Greenspan's Grand Experiment

Way before the potential for a credit crisis was on anyone’s radar, American investment guru Warren Buffet dubbed derivatives, the complex financial contracts that are claimed to be the culprit of the collapse, “financial weapons of mass destruction.” Felix Rohatyn, a former U.S. ambassador and a central player in the 1975 plan that saved New York City from bankruptcy, described derivatives as potential “hydrogen bombs.”

One economic titan, however, felt differently. And as head of the world’s most influential economic institution, his views carried a lot of weight. I am talking about Alan Greenspan, Chairman of the Federal Reserve from 1987 to 2006. Greenspan had deep affection for deregulation. To him, the powerful financial institutions that (used to) populate Wall Street had a very large interest in ensuring that all of their assets were protected and that they had the resources in place to make sure all the investments they made were sound. While defending derivatives during a hearing in 2003, Greenspan said: “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so.”

In 2000, after years of pushing and shoving, Greenspan persuaded Congress to pass the Commodity Futures Modernization Act, the bill that removed derivatives from the purview of federal oversight. The derivatives market thereafter grew from $100 billion to more than $50 trillion. Although the housing collapse is often cited as the culprit of the current credit crisis, derivatives are what actually made our financial system vulnerable. Originally intended to reduce risk and spread prosperity, derivatives instead magnified the impact of bad mortgages. When homeowners began defaulting on their mortgages, the investment houses did not have enough capital to cover the derivative settlement claims and, as a result, are now in great peril.

In essence, the great debt that the world economy has to now face is the result of an experiment by Greenspan to let the market forces run free. Investment bankers, who collected billions of dollars in bonuses, were selling mortgage securities they thought were safe and derivatives that they thought would never have to be paid off. On the other side of the spectrum were the investors, who were buying credit default swaps that would pay off big when other people’s mortgage investments went south. And with the multitrillion-dollar market in place – no one was there to regulate. No one was keeping track of how many derivatives sold. No one knew who owned them. No one was making sure that the investment houses were setting aside the money needed to pay off their obligations if the mortgages went sour.

On Thursday, while testifying at a Congressional hearing, Greenspan admitted that he had “put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending.” Hailed three years ago as “the greatest central banker who ever lived,” the retired Chairman’s legacy will likely be quite the opposite: the man who paved the way to a global credit crisis.

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Credit Default Swaps: Part II

If you happened to read my last posting on credit default swaps, make sure to read the transcript from 60 Minutes last night, who aired another segment on the topic.

For a complete transcript, go to: http://www.cbsnews.com/ stories/ 2008/ 10/26/ 60minutes/main4546199.shtml

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Dean's Roundtable - Building your "Knowledge Bank" by Ethan Samson

We all have a "knowledge bank" that we develop throughout our life, which we rely on and tap into to distinguish ourselves in the workforce. Enrolling in law school was a huge commitment, both financially and mentally, to enhance this knowledge bank through devoting (almost all of) your time to studying law at Chicago-Kent. Sitting in at two of Dean Krent's Roundtable discussions not only showed how valuable it is to expand a student’s "knowledge bank,” but also gave an opportunity to expand it.

Mr. Ted Koenig (Chicago-Kent class of 1983), Founder and CEO of Monroe Capital, spoke often of this “knowledge bank.” Mr. Koenig explained that everyone has a “knowledge bank” that contains valuable bits of information that enable us to work in different fields and different positions. Mr. Koenig’s knowledge bank, prior to entering the business world, has contributions from many sources: he earned his CPA after graduating with degrees in accounting and finance from Indiana University, he had an externship with a court working in organized financial crimes, he worked as an M&A attorney at Winston & Strawn, and then as an attorney at Hollub & Kauf. In 1998 he realized that his wealth of knowledge had surpassed that of his clients, and entered the business world to open his own financing business. Eventually, he opened Monroe Capital, which has provided over $1.5 billion in financing since 2004. The legal portion of his “knowledge bank” has given him an advantage in many aspects of his financing business, including the effect of bankruptcy, assignability of rights, effects of selling off investments, the list goes on. Mr. Koenig stressed that the most important thing as a developing attorney or business person is to build on this bank; take advantage of every opportunity you have as a student, because the opportunities (and time) decrease as you enter the workforce.

