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Theodore Roosevelt: “If we have done anything wrong, send your man to my man and they will fix it up.”
    I am to be Mankoff’s “man.” More anon.

FEBRUARY 18, 2007
    OK: last night was a riotous evening, as expected, but I couldn’t tear my mind away from my meeting with Mankoff. Who could?
    Back to Three Guys.
    According to Mankoff, the admission last week by the world’s third-largest bank that they’re taking a big write-down on their mortgage assets signals the beginning of real trouble. Mankoff reads this as the first of a series of discrete blips that are going to compound into something the size of that giant stone ball that chases Harrison Ford through the jungle in the first
Indiana Jones
movie. Unlike in the film, however, the ball’s going to catch up and Wall Street is going to get crushed.
    To summarize Mankoff’s take in a very few words: a number of factors are in the process of coalescing into a perfect storm. These include Greenspan’s (and now Bernanke’s) free-money policies at the Federal Reserve, which are straight-out pandering to Wall Street; a decline in the housing market bordering on collapse; and the utter corruption of Washington that has followed the massive rollback of regulation that took place under Clinton. Wall Street has been allowed to totally blow through any commonsensical—forget prudent—risk parameters. The big banks have been allowed to become too enormous and complicated to manage. To summarize: Mankoff foresees a huge chain-reaction shit storm breaking over the collective head of Wall Street and the other financial markets, spilling over into the general economy of making, doing, and serving. He’s predicting every kind of computer-driven financial calamity you can think of: credit freeze, bank insolvencies, a foreclosure pandemic, a liquidity crisis, accounting scandals, balance sheet implosions, a few big firms driven to the wall, total breakdown of trust between institutions, all adding up to something onthe order of the 1929 bust—only bigger and more violent thanks to the bubble-inflating technology the Street depends on.
    As Mankoff tells it, what’s going to send the markets crashing is basically theme-and-variations on the cardinal sin of finance: borrowing short to lend long with the collateral being recirculated so that sometimes you have the same billion-dollar stack of Treasuries pledged to secure four or five entirely discrete billion-dollar loans involving different sets of lenders and borrowers. This is what Mankoff calls “chain-letter collateralization,” where the same security is pledged serially: A borrows from B, securing the loan with derivative X, a third-party contract to make B whole if A goes belly-up; B turns around and uses X to collateralize a loan from C, which B then uses to fund its loan to A—and so on and so on, back and forth and in circles.
    The Great Deregulation of the Clinton years, the repeal of Glass-Steagall, the untethering of derivatives, etc., etc., was literally like yanking open the lid of Pandora’s box. Every malign and mischievous imp of finance burst free and began to work its evil spells. Access to unlimited short-term credit, thanks to the Fed flooding the market with crisp new greenbacks, gave essentially second-rate firms like Bear Stearns and Lehman Brothers the wherewithal to compete against the big banks, which up to then had huge reserves of federally insured deposits to finance their lending.
    Specifically, according to Mankoff, the credit markets have put themselves terribly at risk. The world economy runs on two principal fuels: fossil (as in gas/oil/coal) and credit. Shut either down and you’re looking at economic catastrophe, and it can happen virtually overnight. Wall Street got a taste of how that feels back in the seventies, when OPEC tightened the oil flow. The old boys at San Calisto still shake their heads at how bad it got in 1973 and ’74.
    And not only Wall Street. The American Way was