Back in 2001, I was warned that the world’s financial markets were heading towards disaster. The warning came from a lawyer whose law firm was helping create the instruments that began imploding a year ago and came tumbling down on Monday.
Until his death two years ago at age 83, Edwin A. “Eddie” Goodman, QC, OC, PC, was perhaps the most powerful deal-making lawyers in Canada. One afternoon in late 2001, I was lunching with Eddie at The Albany Club, the oldest of old boy hang-outs in Toronto where portraits of the numerous members who did a term or two as Prime Minister adorn the corridors.
“I don’t think anyone understands these goddamned deals we’re writing (finance and tax) paper for,” Eddie said while chewing on pieces of a rich Irish stew, bits of it spraying from his mouth as he talked. “They’re so fucking complicated it’d take years – maybe decades – of litigation to unwind them if any of them fall apart. And if they do collapse, they’ll bring down businesses and governments with them.”
We were talking about the raft of convoluted, intricate and highly specialized financial instruments that were becoming increasingly popular with institutional investors and traders from Bay St. in Toronto to Wall St., London, Hong Kong, Tokyo and Singapore.
From helping create the Toronto Blue Jays baseball team to having a lawyerly hand in every major commercial real estate deal in the country, nudging a reluctant Prime Minister Brian Mulroney into normalizing relations with China four years after Tiananmen Square and then bringing large and small Canadian businesses en masse to the mainland, to helping turn Four Seasons Hotels into a global luxury hotelier, Eddie Goodman left a massive mark on Canadian business and government from the end of World War II into early years of the 21st century.
In the process, he built what became one of Toronto’s most-powerful law firms. So, if Eddie said no one could understand the complex nuances of the financial instruments being created, then no one could. And he thought he knew the reason.
“These damn things are going to get sold and re-sold and then re-packaged so many times until no one is really sure who owns what, or what they own. I think that’s the whole point.” He paused briefly to wipe his mouth with a crisp, white, linen napkin. “Someone will get screwed because eventually, the whole fucking thing will collapse.”
As a person, Eddie was bothered by what struck him as a giant, unregulated, high risk game of three card Monty being created for global players who would have nothing much at risk in creating the underlying paper; as a lawyer, he knew it was his job to do the best he could for a client.
Eddie Goodman didn’t live long enough to see his dark premonition come true. But, as with many things during his truly remarkable life, he had a talent for seeing far over the horizon to know what was likely to come next.
Skip forward to Meltdown Monday. While President Bush and John McCain were blithely insisting that Wall St. was merely experiencing an “adjustment” and the “fundamentals of the US economy remain sound,” billionaire investor George Soros took a dire yet more realistic view, warning “We are just sailing into the storm.”
This explains why Fed Chairman Ben Bernacke – who happens to a noted scholar on causes of the Great Depression in his other life as an academic – is shuttling frantically between Washington and New York, or on the phone to his counterparts in Europe and Asia, as he desperately tries to keep what he must know is a house of cards from collapsing. But in doing so, Bernacke must feel like the Dutch boy with his finger in the dike, trying to hold back the relentless, pounding ocean.
Fact: Even though the Federal Reserve discount window is charging banks less than 2% to borrow money, banks are charging other banks more than 6% for overnight borrowing. What that means is that American banks don’t trust each other enough to lend money amongst themselves, even overnight, at close-to-Fed rates.
Fact: While American International Group was the largest insurer of mortgage-backed securities, the crisis that still threatens to bring AIG tumbling down despite a massive infusion of capital into the company by the Fed as a last minute, desperate move, to keep the firm afloat, there are dozens of other, smaller companies like AIG who have insured the value of paper that is worthless.
Fact: As lenders become increasingly skittish, many commercial borrowers – even those with good or decent credit histories – will find it impossible to obtain debt at affordable rates. From small and mid-sized business to cities or even states may not be able to raise debt. A flood of Chapter 11 filings are likely to hit the courts, beginning in perhaps six months.
Fact: As businesses contract in the wake of tight money, unemployment will rise. Consumer defaults on their credit cards and mortgage payments will balloon, putting even more pressure on banks. Many will have to be rescued or allowed to collapse. Housing prices will continue to decline, adding to the woes of people just staying afloat who will own homes worth less than they paid for them
Between now and Nov. 4, it is entirely possible that the past 30 years of deregulation, of letting business do what it wants without any reasonable government oversight, of believing that my wealth (if I had any) would trickle down into your pocket, will be exposed as the greatest Ponzi scheme even invented by man. While that bodes poorly for the nation, it may propel Barack Obama into the White House.
Before then, former US Treasury Secretary Robert Reich says, “This is the end of the middle of the beginning of the credit crisis.
“We created a kind of casino atmosphere,” Reich continues, “in which almost anybody and any bank could make a lot of money by going deeper into debt, by buying up all sorts of debt instruments, by selling securities to people who didn't even know what was in the securities. In this sort of atmosphere we were begging for some kind of crisis.”
If that is not harsh enough language for you, read what Nouriel Roubini, an economics professor at New York University, posted on his blog: “This will turn out to be the worst financial crisis since the Great Depression and the worst US recession in decades.
“Hundreds of small banks with massive exposure to real estate will go bust,” he predicts. “Hundreds of US municipalities will go bust. Equity prices in the US and abroad will go much deeper into bear territory … This financial crisis signals the beginning of the decline of the American empire.”
As I wrote in The End Is Near For The Richest Poor Nation On Earth on Monday, the meltdown “marks the official beginning of the end of more than four generations of uninterrupted American prosperity.”
So thanks Ronald Reagan, much appreciated Bush 41, delighted to have known you, Bush 43. You must be so proud, Phil Gramm, the architect of deregulating everything financial and John McCain’s economic guru. And a special thanks to the yokels at the University of Chicago business school who created trickle down, supply-side economics back in the 1970s. All of you really smacked the donkey for the rest of us.
*This reminds me of an uncomfortable political situation that existed nearly eighty years ago. In 1935, just prior to Franklin Roosevelt's Social Securit...