Mr. Lee Augsburger, of Prudential Financial, Inc. demonstrated to a group of 7 students his path to building his “knowledge bank.” While it is always expanding, his experiences as a law student (Chicago-Kent class of 1987), attorney, and businessman have allowed him to rise to the position of Senior Vice President & Chief Ethics and Compliance Officer of Prudential, a Fortune Global 500 company. His role in the company is large; he basically oversees how the company takes legal advice and implements it into the business process in the most effective and efficient way possible. As a corporate lawyer, his advice was insightful as to how a company uses advice that attorneys feed them. Lawyers should be aware of the steps taken after advice has been given, and ask if their advice can be implemented into the client’s business so as to be compliant with regulation. Further, Mr. Augsburger advised anyone who is looking to be in-house counsel for a company of any size what sort of experience helped put him in this position. His “knowledge bank” is what allowed him to bridge the connection from lawyers to businesses. Prudential Finance saw the value in this, and put him in the position where he has been able to succeed.

These Roundtable discussions are one very valuable way to expand your knowledge bank while in law school. The opportunity to speak with people working in the positions of Mr. Koenig and Mr. Augsburger does not come often, but when it does, it pays to take advantage of it. Many more opportunities similar to these are constantly being presented here at Chicago-Kent College of Law. Look out for upcoming events such as the October 21 event “From the Courtroom to the Boardroom” and other events which will be discussed here in the CLS blog.

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The Blame Game by Brandon Davis

It is undeniable that greed has played a starring role in our current financial crisis. However, playing the blame game is complex when the actions of so many people in so many positions had a disastrous effect on our economy. Although it may be easiest to blame the self-indulgent nature of Wall Street, other players may be equally, if not more responsible.

I think that we need to focus more on Congress' actions in precipitating our current reality. I agree that furthering social policy goals should be high atop Congress' "To-Do List." However, the current state of our economy can be closely tied to an admirable mandate of Congress: that every American should have the opportunity to own a home.

Since 1992, Congress has pushed Fannie Mae and Freddie Mac to increase their mortgage financing to low and moderate-income borrowers. In fact, Congress has given Fannie and Freddie concrete targets. For example, this year the goal was that 28% of all mortgage purchases would be "specially affordable" loans. These loans typically go to borrowers with income less than 60% of their area's median income. Furthermore, in 1995, Congress bolstered the Community Reinvestment Act and caused an increase in bank loans to low- and moderate-income families by 80%. These methods allowed Congress to increase low-income home ownership without spending a dime on subsidies.

Win-win, right? Not through the lens of moral hazard. Moral hazard is the prospect that an individual shielded from risk may act differently than he or she would act if fully exposed to that risk. The mortgage meltdown stemmed from Congress' drive to increase home ownership by reducing its risks. Moreover, these efforts were directed at the riskiest borrowers, leading to an unacceptable level of moral hazard and, in turn, the subprime mortgage crisis. What can Congress learn? Risk may shift or spread among several parties, but it is never eliminated. Maybe the actions taken to further public policy goals should not be freed from the restraint imposed by ordinary risk.

While the investigation continues into the greedy, Wall Street titans, we should not forget about the harmful effect public policy may have played in the failure of our financial system.
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Corporate Law Society Presents: "From the Courtroom to the Boardroom"

Please join the Corporate Law Society and the Career Services Office on Tuesday, October 21, 2008, when alumnus Howard Davis (Class of 1980), Jeffery Rothbart (Class of 2002) and Paul Cohen will address the topic, “From the Courtroom to the Boardroom: Using Your Law Degree in the Business World.”

