Meltdown DiagnosticsDaniel Gross takes readers' questions about the financial crisis, nationalization, and his new book, Dumb Money.

(Continued from page 3)

PRINTDISCUSSE-MAILRSSRECOMMEND...SINGLE PAGE

FacebookMySpace Mixx Digg Reddit del.icio.us Furl Ma.gnolia SphereStumbleUponCLOSE

_______________________

New York, N.Y.: Hi Daniel, thanks for your insight and taking our questions. I'm curious about the worst-case downside. To a certain extent the excesses of private institutions and individuals (i.e. risky loans) are being transferred wholesale to the government. Is this a process that can continue without end? Where are the limits to what the government can take on as losses, and what will happen when we get there? I am investing for the long term (30+ years to retirement) so if Bernanke is right and the recession lasts just another year I'm not worried—what worries me is the long-term prospect for national viability.

Daniel Gross: Hi—yes, obviously there isn't an open-ended checkbook for the government. (although we certainly seem to be testing the limits). It kind of helps that the rest of the world is in the same situation, since the dollar and U.S. government debt has become a comparative safe haven. So long as this continues, we can probably borrow as much as we want or need. The deleveraging process, however, has to start sooner rather than later.

_______________________

Mount Airy, Md.: Dear Daniel,

I recently learned about credit default swaps and CDOs and how these investments have contributed to the current global economic meltdown. The immensity of the impact of these debts is downright scary. It would seem that we could never inject enough capital into the banking system to offset the effects. Is this truly the case? Also, of the billions of bailout money, how much goes to paying off these obligations?

Daniel Gross: a very complicated topic, and in some ways bigger thanthe banks. AIG, an insurance company, is among the biggest players in credit default swaps. And it's true that a certain amount of the bailout money given to AIG has been used to maintain trades and make counterparties to credit default swaps whole. I think going forward, the companies that are on the receiving end of AIG's CDS payments should be forced to take a haircut.

_______________________

Rhode Island: Hi Dan, regarding the SEC and its role in this debacle, please refresh my memory. I seem to recall that Bush basically fired a previous SEC head because he actually, you know, enforced regulations. That guy was replaced by Cox (is that right?) which leads me to think he was appointed to NOT regulate.

Daniel Gross: Cox's predecessor was James Donaldson, who was much more independent-minded, cut from the cloth of the old Rockefeller Republicans. I'm not sure as the reasons Donaldson left.

_______________________

forecaster/modeler...: So not true what you are saying. The problem is that the correct people were not hired for the correct jobs. There are plenty of people out there running plenty of software programs—and they have NO IDEA how to interpret the results from the software/models/whatever. And then when the 'correct' (i.e., math people/stat people, whatever) DID put the numbers together, well, most of the time, management DID NOT want to look at it properly.

I.e., no one worth their salt wouldn't put in a distribution in there and say: Hey, ya know, the chances of XXX occurring next year is YYY—so the chances of whatever might be 5%, even though it happened last year—and management would typically just ignore it. (Have you met any phDs in math? Not the most outgoing people. I can say that, I have a master's in applied math.)

So what's a quant to do? This 'revolution' was NOT led by quants; the quants were typically standing by looking and saying: but things aren't going to be next year what they were. They may have been off a year or so, but they KNEW the crash was going to happen. Just that no one wanted to listen...

Daniel Gross: I see what you're saying. Many of the people who made the decisions based on the model weren't the people who were maintaining it.

But with economic forecasters, my original point stands. Economists, as a group, always miss calling recessions. In December 2007, as the economy was about to slip into a recession, they collective forecast growth of about 2% for 2008.

_______________________

Boulder, Colo.: As a small business owner, I don't understand how the government can justify spending 40 billion dollars to purchase a 40 percent share in a company whose total value is only 9 billion dollars. Why can't the government act like a private equity firm and buy enough shares in the bank to get a controlling interest and than auction off the bad assets and sell the good assets to private interests? What they are trying to do is the equivalent of giving mouth to mouth resuscitation to a beached whale. It's better to just let the scavengers devour the flesh and move on.

These guys at the Treasury remind me of the venture capitalist, all with Ivy league resumes but no business sense who would keep funding failed businesses they had initially funded with 3rd and 4th round financing simply because they did not want to admit failure. These banks were run by con artists who made very stupid business decisions and these people should be purged from the financial system and their Ponzi culture destroyed.

The government should act like a good private equity firm with the motivation to make as much money for the share holders (we, the taxpayers) as they can while reducing risk. They should be less concerned about preserving individual institutions and more concerned about getting money in the hands of groups who know how to allocate capital. You gain nothing by betting on horses who have proven they can't run. I would be much happier if Warren Buffet, the world's most successful investor, was in charge of this recovery than Larry Summers, who is reputed to be a brilliant economist (an oxymoron) but who was against regulating derivatives and was for the repeal of the Glass Steagal Act.

Academic talent and theory is necessary but not sufficient to prevent another great Depression. The Obama administration also needs to employ practical businessmen to implement the strategy with cold precision.

Daniel Gross: I agree w/ you 100%.

_______________________

Evanston, Ill.: Lehman could have been saved but at that point Paulson was refusing to put up any consideration to get the deal done. He did it for Bears Stearns and Freddie and Fannie. Lehman was a sacrificial lamb and the aftermath was failed game of financial Russian roulette. The Fed has an exigent circumstance clause that allows them to lend unlimited amounts to anyone for collateral IT deems sufficient. Bernanke claims they didn't have good enough collateral but that is a total canard given that the Fed has total unfettered discretion.

Daniel Gross: yes, I think there was definitely a conscious decision to let Lehman fail. There was a sense inside Treasury that Lehman had been put on notice, that they had been given six months since the failure of Bear, Stearns to deleverage, to get their house in orders, and that they just didn't execute.

_______________________

Daniel Gross: Well, that does it for my hour. Thanks so much for all the good questions. And please keep reading. A reminder, anyone interested in seeing the first chapter of my new e-book: Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation, should send an e-mail to: .

PRINTE-MAILRECOMMEND...RSS

FacebookMySpace Mixx Digg Reddit del.icio.us Furl Ma.gnolia SphereStumbleUponCLOSE

SPONSORED CONTENT

• Winter Woes
  Prudie gives advice for all kinds of holiday dilemmas and family crises.
  Dec. 14, 2009
• Turkey Takes a Holiday
  Prudie counsels a vegan whose family refuses to go meatless for Christmas—and other advice seekers.
  Dec. 7, 2009
• Fiance on the Down Low
  Prudie counsels a woman whose partner has secret sex with men—and other advice seekers.
  Nov. 30, 2009
• Search for more Chat Room, The articles
• Subscribe to the Chat Room, The RSS feed
• View our complete Chat Room, The archive