“The subprime-mortgage-market meltdown is a classic example of the way small fry get devoured, but the whales of Wall Street get rescued,” writes Fortune senior editor-at-large Allan Sloan. He adds:
If you believe in markets — which I do — this rescue is especially galling, because Wall Street enabled this mess in the first place. How so? By happily sucking up hundreds of billions of dollars’ worth of suspect mortgages from marginal U.S. borrowers — and begging mortgage makers to create more of them. The Street sliced and diced this financial toxic waste into a variety of esoteric securities, making a nice markup when it sold them and generating a continuing stream of profits when it made markets in them.
Somehow analysts at credit-rating agencies, looking at computerized scenarios rather than at the real world, decided that the bulk of the securities backed by these trashy loans could be rated triple-A.
It’s really amazing: Most of the loans to substandard creditors borrowing 100 percent of the purchase price of homes they couldn’t afford were rated the same as GE and the federal government. That makes no sense. But the money rolled in, and Wall Street — by which I mean the world’s biggest and most important financial institutions — didn’t care about the real world or ask any questions. It was too busy making money, and cashing bonus checks generated by subprime-mortgage profits.
Sloan grants that we don’t want “the world’s financial system to implode,” so it’s a good thing that Federal Reserve chairman Ben Bernanke and the world’s other central bankers think some institutions are “to big to fail.” But Sloan wants those big institutions to pay a price for their bailouts:
I’d feel a lot better if the Street had to pay a serious price to its rescuers — say, having to fork over a big equity stake and pay a loan-shark interest rate. That way taxpayers, who are picking up the tab for the rescue, would get paid bigtime for taking on bigtime risk.
After all, that’s the Wall Street way.
An editorial in The Economist says the Federal Reserve and other central banks “must stand back” from intervening, through interest rate cuts, in the credit crisis that’s causing a panic in the world’s stock markets. The editorial concludes:
The retreat to a new level of risk was never going to be orderly or free of casualties. Neither should it be. Bankers and investors need to suffer precisely because the methods of modern finance have been found wanting. It sounds Darwinian, but the brutal demonstration that you pay for your sins is what leads the system to evolve. Markets learn from their mistakes. Only fear will spur investors to price risks better and get them to put more effort into monitoring their counterparties.
If these lessons are to sink in, central bankers must stand back — as, by and large, they have done. Every intervention now will be taken as a sign of what the regulators will do next time. If they bail out banks that have mispriced risk, the mispricing will continue. And when the central banks do step in, it should not be to save the financiers. The cost of intervention is warranted only to save the rest of the economy from the financiers’ folly. By that test, central banks were right to lend money to the banks in recent days, because it ensured that a liquidity crisis did not become a solvency crisis. They may yet have to take over a failed bank, though only if that is needed to stop a run. It is still far too soon to cut interest rates.
Because this crisis taps so deeply into the newly devised structures of finance, anyone who says the worst is definitely over is either a fool or someone with a position to protect. As risk has become bewilderingly dispersed, so too has information. Nobody yet knows who will bear what losses from mortgages — because nobody can be sure what those loans are really worth. Nobody knows if tighter lending standards will oblige borrowers to raise more capital, triggering more sales in stockmarkets and more pain. Nobody knows how messy the inevitable bankruptcies will turn out to be. What markets need now is time to piece that information back together.