The American Spectator

p>Yes, we were warned. But no one in a position of power was going to do anything about it. They were all making too much money. br> — Michael Tobias /p>

Really, now. The Wall Street Journal’s editorial page has been harping on the problems at Fannie and Freddie for years. Why not give them some kudos? Further, the Federal Reserve board issued a study in 2003 (!) showing that the benefits of the taxpayers’ guarantee went to the shareholders and management, not the homebuyers. As we all know higher leverage in good times means higher profits. With the implicit, now explicit, guarantee by the taxpayers, it was a classic “heads I win, tails you lose.”

I have always been amused by Mr. Buffett’s disparaging of derivatives. Insurance is, by its very nature, a derivative! Insurance happens to be the core of his investment empire. Are derivatives only good for him, but no one else?

The current mess is based on two things: excessive leverage and so-called fair value accounting, FVA, coupled with Sarbanes-Oxley rules. They reinforced each other as problems arose. FVA required firms to value their assets at the best price offered for them, or go to jail under the Sarbanes-Oxley travesty. Even if the securities in question were performing well, a low-ball offer became the market price. This caused firms to write down the assets. This writedown came straight out of capital. This is where leverage came into play. A firm leveraged 25-to-1, say, would have its capital wiped out with 4% writedown in its assets. Add into the mix the fact that banks’ balance sheets are almost as opaque as re-insurance companies are.

To show how ludicrous the current situation is, consider the following: the total of subprime mortgage debt in mid-2007 was about $1 trillion. The announced write-offs are close to that. Does anyone seriously believe that the whole subprime mortgage market is going to default and that the underlying assets, the houses, will have zero value? This is the type of nonsense that FVA has brought us to.

p>I’m not trying to remove any culpability from the execs at these firms. They weren’t forced to leverage themselves to the hilt. Also, it would have helped if they paid attention to what was going on down in the trenches. It appears they took the Barings Bank’ management view: as long as accrual accounting showed we were getting richer, don’t ask any questions. br> — James M. Mulcahy br> Grand Island, New York /p>

Thank you for “Warren Buffett Told You So” by Philip Klein. However, I have to disagree with his analysis to some degree. The derivatives involved in the current crisis, the Mortgage Backed Securities (MBS), are a very small part of the total derivatives market. Derivatives used to be called futures and options, which began life in the17th century Dutch Republic. They have been used extensively since then without causing any crises. Boone Pickens used derivatives in the mid-'80s to protect his company against falling oil prices. Southwest Airlines has used them to protect it from rising fuel prices. So I don’t think it’s fair to blame derivatives in general, or the MBS derivatives, either.

The author states in the article that “…financial firms lost sight of what they actually owned, and became overleveraged.” That’s the key — overleveraged. The derivatives didn’t cause firms to become overleveraged. That was a conscious choice based on the low interest rates from 2001 to 2006, a policy of the Feds. Unnaturally low interest rates cause many businesses to borrow too much. Then when the crunch hits, they have to unload that debt and some can’t so they fail.