There is an odd symmetry to a year that began with a subprime meltdown—initially affecting those at the lower end of the economic spectrum, before it lit the fuse that burned down the entire house—and ended with the Bernard Madoff scandal, an old-fashioned Ponzi scheme whose victims were nominally sophisticated investors. Clearly, nobody has been immune to this now-global plague. Every effort to rebuild an economy in free fall has been one moment too late or one step too short, and the remedies, though expensive, have so far at least failed to address underlying structural issues.
Yet certain truisms have continued to prove their validity. As Justice Brandeis observed, sunlight is the best disinfectant. The transparency that comes with the glare of sunlight is hard for companies and government to deal with—and so is resisted.
But transparency could begin to remedy one of the great costs of our current crisis: the public's monumental loss of confidence in the markets. One of the great accomplishments of the past 50 years has been the so-called "democratization" of the markets—the successful effort to get Americans of all economic levels to invest in our process of capital formation. Not only did this create greater liquidity, but more important, it gave a much larger piece of America the opportunity to benefit from economic growth. The rise of the "ownership society" became a noted part of our politics as well as our sense of well-being.
Now, many of these investors are rightly concluding that the market has become nothing more than a casino on steroids—with Wall Street and corporate CEOs playing the role of the house, swinging the odds against the investors at every turn. Trust will be regained only if there is a fundamental change in the rules of transparency and only if those rules are enforced. Such transparency could have prevented many of the cataclysms of the past year. So it is all the more troubling that we continue to fail to require anything close to the information flow that we should—either about the behavior that brought us to where we are or about the transactions and efforts that are now being funded by taxpayers.
No doubt we all have our favorite questions that have not been answered. But here are a few year-ending queries to the players who have been central to the unfolding events of the past months. Some of these questions are retrospective in nature; some are prospective.
- First, for our Treasury Department—and the Federal Reserve—which seem able to lend or guarantee at a scale unheard of until now: Where is all the money going, and how is it decided who gets it? Many of the investments appear to be much less critical than an investment in Lehman Bros. would have been, for example. If this reflects learning, wonderful. But what is the current metric for evaluation?
- Speaking of Lehman, what precisely was the conversation at the Fed among the various bankers that led to the conclusion not to give Lehman assistance but to give AIG an almost unlimited Fed pipeline? What, exactly, did each bank tell the government about its exposure to Lehman or AIG, and when?
- What did the government tell the banks about their obligation to lend, once they had received the infusion of billions to restore their balance sheets? As we have seen, the banks are holding onto an enormous amount of the cash, failing to inject needed oil into a system whose gears have ground to a halt. It defies common sense that the banks have been permitted to receive this capital and yet have not been required to lend in any significantly greater volume. As a result, the economy continues to fall like a rock.
- When did the Fed, Treasury, or the Office of the Controller of the Currency begin to evaluate the credit risk of the subprime debt pipeline, and what did any of them do about it? This is the old what-did-they-know-and-when-did-they-know-it question.
- Have these government entities begun to think through the possibility of requiring banks that securitize debt to maintain an ownership of some significant percentage of this debt? That would begin to address the risks that result when those who originate debt really have no concerns or accountability for the long-term capacity of borrowers to pay.
- For the banks, which have received an unceasing supply of credit and guarantees: We have heard too often from those at the top that "we didn't have operational responsibility; we relied on our risk managers." We are now major equity investors in these banks. Our capital is now at risk. So let's get—right now—all the analysis of the subprime debt that was originated, securitized, or bought. If the credit departments got it so wrong, we deserve to know that so we can remedy the situation by bringing in analysts with greater skills. If the credit analysis was correct and the risk managers were sending warnings up the chain, we deserve to know that as well. Because then the senior managers—despite their disclaimers—have some questions to answer. There are few things more essential for a bank than knowing that its loans will be paid back. We had better figure out how the banks got it so wrong. Any bank unwilling to release these documents should not get public funding.
- Also for the banks: What would it cost to modify meaningfully all the subprime mortgages such that delinquencies and defaults can be brought back into line? Have they calculated this figure? Loan modification is a necessary step to resolving the underlying housing crisis, and one way or another, it has to get done. Why loan modification wasn't a condition of the banks' receipt of capital is a mystery that remains unresolved.
- For the rating agencies, we should also require public disclosure—of their subprime analysis. Let them withstand the public scrutiny of the process that generated AAA ratings on debt that so soon became toxic. Perhaps they will be vindicated. Perhaps there really was no way to see around the corner. Or perhaps we will conclude that the agencies simply do not have the analytical tools to sense inflection points, in which case their ratings really are not worth a great deal.
As we struggle through the difficult process of rebuilding, many errors will be made in good faith by those trying to deal with an unprecedented situation. But it will almost always be the case that transparency will assist in the long term, uncomfortable though it may be in the near term. Until we get comfortable with that notion, we will continue to sink deeper and deeper into the crisis of confidence gripping our economy.