Memo to: Contributors to the Global Financial Disaster

From: Len Rushfield, Adjunct Professor of Finance,

Pepperdine University’s Graziadio School of Business and Management

Objectives

As we conclude the first year of the global financial crisis with the crescendo from the Lehman Bros. bankruptcy, Merrill Lynch buyout and AIG bailout, this is intended to provide feedback on your performance including grades for the last year of your work.

Grades provide reference points for useful comparison and are not intended to embarrass anyone.

Federal Reserve Monetary Policy

Your effective work in overcoming the last big dot.com crisis filled us with high expectations. Everyone listened attentively to your confident observations that vast amounts of liquidity would not be a problem in the inflation of the real estate market.

You get high grades for persuasiveness, but not for accuracy. Overall your final grade of “C-” reflects on your constructive intentions, which were offset by the weaknesses in reasoning.

Banks Mortgage Lending

In the past, many observations about your work asserted that you were “diligent but dull.” Many of you certainly surprised us this time. The originality demonstrated by the abandonment of basic banking principles, including obtaining truthful financial statements and limiting lending to borrower repayment capacity, was very much evident among the more aggressive members of your group.

Unfortunately, two institutions with a strong presence in Los Angeles, Countrywide Financial and IndyMac Bancorp, were obliged to drop our course early due to lack of liquidity. Of course grades of “F” were waiting (and were awarded by the FDIC). On the other hand, some institutions, including two with a huge presence in the California market, Wells Fargo and Bank of America, showed admirable restraint and earned admirable grades: “A-” for both of you.

Regulators Bank Supervision

As usual, you could be counted on to complete all assignments on time and with diligence. But your performance remained very much “in the box” when events called for more aggressive thinking.

With your limited interest in what was going on outside the balance sheets, the banks under your supervision created an enormous amount of defective and risky assets placed in the markets through securitization. The reckless lending practices at the aggressive banks were well-known in the market but evaded your normally thorough review.

There is a great deal of room for improvement, and you have been good at correcting past deficiencies, so the grade “C+” is intended to encourage better efforts in the future.

Investment Banks Securitization

As our most aggressive participants, you continued to demonstrate extraordinary confidence and enterprise. The ability to generate vast amounts of innovative mortgage investments through your securitization activities was breathtaking.

Your creativity certainly has been a driving force in the economy. However, the focus on highly profitable transactions and your muted concern for risks imbedded in the investments you marketed were really disheartening. For the least responsible among your group, Bear Stearns and Lehman come to mind, an “F” has already been awarded. But the standards of your profession have been admirably demonstrated by some Goldman Sachs is an excellent example which managed to be an outstanding exception that proved the rule that profit and ethics can be merged. Goldman deserves the “A” that it receives and extra encouragement to represent the best of your profession in the future.

Rating Agencies Debt Quality

Since you were our smallest group (Moody’s and S & P;) and very quiet in class, your contributions went largely unnoticed. Your past work was generally excellent so there were high expectations for your performance. But it was a major error to exempt you from the prerequisite course in Quantitative Analysis.

Your assignments continuously had very high ratings, usually AAA, until the gaps in your reasoning became apparent. “F’s” for both of you, unfortunately.

Global Investment Institutions Due Diligence

We very much value the international character you bring to our deliberations. The global marketplace is a vibrant reality for the national economy. But it appears that there were deficiencies in understanding.

Many of you who appeared most serious and committed to the work made huge miscalculations in your analyses with stunning losses resulting for your institutions. The Swiss come to mind. The resulting grade is “D+”. You can do better.

In Summary

For those of you who have done well in the last demanding year congratulations! We are counting on your leadership in the uncertain times ahead. For those of you who did not perform up to expectations, we know you will focus on improvement and do better.

For those of you who failed, please don’t repeat the course.

Next Course

Work in the new academic year has started with new challenges that will call on your best efforts. Some of you will return with new roles as Goldman Sachs and Morgan Stanley have decided to change career plans to the more conservative prospects of commercial banking. Bank of America has a broad new agenda with the addition of Merrill Lynch to its group. We can expect some conflicts as everyone gets accustomed to their new conditions. The course has been expanded to integrate the expectations of the $700 billion government bailout plan so be ready for more homework and trickier questions on your exams!