Thursday, February 5, 2009

The China syndrome: it's our fault they don't trust us

--The root issue of the financial mess is the lax financial principles, unfettered leverage and malfeasance, allowing insider trading and failure to rein in the liars. --the big victims are note entities, but out financial systems. By Janet Tavakoli Published: February 5 2009 02:00 Last updated: February 5 2009 02:00 When Washington passed out hundreds of billions in bail-out funds in September 2008, it said it could worry about the cause of the meltdown later. This allowed lack of trust in the US financial system to fester. More recently, the Obama administration turned up the rhetoric against China, saying it believed the country was "manipulating" its currency. The president also wants to see a Chinese stimulus package. The US needs China to hold the US Treasury and agency debt it owns and to keep buying new US debt. So if Washington wants to ease tensions and keep its borrowing options open, it should look to Wall Street. Did Washington think it could allow US investment banks to carpet bomb Asia with financial mini-bombs and escape the fallout? In Hong Kong alone, $2bn of Lehman's principal-destroying mini-bonds were sold. Most US investment banks joined in the insanity. Investors - including officers at nosebleed-high levels in Japan, Macao, Hong Kong, Singapore, and mainland China - have been burned as their triple-A investments were wiped out. George Soros in his recent Financial Times article was correct that credit derivatives created issues, but he missed the most glaring problem. US investment banks were not the victims of bear raids; they were fundamentally unsound. Investment banks and hedge funds turned financial risk into financial crack with leverage. The risky overrated debt had no upside and lots of downside. Leverage in the form of massive borrowing and credit derivatives made the fall swift, painful and often fatal for equity investors in investment banks and hedge funds. Pundits trying to inflate their own bubbles of self-credit put the blame on unsound models. But such fools for randomness are a distraction from the key issue: malfeasance. Financiers and structured finance professionals were aware of the negative potential of risky loans. Yet they took it even further. The risky tranches - those that any investment banker worth their salt knew were write-offs - were used to create other packages that their buddies "managed" in one fund, while shorting in their hedge funds. The problem was not the models' failure to capture probability outliers but the industry's failure to rein in the liars. Sophisticated investors with structured finance expertise (bond insurers, bank portfolios, large pension funds) became willing victims by failing to perform basic due diligence. But there were genuine victims: naive homeowners who were misled into risky mortgage loans and retail investors who were missold risky mislabelled products. The biggest victim has been the global financial system, and we are all suffering the effects of mischief that remains unchecked. There is no innocent explanation for many of the securitised bonds made and sold by investment banks. They were a conduit for shifting losses. There were no black swans or swans of any colour involved. Like Black Bart, the 19th-century Californian stage coach robber, Wall Street bankers made off with the loot without firing a shot. They were enabled by Washington overseers and financial regulators who - when not beneficiaries of the good times - behaved like ostriches. Meanwhile, news of the fact that no one in the US has been brought to justice has not escaped notice. It is possible that Chinese banks are being less co-operative with the US because Wall Street scammed them. There is hope, but the only way out of this is a return to sound financial principles, which will include cleaning up our mess. At the Davos conference, Jamie Dimon, JPMorgan chief executive, sounded like Warren Buffett or Charlie Munger (or Janet Tavakoli) when he remarked: "Some really stupid things were done by American banks and American investment banks. To policymakers, I say: Where were they?" Janet Tavakoli is president of Chicago-based Tavakoli Structured Finance. Her book Dear Mr Buffett: What an Investor Learns 1,269 Miles from Wall Street about the global financial meltdown is published this year

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