WORSE Than AIG. Seriously.

Image by jeco via Flickr

See that crushed up globe. That's the world. See the hand crushing the globe - that's the hand of the credit ratings agencies.

Ok, yes, I was and am outraged about the whole bonus matter at AIG. Can you believe anything can be worse than that? OH YES! We need a new word in the dictionary to describe the credit ratings agencies because "outrage" will not do. Have you read this madness? Ratings Agencies, To Blame For Some Of The Crisis, Could Now Benefit. The article references today's Wall Street Journal Article: Raters See Windfall in Bailout Program

See this outrage:

"The new rescue effort, run by the Federal Reserve, kicked off Thursday with bond deals totaling more than $7 billion. Each bond issue will need to be blessed by at least two of the three big rating firms: Moody's Investors Service, Standard & Poor's Ratings Services and Fitch Ratings."

WHAT? "Blessed"? Who are they to "bless"?

Please revisit my post explaining in detail why they have no "blessing" credibility: Rating The Rating Agencies

Consider: The ratings agencies told AIG all the garbage they were buying was the greatest thing since sliced bread. The ratings agencies branded all the garbage as priceless so the whole world would buy them. Everybody bought all the garbage and now we are in a mess. When AIG was scrambling for funds to meet the contract requirements of the Credit Default Swaps and the whole financial sector was in a free fall, what did the ratings agencies do? They threatened to downgrade. Well, if you are a country or company looking for funds, and the ratings agencies say they are about to downgrade you, no one will give you one cent. Did I say that the ratings agencies were the very reason why AIG bought the garbage in the first place?

Consider: AIG has a financial products problem that is SO huge that it impacts the entire global financial system. It is "too big to fail". On the other hand, the ratings agencies can rate EVERYBODY - so all products, all countries. The rating agencies have had FAR MORE POWER to destroy the ENTIRE global financial system and the ENTIRE global economy. The ratings agencies make AIG and its dramas look like kindergarten stuff. Ratings agencies can literally cause world war. They are "playing" with a lot of people's lives with rating sovereign debt, in particular. When countries are downgraded, they have difficulty accessing funds. When they need to make decisions so people can live - literally - they have to live under the written threats of further downgrades. The decisions that let people live are usually the complete opposite of what the credit agencies threatens the countries that they better not do or else. Seriously, these ratings agencies think they run countries - and quite frankly they are allowed to. Even the IMF has better bedside manners. The ratings agencies care ZERO about development. At least the IMF will talk about poverty. Can you imagine? The ratings agencies make the IMF look generous. An entire economy and society can hinge on a few utterances from these rating agencies. And if they were right, I would say - it's part of the system. But they're wrong. That's the shocking part. And they are unsupervised with no transparency. Utter madness.

Consider: The rating agencies caused this mess AND admitted that they were wrong, but they are STILL allowed to rate even through they are STILL wrong. They are driving the nails into the coffins of the entire global financial system and companies and countries. If they make a mess of the global economy, and everyone's prospects dim, how do these ratings agencies be allowed to downgrade them? These ratings agencies have to take responsibility. Whatever they say, people still listen to them. So if you are a sound company, and a ratings agency gets it "wrong", too bad for you and your employees. Many companies would be here now, many jobs would be here today if these ratings agencies were suspended after Lehman collapsed. Congress needs to do that analysis - what companies suffered and jobs were destroyed because ratings agencies were allowed to keep chattering after Lehman collapsed. Try this analogy: If the financial sector was bleeding, the ratings agencies opened the wounds wide and made new ones - and the ratings agencies were the ones that inflicted the wounds in the first place! And if you are the Government, the ratings agencies can shut down your relief effort. Don't believe me? From the WSJ article:

"One of the biggest concerns surrounding TALF is the seemingly arbitrary nature of ratings decisions. Many of the ratings firms, for example, changed their view of one part of the auto-financing sector, deciding that loans made to auto dealers were far riskier than they previously thought.

Their downgrades meant that bonds backed by loans to those dealers would be unlikely to get triple-A ratings, effectively shutting them out of the TALF."

NOW, hear this one, the US government's $7B bond rescue effort REQUIRES rating by these agencies. What is the US Government ON? So they are going to listen to these people who caused the mess, said they are wrong and still make a mess? And I hope you are sitting down because they are actually going to PAY them for this service - with taxpayers funds - YOUR MONEY. No, I ask again - have we collectively lost our minds?

Want to know how much money?

"Rating services typically charge $40,000 to $120,000 for every $100 million in so-called structured-finance securities they rate. For the initial $200 billion portion of TALF, that translates to $80 million to $240 million. If the program is extended to $1 trillion as the government plans, those fees could skyrocket to anywhere between $400 million and $1.2 billion."

You know what. I've been very supportive thus far, and tried to be very understanding. But I think that something is gone really wrong here. Forget too big to fail. Let the whole entire thing collapse and let some other monetary system take its place, and some other financial sector system take its place. Because what is happening now is not only completely illogical and completely counter to any form of recovery, frankly it is extraordinarily insulting to any normal person's intelligence.

Americans, citizens of the global economy, are we really going to take this?

Why The US Should Nationalize Banks

Image by wilmack via Flickr

I realize I am venturing into a controversial topic, but I think the time has come for us to debate this matter of the US nationalizing its banks seriously.

