I chose this elegant eatery near the World Financial Center and half a mile uptown from Wall Street for a reason. A little more than a year ago, in happier times for the financial services industry, I had a lunch there with the CEO of a broker-dealer. Back then the place was so busy, I had trouble deciphering my voice recorder over the hum and excited chatter of other diners.
Who: Tanya S. Azarchs, Managing Director, Financial Services Ratings, Standard & Poor’s
Where: Acappella, One Hudson Street, New York, August 13, 2008
On the Menu: Fusilli pesto, porpadelle boscaiola, paglia fieno and an anatomy of the credit crisis.
You’ll be glad to hear that even in mid-August the restaurant is far from empty. A year into the financial crisis, Wall Street types apparently still have money to pay for good North Italian food.
But they might have lost their appetite had they listened in on my conversation with Tanya Azarchs, managing director at Standard & Poor’s Corp. Her job is to rate the creditworthiness of money center banks and bulge bracket investment banks. Her view on the financial sector is not comforting.
“What we have seen so far is the first stage of the financial crisis, which affected mostly investment banks and money center banks. We are now entering the second stage of the crisis, in which a wider variety of lending institutions will become involved.”
Start at the BeginningAs befits a bond-rating analyst and a former teacher, she likes to start at the beginning, going through the history of the current financial crisis in a logical and methodical manner.
“There have been various explanations of the crisis,” she says, listing as examples a long period of easy monetary policy, excess liquidity from hedge funds and lax regulation. “But the subprime crisis came into being mainly due to loose underwriting standards,” she concludes.
Specialized mortgage lenders kept raising the ante, taking on more and more risk based on a fundamentally flawed assumption that real estate prices will always continue to rise and that households don’t default on their primary mortgages. While some sophisticated lenders came to believe this logic, in reality big banks had to play the game the way it was being played, even if they had misgivings. Azarchs quotes the now-infamous saying by Chuck Prince, the former CEO of Citigroup, admitting that being bankers, “as long as the music is playing, we’ve got to get up and dance.”
The music stopped in early August 2007. The result is well-known. When home prices fell, we learned that home owners regard their homes quite unsentimentally, just as they do any other investment, says Azarchs. Once they realized they are in a deep negative equity hole — and once their teaser rates adjusted sharply upward — they chose to cut their losses, leaving their homes for the lenders to dispose of as they saw fit.
When the music stopped playing, suddenly unsellable loans weighted down the banks’ balance sheets, causing multibillion-dollar write-offs and massive losses. The good news, says Azarchs, is that the subprime crisis has more or less run its course. After being dead in the water for months, the market for asset-backed collateralized debt obligations came back to life in late July, when Merrill Lynch sold $31 billion of such securities to an affiliate of Lone Star, a hedge fund. The price was 22 cents on the dollar.
Bad News Ahead”The hope is that this has set a floor for the value of such assets,” says Azarchs.
Of course, the securities are probably worth more, because most of the underlying mortgages are not going into default and investors will get most of their money if they hold them to maturity. But banks are forced to mark their holdings to market and, moreover, the temptation is to wipe the slate clean — especially if a new management team is brought in to sort out the mess.