media and red flags

DID MEDIA MISS RED FLAGS?
If regulators couldn’t see the diseased bark and wilting leaves, how could the media see the forest for the trees
TODAY Weekend • October 25, 2008
KENNETH S CHIANG

FINGERS pointed in all directions, including at the mass media, as the widespread financial meltdown wiped out trillions of dollars recently, but just as it’s wholly wrong to shoot the messenger for bringing bad news, it’s not entirely right to fault journalists for failing to sound a warning.
The queue for blame probably stretched for blocks. Long before the media’s turn, regulators and legislators, investment bankers and economists, mortgage lenders and borrowers should all face tough questions.
"Almost no one expected what was coming," claimed Mr Daniel Mudd, former chief executive of Fannie Mae, "It’s not fair to blame us for not predicting the unthinkable." The United States home mortgage colossus, together with its corporate cousin Freddie Mac, cost American taxpayers US$200 billion ($300 billion) to rescue.
As recently as last March, Mr Christopher Cox, chairman of the US Securities and Exchange Commission (SEC), felt"a good deal of comfort about the capital cushions at these firms". He was referring to the troubles facingMerrill Lynch and Lehman Brothers as well as Bear Stearns, even as he heard from his staff it hadUS$17 billion in cash and assets, supposedly sufficient to survive the crisis.
Barely five months later, Bear Stearns went to J P Morgan Chase in a fire sale, with the US Federal Reserve Board to absorb up to US$29 billion in Bear losses. Merrill sold itself to the Bank of America, and Lehman went completely belly up.
Mr Mudd elaborated on his excuse for what Fannie missed: "You’re dealing with massive amounts of information that flow in over months ... You almost never have an ‘Oh, my God’ moment."
Ah, information, as though that was the responsibility of journalists, not financial professionals. If regulators could not see the diseased bark and wilting leaves, how could the media see the forest for the trees? The red flags that some business journalists did spot made little impact, amid happy talk and surging prices.
Even as the blight spread unseen, those who would blame others had themselves been adding to the problem. Fannie Mae came under congressional pressure to increase loans to low-income borrowers. Such politicalmeddling in financial risk assessment was recipe for a toxic mess.
Given its multi-trillion dollar dominance of the mortgage market, Fannie was a prime player in the sub-prime crisis that led to the current credit crunch.
In the new millennium, mortgage lenders — bobbing in a liquidity ocean — were pressing loans on almost everyone, inflating a real estate bubble.
Call them irresponsible or predatory, but they had willing partners in borrowers eager to flip properties for profit in a booming market, or aspiring homeowners too illiterate or innumerate to comprehend mortgage contracts’ fine print.
A few institutions did sound the alarm, which echoed in the media. In a 2004 report, the Organisation for Economic Cooperation and Development expressed concern over distortions Fannie and Freddie presented: They had grown too big, strayed too far from their mandate by going into asset management and were under-regulated.
More than a year earlier, the Office of Federal Housing Enterprise Oversight — their regulator — had warned that "the economy could be seriously impaired if one of them were unable to meet its obligations". Their huge portfolios — of many dubious instruments, it turned out — encouraged perceptions they were too big to (or be allowed to) fail, thus increasing moral hazard all round.
Industry-wide, even if there was no ‘Oh, my God’ moment, there was something of a smoking gun: On April 28, 2004, the SEC met briefly to approve an exemption major investment banks had sought from a regulation limiting the amount of debt they could carry.
According to The New York Times, the decision freed billions of dollars held in reserve against investment risks, allowing the banks to wade into the fast-expanding market or mortgage-backed securities and other new-fangled instruments.
The SEC hearing attracted little or no media attention. Should it have made headlines? It is difficult to argue that the media should have started ringing alarm bells, or that they would have much impact if they did.
Financial and economic advisers’ warnings went unheeded. The SEC seemed to ignore the information the banks provided of their increasingly risky investments in sliced and diced mortgages. Banks were to self-regulate which, in practice, amounted no regulation. The rest became history, still not entirely free from fear and loathing, but which the media now cover in full.