After practicing law for ten years, Howard Davis, Class of 1980, and partner Jerry Kleiner teamed up in 1991 to open Vivo restaurant in what was then an undeveloped West Loop. Since then, Mr. Davis and Mr. Kleiner have established themselves as the creators of some of Chicago’s most imaginative and respected restaurants, including Marche, Red Light, Gioco, and Opera.

Jeffery Rothbart, Class of 2002, is the Principal of Boulder Net Lease Funds, a private equity real estate fund. After practicing real estate and tax law, he formed Boulder Net Lease Funds, where he serves as day-to-day manager and is primarily responsible for the identification of investment opportunities, acquisition related activities, asset management and serves as liaison to the legal, accounting, securities, insurance and financial advisors.

As Vice President of Mesirow Financial Real Estate, Inc., Paul Cohen is the assistant project manager on several of Mesirow’s largest projects. Specifically, Mr. Cohen currently works on the development of 353 N. Clark, a 1.4 million square-foot high rise office and retail property in downtown Chicago. He plays an integral role in the legal, marketing, leasing and management functions of the project as well as structuring financing for the project. Mr. Cohen received his JD and MBA from Washington University in St. Louis, MO.

The event will convene at 12:00 p.m. in Room 510. Pizza and refreshments will be served. Read More......

Credit Default Swaps

For those who watched 60 Minutes’ segment Sunday on “credit default swaps,” were you enraged to hear about these financial explosive devices? Were you embarrassed to find out that our economy, the financial pioneer, has been taken advantage of by champagne drinking, shrimp cocktail eating Wall Street titans? I was, and I had trouble sleeping last night because of it!

If you did not catch this week’s edition of 60 Minutes, the show laid out the following horror story: Mortgage lenders sold loans with low introductory “teaser” interest rates. The lenders then sold the huge volume of loans to Wall Street banks, like Bear Stearns, Lehman Brothers and Merrill Lynch, who then bundled them into bonds known as “mortgage backed securities.” To entice investors, the investment houses created and sold a “credit default swap” that was marketed to protect the investors against losses if the investments went bad.

And this is where it gets bad. In essence, a “credit default swap” is an insurance contract. However, the banks were very careful not to classify it as “insurance” and used a magic word, “swap,” as a substitute. If it were insurance, the person who sold the policy would have to have capital reserves able to pay in the case the insurance was called upon or triggered. But because it was a “swap,” and not insurance, there was no requirement that adequate capital reserves be put to the side. When homeowners began defaulting on their mortgages, and Wall Street's high-risk mortgage backed securities also began to fail, the big investment houses had not set aside the money they needed to pay off their obligations. And this is where we are today.

Thomas Friedman, the Pulitzer Prize author on foreign-affairs, says that there have only been a few times in his life when he has truly been frightened for this country: the Cuban missile crisis in 1962; when J.F.K was assassinated in 1963; on September 11, 2001; and today, the scariest moment of them all. While the first three attacks on the U.S. were by outsiders, today’s financial crisis was a result of our own failure to regulate our financial system. In other words: we let greed take over.

Look at us now. On Monday morning, the Fed announced that the system will receive yet another enormous injection of liquidity, saying it would make as much as $900 billion available. But what is especially frightening is that even with action of this magnitude, confidence does not seem to be restored. By Monday, the Dow dropped 370 points. European markets are falling. Russia and Brazil shut down trading. Not exactly confidence-boosters.

About one hundred years ago, in response to the creation of the Federal Reserve, Charles Lindbergh, a Congressman from Minnesota, made this comment: “From now on depressions will be scientifically created. Like two con men working a mark, the Fed made credit easy while…newspapers hyped what riches could be made in the stock market.” Well said Congressman Lindbergh. Nothing seems to have changed.

For a complete transcript from last Sunday's 60 Minutes, visit: http://www.cbsnews.com/stories/2008/10/05/60minutes/main4502454.shtml Read More......

Welcome to the Chicago-Kent Corporate Law Society Blog!

To post on this blog, please contact us at chicagokentcls@gmail.com. We welcome comments on current events, relevant topics, or questions to pose to CLS members. Be sure to check back regularly as we update the blog! Read More......