Can You Believe This?

by Peter G. Miller
April 29th, 2008

Ben Stein — the droll actor and financial columnist — had a remarkable story in the business section of the Sunday New York Times.

There are any number of reasons for the mortgage meltdown, and also why FHA mortgage standards make so much sense in their present form. On the other side of the street, the lengths to which the lending industry has gone to undo financial sanity in the private sector are a constant source of wonder.

Stein describes a speech from David Einhorn of Greenlight Capital, a hedge fund.

According to Stein:

“Under an interesting set of rules promulgated by the Securities and Exchange Commission in 2004, called ‘Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities,’ the amount of capital that had to underlie assets was reduced substantially. (Mr. Einhorn rightly says that this set of rules should have been called the ‘Bear Stearns Future Insolvency Act of 2004.’)

“Through the act, the S.E.C. — acting as one of Wall Street’s chief regulators, mind you — also allowed such things as ‘hybrid capital instruments’ (much riskier than cash or Treasuries), subordinated debt (ditto) and even deferred return of taxes, to be counted as capital. The S.E.C. even allowed the banks to hold securities ‘for which there is no ready market’ as capital.”

In real estate a property for which there is no ready market is called just about worthless.

Lately I’ve been hearing from folks who say that investors are supposed to know about the mortgage-backed securities they buy. This is a great concept, but it begs the question: How? In real terms how are investors supposed to know? Who could possibly believe that amid thousands of pages of regulation that the SEC would come up with something so patently flawed and so financially dangerous? Isn’t the SEC supposed to protect the public?

Where, exactly, is the prospectus which says that mortgage-backed securities may have no ready market — and if such a prospectus exists how was it rated?

The full Stein article can be found at: Wall Street, Run Amok, April 27, 2008.

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