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Regulation

Financial Metaphors Run Amuck

By Max Frumes, Medill News Service

WASHINGTON — Bazookas, tsunamis and tortoises. Oh my.

The financial world and its regulators struggle to explain complex concepts, at times turning to metaphors that would make an English teacher cringe.

Henry Paulson, the former Treasury Department secretary, took his turn in front of the Financial Crisis Inquiry Commission on Thursday, armed with an arsenal of his own metaphors. Here’s a sample from the exchange, with the group trying to find out what went wrong and how to fix it for next time.

Subprime securitizations were scary micro-organisms: When subprime securitizations began to go bad, it created fears of all securitizations, even unrelated ones. “People use this E. coli example or mad-cow disease,” Paulson said, referring in part to the 2006 E. coli scare that created an aversion to all spinach, even the untainted. “I do think that it’s a good example because there was so much uncertainty about that. It infected, you know, so many in securitizations in terms of the investors’ concern.”

The authority to backstop Fannie Mae and Freddie Mac was a bazooka: Just before the two mortgage giants failed in 2008, Paulson said that having the authority to back them up would be like having a bazooka in a street fight — i.e., if you have enough firepower then you’ll never have to use it. “You asked us to give you a bazooka you would never have to use and then shortly thereafter you used it,” said Douglas Holtz-Eakin, FCIC commissioner. Fannie  eventually raised $7 billion. Freddie committed to raise capital, but never did.

Financial crises are toothpaste: When trying to assess whether Paulson could have stopped what led to the financial crisis, FCIC Chairman Phil Angelides asked if “the toothpaste was already out of the tube” by the time Paulson took the helm at Treasury in 2006. “Most of the toothpaste was out of the tube, and there really wasn’t the regulatory apparatus to deal with it,” the ex-secretary responded. (Alternative version: Financial crises are baked goods. “The situation was already baked” when Paulson arrived.)

Financial crises are tsunamis: Angelides implied that Paulson should have seen it coming. “Even when a tsunami comes, you have warnings ahead of time,” he said. Paulson didn’t run with this metaphor, replying that financial history didn’t predict the widespread decline in housing prices. He said he didn’t know what could have been done with such a warning. Crises happen no matter what, Paulson added, and will continue to happen.

Skin is money: In securitizing mortgages — the process of bundling the debt and selling it off — the originators didn’t have a stake in whether the mortgages were paid off or not. They didn’t have “skin in the game.” Also, market makers, or those who hold enough of a security to provide quick trading, don’t have skin in the game, critics claim. Paulson warned that it’s also important not to have too much skin in the game. “Where the big problems were, were the two or three institutions that not only had skin in the game, they had half their body in the game,” Paulson remarked.

Complex derivatives are cookies: Banks that packaged collateralized debt obligations, which are slices of other securities involving subprime mortgages, wound up suffering from their own cooking. They “choked on their own cookie.”

Bear Stearns was a wounded beast: FCIC commissioner Keith Hennessey asked if Bear Stearns was just the “slowest steer and the lion got it.” Also, Bear was referred to as the “weak deer” that served as food to short sellers, who were coordinating to bring it down. Though he did not believe that short sellers were a big cause of the crisis, Paulson said there were coordinated attacks. “It sure looked like to me some kind of coordinated action,” he added.

Unacceptable collateral is a Styrofoam tortoise: Former Rep. Bill Thomas, the FCIC’s vice chairman, chimed in with his own tortured metaphor to make a point about the role that accounting gimmicks may have played in the collapse of Lehman Brothers Holdings Inc.

In Thomas’ story, tortoises were disappearing rapidly, and some thought it had something to do with sheep. Someone suggested using Styrofoam tortoises to track their interaction with the sheep. Thomas replied that they might as well use Styrofoam sheep too, with the point being that it wasn’t an acceptable substitution — just as shaky mortgages aren’t a substitute for stable securities.

It turned out, he said, that crows were “flipping tortoises in the morning for a warm meal in the evening,” nothing to do with the sheep. Paulson said the participants got sloppy in their decisions, like those who accepted mortgages as the collateral.

The housing market is tinder: Paulson had yet another metaphor. He said subprime was only the most flammable part of the problem, “the driest tinder,” and that other parts of the housing market were flammable and eventually caught fire.

Marketwatch

New Curbs on Short-Selling

By Marcy Gordon, AP Business Writer

WASHINGTON – Federal regulators on Wednesday imposed new curbs on the practice of short-selling, hoping to prevent spiraling sales sprees in a stock that can stoke market turmoil.

The Securities and Exchange Commission, divided along party lines, voted 3-2 at a public meeting to adopt new rules.

The rules put in a so-called circuit breaker for stock prices, restricting for the rest of a trading session and the next one any short-selling of a stock that has dropped 10 percent or more.

Short-sellers bet against a stock, in a practice that is legal and widely used on Wall Street. They borrow a company’s shares, sell them and then buy them when the stock falls and return them to the lender — pocketing the difference in price.

The SEC move followed months of wrestling with the controversial issue. The SEC asked for public comment last April on several alternative approaches to restraining short-selling, and a bipartisan group of senators have been pushing the agency to act or face legislation.
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