The truth about financial crisis

Believe it or not, the global financial crisis spawned from good intentions that were poorly executed; the following is extracted from Wall Street Journal, who interviewed Stephen Schwarzman, the chairman of Blackstone Group
(http://blogs.wsj.com/deals/2008/09/24/wall-street-crisis-stephen-schwarzman-explains-it-all/?mod=sp_deals ):

It’s a perfect storm. It started with Congress encouraging lending to lower-income people. You went from subprime loans being 2% of total loans in 2002 to 30% of total loans in 2006. That kind of enormous increase swept into the net people who shouldn’t have been borrowing.

Those loans were packaged into CDOs rated AAA, which led the investment-banking firms [buying them] to do little to no due diligence, and the securities were distributed throughout the world, where they started defaulting.

When they started defaulting, out of bad luck or bad judgment, we implemented fair value accounting….You had wildly different marks for this kind of security, which led to massive write-offs by the commercial banking and investment-banking system.

In the face of those losses…you needed to raise new equity…which came from sovereign-wealth funds in part, which then caused political resistance to sovereign-wealth funds, who predictably have withdrawn from putting money into the system….It seemed pretty obvious that would happen. We now find ourselves with a liquidity crisis where fundamentally the cost of money for financial intermediaries [such as investment banks] is significantly in excess of their cost of lending it. So several institutions found themselves in a structurally impossible position. We had a series of bankruptcies, whether Bear Stearns or Lehman, or forced sales like Merrill. Goldman reverted to a banking charter for a lower cost of funds, which today is still not low enough for the business.

So that’s the story of how we got there.

In this high technology era, it makes one shudder now as to who we can trust these days; when financial institutions blindly follows orders by politicians (who may or may not have any knowledge of financial markets), it is high time for us to put in some check and balance. The question is not what or how – it is a question of when these check and balances are put into place to prevent such a major fiasco from happening – again.

The corrective action would be to ensure that we elect the right people to form the government.