Maurice Greenberg on What's Next for Wall Street
TNI's editor Justine A. Rosenthal interviewed Maurice Greenberg, prominent financier and Chairman & CEO of C.V. Starr & Co., Inc. about the financial crisis.
Justine A. Rosenthal: What do you think was the real cause of the financial collapse? Could you give our readers a primer on what went wrong?
Maurice R. Greenberg: I think there were several things, it wasn't just one thing. I do believe that keeping interest rates as low as they were for a number of years led to credit decisions that were badly thought out. Credit became so easy to get and leverage became so high that companies were leveraging twenty or thirty times their capital, which is an awfully large number.
There was also a desire in the country, and it was government policy, to expand home ownership as rapidly as possible. People that didn't have the net worth or the earning power to justify home ownership got into homes. But there is a limit to everything. Prices rose and obviously a bubble was created, and then the bubble burst.
But there were other issues as well. There's something called fair-value accounting, which essentially means you mark to market. And companies were forced to comply with this system starting in 2008. If you are running a trading company such as an investment bank where you're trading securities day to day, you have to mark those securities to what the market is at the end of every day so you know if you've made a profit or loss in the transactions you've undertaken. But if you're running, say, a life insurance company where you're assuming you need to earn at least 3 percent on the premiums you're charging in order to fulfill your obligation to the insured, you invest in, say, a twenty-year bond that pays 4.5 percent. You match that bond with your 3 percent obligation, and you hold the bond to maturity. What do you care if the bond sells higher or lower during the intervening period? If the bond continues to pay the interest you were expecting, that's all you care about.
But when you're required by the accounting principles that were applied recently to mark the bond to market, you have to recalculate every day. The bond would go up and down during the twenty years, which then creates volatility and in many cases leads companies to need to raise more capital, but the bond sells at a discount. All of this leads to tremendous volatility in the marketplace.
As of this morning, the SEC said it is no longer necessary in all cases to mark to market. That should provide tremendous relief in many parts of the economy because many companies have been hard-hit by this practice.
Confidence is also an important factor in any economy. And when confidence gets lost, people don't do business. When credit becomes almost invisible, business dries up. And then there's a flight to safety. Companies or people don't want to have their money in a bank that isn't guaranteeing the deposits, or one that limits the amount of guarantee that exists.
So you had all those factors driving at one time, and things just came to a rapid halt. It's the first time in the memory of any adult that we've had an economy that simply ground to a virtual halt. Unemployment rises, business declines. Toxic products or investments like subprime mortgages are on banks' balance sheets-all of which must be marked to market. All of these factors caused the situation we're currently in.
How much will this change in mark-to-market policy alleviate the crisis?
It will have an impact. The problem is since you already had to mark to market, there will be a lot of wariness now that you don't have to do it. Some will ask what the assets are really worth. Before, with mark to market, you marked an asset, say, at 20 cents. Now, you're saying it's 70 cents. Which one is right? You're going to have a lot of disbelievers out there, but it should have some impact and influence the rating agencies.
Rating agencies downgrade a company, from say AA to A, based on these mark-to-market valuations. In many cases, these downgrades require the company to raise capital. But you can't raise capital in the marketplace we're in today, or if you do raise it, you're going to pay exorbitant funds for it. It's a vicious cycle.
Look at what the Federal Reserve and Treasury Department did to AIG. It was downgraded because of mark-to-market practices and had to raise capital, so the Fed charged them 8.5 percent on $85 billion, whether they took the $85 billion or not. In addition to that, they want to own 80 percent of the company. So you've got these crazy kinds of events taking place, and confidences get shattered. And confidence, as I said, is crucial.
Given all this brewing below the surface, how could people say we had a healthy economy?
Because it was covered up by lower interest rates and rapid growth. People who had no right to home ownership got into homes. They didn't have enough income to justify the purchase, but they believed the price of their home would rise and they'd flip it, make a profit and move on. That got out of control.
And new, very complex products were created at the same time. Investment banks took many of these mortgage products-products that were rated AAA, A, BBB-and packaged them all together. People bought them without realizing that if any one part of that tower was downgraded, the whole thing would be downgraded. All of this led to unsavory practices that got out of control.
So when are we going to see the end of this? How many more failures can we expect?