Stein’s big idea this week is that if banks have taken large losses, their
board members should be held responsible. It’s something I’ve
said in the past, so I should agree with him, right? But this is Stein,
of course, which means that even when he’s right, he’s right for the wrong reasons.
Take banks’ losses on CDOs. What happened there? Banks such as Citigroup and
Merrill Lynch would bundle up lots of bonds, many of them backed by subprime
mortgages. They would then take the income from those bonds, and split it into
tranches, much like the income from mortgages is aggregated and tranched in
mortgage-backed securities. They would then sell the tranches to investors attracted
by the high yields on offer, and they would make healthy profits by charging
a fee for their services structuring the CDO in the first place.
But there was a problem. It turned out to be quite easy to sell the lower-rated
tranches of the CDOs, and even the weakest of the AAA-rated tranches. But at
the very top of the waterfall, there was a large chunk of so-called "super-senior"
notes, which yielded so little that no one seemed particularly interested in
buying them. As a result, the banks structuring the CDOs tended to keep those
super-senior tranches on their own books – an activity which they thought
carried negligible risk, since the debt was, as we used to say in England, as
safe as houses.
When houses turned out to be not very safe, those super-senior tranches went
from being safe to being unsellable at pretty much any price. You could try
to look to something like the ABX index to get an idea of what the market considered
them to be worth, but for many
reasons the ABX is an atrocious guide to the value of super-senior CDO tranches.
All the same, those CDO tranches are now clearly not valued at par, and so the
banks concerned, responsibly enough, have written down the value of those tranches
by many billions of dollars.
Now, here’s Stein:
Why didn’t the directors ask the chiefs, “Gee, how can you continue
to earn a far higher rate of return on debt than the market rate? How are
you defying gravity this way? Can it last?”
Why were the questions not asked?
Well, Ben, the questions were not asked precisely because the super-senior
CDO tranches weren’t earning more than the market rate: that’s why
no one was particularly interested in buying them. They were considered ultrasafe,
ultraboring, low-yielding assets. The banks were happy to hold on to them because
they were safe and because they came with hefty fee income attached. But if
no one structuring these things foresaw that they might plunge in value, it’s
a bit much to ask directors to be so prescient.
What the directors should certainly have been doing is keeping an eye on total
CDO exposure – that’s where the Merrill directors fell asleep at the wheel.
But the number they should have been looking at was the rate of increase of
total CDO assets, not the spread between market interest rates and
the yields on CDOs. Looking at that spread would have told them nothing.
Stein doesn’t stop there, of course. He accuses Merrill of being "P.C."
in its choice of directors, stopping just short of making the same accusation
about the chairman of the board in particular, who of course was African-American.
And he is also unimpressed by Bob Rubin:
When I saw that Citi had taken a bath in collateralized debt obligations
and subprime, and saw that Robert E. Rubin had been on the board in a major
position and had failed to stop the train wreck, I was staggered. And now
he has been named chairman. He couldn’t protect Citi’s stockholders,
and now he’s in charge? And let’s remember, he was Treasury secretary
when we had the first part of one of the worst bubbles in stock market history.
What on earth are the Citi directors thinking?
Clearly, everybody on Citi’s board "failed to stop the train wreck"
– should they all have been defenestrated along with Chuck Prince? And
I really don’t see what Rubin, as Treasury secretary, can or should have done
to prevent a stock-market bubble. It may or may not be fair to blame Alan Greenspan,
who was in charge of monetary policy and margin requirements, for that bubble.
Rubin, by contrast, was in charge of fiscal policy, which has precious little
effect on stock prices.
Stein finishes off with an appeal to patriotism, implicitly accusing Rubin
and the other board members of immorality:
It certainly hurts to spend day after day, as I did this fall, at Walter
Reed Army Medical Center — where the incredibly brave wounded soldiers
from Iraq and Afghanistan learn about walking and eating without their natural
legs and arms — and to realize that the America for which they’re
fighting is led in so many arenas, especially the money one, by such weak,
It’s high time that the America for which soldiers sacrifice so much
is run on a moral standard more like theirs.
Do you hear that, Mr Rubin? You should behave, at Citigroup, much as US soldiers
behave in Iraq and Afghanistan. Your thank-you letter for this advice should
be sent to Ben Stein, c/o the New York Times, 620 Eighth Avenue, NY 10018. Hop
to it, before more "fresh tears keep the ground damp" at Arlington