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Financial Origami: How the Wall Street Model Broke

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In Japan, where origami, the folding of paper into intricate animals and other shapes, is a national hobby, it is believed that someone who folds 1000 origami cranes will have her or his wish granted.

Brendan Moynihan, an editor-at-large at Bloomberg News, author of a new book about the recent (and he would say continuing) financial crisis titled Financial Origami: How the Wall Street Model Broke (Wiley & Sons, 2011), suggests that the Wall Street financial giants didn’t wait to fold 1000 cranes to get their wish. Instead, financial companies like Lehman Brothers, Bear Stearns, Goldman Sachs, Morgan Stanley, Merrill Lynch and Deutsche Bank twisted and folded the various securities and loan documents in their possession to create new securities designed to shift risk onto investors and increase profits and bonuses for themselves.

Instead of producing cranes, they ended up folding themselves a “black swan.”

Moynihan scoffs at the assertion by Wall Street executives that they are financial “innovators” and “financial engineers.”  He says, “What Wall Street calls financial engineering, I call Financial Origami.”  In his view, all that financial companies do is “take a few basic pieces of paper stocks, bonds and insurance contracts and fold their attributes together to make ‘new products,’ sometimes to skirt regulations, sometimes to meet investor needs, and always to boost profit.’”

There have been a number of books written that have reported on the financial crash and that have sought to explain the arcana of how Wall Street’s banks and investment banks created the disaster that brought down the global economy, but Moynihan, who spent 20 years working in the financial industry before becoming a financial journalist, has written, at 151 pages, the shortest and most concise of them.

He doesn’t offer much hope that the Dodd-Frank Act banking reform legislation passed by Congress and signed into law by President Obama in 2010 will solve the problem.

“Wall Street has made its money by figuring out its way around the regulations,” he says.

The biggest problem, in Moynihan’s view, has been all the origami folding that Wall Street has engaged in over the last few decades -- the “refolding” of their charters from private to public companies, the refolding of their functions in the securities industry to create single firms where there had once been discrete firms handling discrete aspects of financial activity, and finally the unfolding of the mortgage-origination process.

All these actions, he says, produced conflicts of interest that he says reached “epic proportions” in the dot-com boom and bust in 2000, and “Biblical proportions” in the financial crisis of 2007-8.

In the dot-com boom instance, we saw investment bank analysts touting the shares of companies that their own institutions were acting as advisor to in initial public offerings--a conflict that led to outside investors getting fleeced, and to an absurd inflation in the valuation of start-up companies that had often had no profits at all. Ultimately, of course, it all came crashing to the ground, taking millions of Americans’ investment portfolios with it.

In the more recent run-up to the 2008 financial crisis, investment banks and banks invested heavily in mortgage-backed securities--financial origami products that were made to look like sterling, AAA-rated investments, but which were really riddled with default-prone mortgages offered to people with no ability to make the monthly payments. Again, it all came crashing down, this time taking most of the global economy with it.

As have many writers before him, Moynihan points to the 1999 revocation of the 1933 Glass-Steagall Act--a Depression-era law that barred banks from engaging in investment banking, and barred investment banks from take deposits or engage in commercial lending--as the big turning point that led to the current economic crisis. He says that the heavily industry-lobbied repeal of Glass-Steagall was “the final crease in folding the industry into one-stop shops for financial services, especially the commercial banks.”

Other conflicts of interest developed along the way. A critical one was at the ratings firms, S&P, Moody’s and Fitch.  These companies, Moynihan explains, didn’t just rate the mortgage-based products created by Wall Street firms. These supposedly arms-length objective ratings “agencies” also got paid as consultants to advise in the creation of the various derivatives products whose credit-worthiness they were being paid to rate. But it was the elimination of the line between investment banks and banks that paved the way to the crisis we’re trying to recover from today.

The answer to this crisis, Moynihan says, is not regulations, though he does favor a return to Glass-Steagall. “History shows that Wall Street has been adept at getting around the rules and regulations imposed upon corporate behavior and financial instruments,” he says.

Instead, he raises the hope that investors--especially the big institutional investors--will ultimately, by rejecting the services of compromised institutions with their many conflicts of interest, compel Wall Streets banks and investment banks and the rating firms to stop playing both sides of the game.  

“There is a lot to learn,” he suggests, from the firms like investment bank Brown Brothers Harriman, mutual fund manager Marketfield Asset Management, and ratings firm Egan-Jones, each of which “avoided the business models that wreaked so much havoc on the financial system.”  What these companies and others like them share is a willingness to stick to playing a fiduciary role with clients, instead of trying to profit from both sides of deals.

“It will be interesting to see if the clients start demanding this,” he says.

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