " is the answer. The customer remembered well what the broker had said: “the value of you house will always go up. " That was the trigger that made him decide. The first sale is done, by the first salesman (in his role as a broker - the sales"man" can of course be either a woman or a man). Now he must arrange a loan. He calls the mortgage bank and the acknowledges that the income is not sufficient to issue a mortgage. But the client on the other side is interested in the deal, knowing that this is a sub-prime case, but it could be just the case that will offer his performance target. He goes to his boss, explains the difference and convinces him to sign the contract. Salesman number two.
Where one side of the chain the contracts are being delivered, the other side requires a follow-up. The (again sub-prime) mortgage provider is overexposed and must resell its mortgages. This is done by the similar mechanism; a sales between the mortgage provider and the bank (salesman three) and from the bank to the investment bank where the mortgage is securitized so that the mortgage-backed-securities can be traded. (salesman four). In between is the rating office that rates the securities. The credit rating officer is independent but receives a phone call from the bank and they discuss the market, which is going “fine. " The rating is set too positive. Salesman # 5.
At the top of the market this process stops, there are no more houses and mortgages to be sold. The retail side of the finance sector goes to sleep knowing that the best of times is over. The commission is in, performance targets are achieved and new targets must be set when the situation stabilizes at different levels.
At the wholesale side of the financial market, the problems are only just beginning. The mortgage backed securities decline, the collateral decreases and the sub-prime market crashes slowly. There is no sales on this side as it is all pure trading, with declining securities that reflect the market problem.
Halfway trough the crisis, some guru stands-up telling that the crisis is over. Salesman number six. Credibility is on its lowest levels. The stakes are so high that the fundamentals of the financial system deteriorate. The FED comes in. They change a rule by which the two main mortgage institutes are backed by the lender of last resorts. “they play a central role in our housing finance system and must continue to do so in their current form as shareholder-owner companies, " the Treasury claimed. “Their support for the housing market is particularly important as we work through the current housing correction. " Salesman number seven.
On the Stock-exchange a new rule is issued by the SEC which forbids (naked - without previously borrowing the security) short-selling of financials. That is the last sale although it does not result in a transaction but it is a measure to raise the level of confidence.
A single (sales)man - as a productive role, not as a person! - caused this financial crisis. A crisis is about trust and in the financial crisis there is no more trust left. That is because everybody in the salesman role has over-convincing others to get the sale executed. Basically a pyramid sales-game. Performance targets are the motivation. Trust is the fundament and trust is not an issue when the market goes up. When the market goes up, the salesman is offering a win-win deal, but only when the market goes up. At the turning point the level of trust has gone, making it a win-loose-game.
H. J. B.
© Hans Bool