Friday, September 19, 2008

Financial Crisis Primer

**Make sure to read Part II, here.**

While I have written posts about the Freddie/Fannie mess as well as the collapse of Lehman and Bear, I found an excellent synopsis of the situation in the Sept. 19, 2008 print edition of "The Wall Street Journal." Cheap? No. 100% Free. Trade stocks for free on The Free Trading Community.

On page A21, Todd G. Bucholz writes in the Bookshelf section an article titled, "The Woe on Wall Street." The article is a review of David Smick's book, The World is Curved. Here is where I found this gem of knowledge:

"The real problem running throughout the system was not a lack of new regulations. It was a lack of skin - that is, skin in the game. Mortgage brokers turned into fly-by-nighters, immune from the effects of reckless decisions. Local bankers, securitized loans and packed them off to some naive investor or to a rating agency manned by analysts who weren't sharp enough to get a job at Bear Stearns or Lehman. Homebuyers who put nothing down or lied about their income could pack up and run off, leaving no skin behind. The entire housing sector began to look like a motel renting rooms by the hour, as johns and hookers snuck out during the wee hours."

Phew, in a paragraph, that's it. Each player had a part to play. In each case, there was a lack of fundamental risk management. Mortgage brokers were setting up loans to folks who shouldn't have had them. The banks lent the money anyway, and sold off the loans to those who didn't have the skill or desire to evaluate them properly. Investment houses saw low interest rates as the sole risk premium, ignoring all that they had learned at Wharton or Harvard. Protect your Medical Identity with TrustedID. $1,000,000 Warranty & Great Customer Service

While I don't wish to understate dishonesty or chicanery, I can't speak strongly enough of proper risk management. I invite all those who study or have studied such things to go back to your Finance books. Look at the sections about risk management. Its worth the read. And to think, I only got my MBA from a state school.

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