I have just finished Dr. Alan Greenspan’s latest book, “The Map and the Territory” and to some extent it fairly represents what caused the “Great Recession.” However, Dr. Greenspan omits the role of the Federal Reserve in causing the Great Recession.
In 1960, Mortgage Debt Outstanding to Personal Income was 50.61%. By 2004, Mortgage Debt to Personal Income was 107.34% and by 2008 it was 119.63%.
In 1960, Mortgage Debt to GDP was 7.35% but by 2004 it was 87.09% and by 2008 it was 111.23%.
In 1974, Mortgage Debt was $19.3 billion and government expenditures were $358.2 billion and Mortgage Debt as a percentage of government expenditures was 5.39%.
By 2004, Mortgage Debt was now $10.637 trillion and the federal government’s expenditures were $1.880 trillion or a Mortgage Debt to government expenditures of 565.8%. By 2008(after Greenspan’s departure) Mortgage Debt was now $14.661 trillion and federal government expenditures were $2.524 trillion or a ratio of Mortgage Debt to federal government expenditures of 580.86%.
But Greenspan’s biggest error, in my view, is his failure to provide quality audits (and the same condemnation holds for the FDIC) of commercial banks. Edward Altman, a professor at New York University, has devised what I believe is the best method of analyzing a bank’s credit portfolio. Professor Altman examined 66 companies that went bankrupt and developed a method for determining the key causes of bankruptcy. Without boring readers with too many details, his key analysis compares earnings before interest and taxes to total assets and gets a weighting of 3.3X.
In essence any company with a score of below 2.675X is of concern. So why shouldn’t the Federal Reserve, the FDIC and the Comptroller of the Currency use this methodology in analyzing bank portfolios. The bank under examination would need to weight exposure by individual company and the appropriate regulatory body would spot check the results, perhaps examining one of ten responses to assure the quality.
This methodology would allow examiners to see if bank loan portfolios were improving or weakening over a three year to five year period.
In my last years, I was the United States General Manager of Depfa Bank and my experience with bank examiners was not inspiring. They were frequently commercial bankers who were let go by banks for underperformance and thus were at the bottom of the intellectual barrel. Depfa Bank was a pure public finance bank and the examiners would question our portfolio. Unlike the case with structured securities where the rating agencies were played off by the five investment banks, i.e. the investment bank would propose a deal to, say, Moody’s and be rejected and they would say, “Fine, we will simply have it rated by S&P” and Moody’s would cave or cave more times than not. But with public finance, the issuers had no such luck and thus the ratings were correct over 95% of the time. So the examiners would question the ratings and I would say to them, “We have ratings from the rating agencies, we have our own house ratings as well.” Well how do you know these ratings are correct?” A question that really does not deserve an answer in my view.
The author spent 36 years in commercial banking and last served as General Manager for Depfa Bank. He currently is teaching at NYU’s School of Continuing Education and is the author of “Handbook of Corporate Lending” with Doctor James Sagner and “Case Studies in Corporate Lending,” both published by Amazon.
For more information about LexisNexis products and solutions connect with us through our corporate site.