Lower rates won't ease mistrust fed by cover-ups


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The Federal Reserve gave the economy another teaspoonful of tonic last week, and investors gulped it down and liked it.

But it's too early to expect a clean bill of health. The incubation period for economic remedies and problems is often six to 12 months, and the economy could be sickened by more than tumbling home prices and the potential that house-poor consumers might not spend much.

There remains a hangover from midsummer's credit crunch and continuing weakness and mistrust in the financial system as the nation's largest banking firms start reporting the damage they caused themselves and investors by cavalierly creating securities backed by undependable subprime mortgages.

Those securities, which were based on homeowners making mortgage payments on time, plunged in value when it became undeniable that many would not be able to make their payments. And the securities, along with others suffering guilt by association, continue to be shunned by investors because they were based on weak analysis about the mortgage market.

"There is a lot of supply and not a lot of demand because investors are mistrustful of the process," said Janet Tavakoli, president of Tavakoli Structured Finance.

The breakdown in trust that Wall Street brought about through lax lending and underwriting standards, along with secretive accounting, cannot be cured by interest rates alone, she said. "People didn't think: Can people pay these back?" And the lack of diligent analysis continues to be a drag on banking profits and the willingness of lenders to take a chance on lending money to entities that could have secret financial problems.

Even traditionally safe commercial paper, which finances essential short-term borrowing by various types of businesses, is suspect because much was backed by mortgages.

You can see the lingering mistrust in banking stocks like Merrill Lynch's, which has dropped about 29 percent for the year. You can see it in the $27 billion in write-downs investment banks have taken on mortgage-related securities and leverage loans.

And you would have heard it last week if you listened to Michael Moskow, the former president of the Chicago Federal Reserve, speak to a luncheon of investors held by Altair Advisers.

"We clearly need more transparency," Moskow said as he laid blame for the recent credit crunch in multiple directions.

It started, he said, by lenders changing the rules of lending - financing 100 percent of the costs of borrowing a home by using strategies like piggyback loans. Then, Wall Street bundled the flimsy mortgages into securities and sold them widely without alerting people to the risks. Rating agencies, such as Moody's and Fitch, also failed to analyze the risks or warn investors about them, Moskow said.

"It's important that people have confidence in the numbers firms put out," he said. "We have depended on rating agencies, and they have got to step up their effort to do a better job. We need to examine the role of the agencies and conflicts of interest."

As Wall Street churned out hundreds of billions of dollars in mortgage-related securities the past few years, rating agencies gave the safest ratings of AAA to many that, in retrospect, were not that safe. In the past few months, the agencies have said they need more reliable data than they have had. They have evaluated their analyses and marked down ratings.

Tavakoli notes that one of the problems is that investment banks are "denying their losses. That's shaken confidence."

"The markets can deal with a lot, but not cover-ups. It shakes the markets' confidence, and we have a long way to go in coming quarters."


Gail MarksJarvis writes for Tribune Media Services.

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