Please indulge me while I share my background so you can understand my perspective. As it happens, I have some experience in this particular area:

• I worked with the Ministry of Finance in Jamaica when the local financial sector was in crisis in the 1990s. Although I had no decision-making authority, I did have an incredible amount of exposure to the Government's and the Central Bank's deliberations at the highest levels about what to do, and then I was actually able to see what was done

• After a brief stint at Harvard for graduate school, I returned to Jamaica and undertook many responsibilities. One of these was as a member of the board of the holding company that held the 4 nationalized entities that the Government had merged into one for re-privatization. The job of the board was to make it into an entity that would attract private capital. Simple mandate: Get ready for re-privatization ASAP. There were what seemed to be zillions of subsidiaries, I sat on the board of many of those and read hundreds of minutes in addition to the re-privatization preparation. It was almost like a full-time job. The nationalized entity was successfully re-privatized, has never had a hint of a problem since and is now owned by Royal Bank of Canada.

• After a year at the Wharton School where I went back to do my MBA, I was asked to serve in the Government of Jamaica as a Senator and a Deputy Finance Minister. I had to take a Leave of Absence from school to do that. My tenure with the Government as a Senator and Deputy Finance Minister was after the financial sector crisis, and after the re-privatization of the nationalized banks and coincided with strengthening the regulatory framework for the financial sector
  

I will never claim that Jamaica did it perfectly. But, the sector is stronger than it was before. And like every experience in life, there are learning lessons.

Now with regard to the US, I started writing the weekend of the Lehman collapse. That was the genesis of the notes on Facebook, the commentary of the articles and this blog. I kept writing that I had hoped that by observing what had happened when other countries had their crises, that the US would have learned from those experiences and not make the same mistakes. That did not happen.

Finally, however, there is a new Administration, and a sizable majority in Congress. So things can happen.

We are now debating nationalization of the US banks, so here are my two cents:

• The private sector is THE engine of growth. Government's job is to facilitate. If, however the private sector is unable to be THE engine of growth, the Government's job is to step in. At no point can the economy come to a standstill, or people die of starvation because of ideology.

• The financial sector is special - very very special. It is not any sector. It is the sector that facilitates all other sectors. It is not optional. Without a financial sector, people would keep money at home or elsewhere stashed away. That poses a massive national security problem that no country could manage. Without a financial sector, wealth generation would be severely limited, and international trade would come to a virtual standstill.
  

• The financial sector cannot - I repeat cannot - operate in the absence of confidence. If institutions are solid and strong, and there is no confidence generally, the whole sector becomes weakened. If the sector is weak and there is no confidence, it becomes crippled. A crippled financial sector results in a national security crisis and economic crisis, at minimum.

• If the private sector were perfect, there would have been no crisis. Therefore, the argument that governments are inefficient holds no water. What matters is that the government has credibility to borrow from other governments. Private institutions that have been impaired do not have that credibility to borrow - sometimes not even from anyone, any entity or otherwise.
  

• What must happen is that private institutions' credibility must be restored ASAP. Those that are solid cannot be made to suffer for those that are weak. Every day you hear on CNBC - "Not sure if you can trust the financials (financial statements) of the banks" "Stay away from the financials stocks". Well, let's examine that. Not all banks have problems. But the rumor mill doesn't distinguish and banks do business with each other. So the whole sector starts getting painted with a brush. Not good. Therefore, those that are solid need to be left alone to do what they do best - without government intervention or nationalization. Jamaica did that. There were a few institutions that did not need intervention, did not ask for intervention, did fine without intervention and are doing just fine today. However, those that are weak should be nationalized, repackaged, made efficient, and then re-privatized on an aggressive timetable. Yes, I did say efficient. The Government can hire private sector experts to evaluate, design and implement what needs to be done for this purpose.
  

• Nationalization therefore makes sense when 1) there are serious national security risks from people keeping money at home because of a lack of confidence 2) it is a short term - I repeat, short term measure - for the sole purpose of cleaning up the entities such that private capital will be interested. The Government is not in the business of personal or commercial banking. Nationalization is only to protect depositors, restore normalcy and confidence in the sector, surgically remove what needs to go, and then place the nationalized institution or institutions in a state that will attract private capital

• NOTE: Nationalization just to nationalize is the wrong move and sends the wrong signal. The Government must be satisfied that depositors are at risk, the banking system is at risk from contagion, and that the entities do not have the capacity and wherewithal to fix their problems themselves.

• HOWEVER: To oppose nationalization on ideological grounds in not only impractical, it can spell the demise of the entire domestic financial sector, and in the case of the US because of the depth of the inter-linkages, the entire global financial sector. And because the financial sector is so special, we could face global instability, social instability and perpetuated economic decline.
  

No one can deny that the world changed drastically.

The US Government owes itself, its people, its position of leadership in the world and the global community a clean up plan on an aggressive timetable for its banking sector - no matter what ideology it falls into as long as it works.

Otherwise, the US must decide not only how it is going to deal with its own domestic problems from further bank weakness, but also how it will deal with the world - in any and every way - if its position of economic leadership is lost.

The world has already decided that a new global financial architecture is necessary. Is the US going to help shape it, or just learn to live with it - whatever it is? There are many developing countries that have had to do that. Maybe the US should ask one of them what that feels like - to not lead but to have to follow. Maybe that will give them the impetus to get on with it.