Think Twice Finance

The Subprime Mortgage Crisis: A Personal Journey. Part 1

As I watch the sorry sight of the collapse of the mythical global regulatory structure known as the Basle Accords I & II, my mind constantly wanders back to an ironic episode in my personal struggle for banks’ “right” to act like private profit-makers in a regulation-bound environment. Never a scrapbook kind of guy, I can’t put an exact date on these events, but it was in the mid-80’s. The bank regulators had announced their intention, which around 1990 became reality, to place regulatory controls on bank risk-taking. I was a derivatives arbitrageur for an American bank, Manufacturers Hanover, at the time. This announcement caused me great concern on a couple levels. First managing my own risks was quite a difficult and fluid process. Second, understanding the process of managing those risks was my core value-added in the industry and, thus, obviously, the source of my income.

I wrote a letter to the American Banker condemning the regulator’s entry into the risk management process. I pointed out that nobody, least of all a regulator, was competent then to manage with one set of rules what was a rapidly innovating and challenging cutting-edge skill. This letter predictably brought on a regulatory feeding frenzy in response. The American Banker’s letters section fairly expanded to 10 times its original size, fueled by the hot air of outraged assistant secretaries at various regulatory agencies. I shot back the regulators’ own published current proposal for regulating interest rate risk, which was to give each bank a single grade for risk management – good or bad. One doesn’t need an aeronautics degree to see that plane won’t fly.

To my disappointment, a very senior officer of the bank stuck his head around the corner of my office next day. He said, “Cut it out. We have to make deals with these guys and we have to get along with them.” At that moment I realized I was playing the wrong game. Here I was, defending the interests of the stockholders and trying to make an honest buck. (Well OK, many honest bucks.) But the real action was the deals that management was cutting with the regulators behind closed doors. It was a moment of personal tragedy. I questioned whether what I was doing was going to become some sort of manipulated charade, and basically lost confidence in our future. Ultimately I resigned.

It was one of those moments where one is a burnt tree and therefore missing the fact that bank officials and bank regulators were running around throughout the forest with gas cans and matches. Next post will take up developments in the bank/regulatory environment that followed, as we wend our way to through the real story of the unfolding of the subprime mortgage crisis.