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How We Missed the $8 Trillion Housing Bubble
Ernest (Ernie) T. Patrikis is a partner White and Case. During his 30-year career at the Federal Reserve Bank of New York, Mr. Patrikis served as General Counsel for many years and later acted as Chief Operating Officer in his role as First Vice President. He also served as Deputy General Counsel and an alternate member of the Federal Open Market Committee, a staff member of the President's Working Group on Financial Markets that was created in the aftermath of the 1987 financial markets crisis, a member of the Committee on Payments and Settlement Systems of the G-10 central bank governors, legal advisor to the Basel Committee on Banking Supervision, and one of the principal drafters of the US International Banking Act of 1978. Mr. Patrikis began his eight years with AIG as Special Advisor to the Chairman in 1998 and became General Counsel and Senior Vice President in 1999. As General Counsel, he directed one of the largest corporate law departments in the world, managing all of AIG's corporate, litigation, governance, regulatory, compliance and enforcement matters.
Question: How did we fail to see an $8 trillion housing bubble? (Dean Baker, Beat the Press)
Ernest Patrikis: Well Shiller at Yale wrote a book, that’s his name, and told us that we had this huge real estate bubble. I didn’t read the book, but I knew what he was saying. And awful lot of people knew about it. The way I look at it, there’s no single cause. This event, as horrendous as it is, took an awful lot of people working hard to get us there. It’s bank supervisor’s not doing their job, it’s directors and management of financial organizations not doing their job. It’s Congress not doing its job with Ginnie Mae and Fannie Mae. I can go on and on with a large list. It’s the securitizers who were securitizing and had no skin in the game in terms of the loans they were working at.
It was the investment banks who would specify the nature of the securitized products and what those loans must call for. It was the rather slimy brokers for real estate lending and mortgage bankers. It was S&L’s, Federal S&L’s who had these transactions go through them for usury purposes who really didn’t care what the transactions were. It just goes on and on. The Fed, the interest rates too low. So, it really, I think inappropriate to say it’s any one person when I think it’s a systemic event, and that’s what we have is a systemic event.
Society is to blame, not any single group of people and we should punish any single group of people. Our firm gave a presentation last February, and I think we listed two full pages of what I call, “The Villains.”
Question: How is AIG to blame?
Ernest Patrikis: Well, at AIG-FP, Financial Products the Swap Sub to me the financial products was unique amongst the AIG Subsidiaries, it was almost as if it was not a part of AIG. It was extremely independent and set up to be that way. It also was, I think, unique in that four of the holding company directors were on the board of AIG-FP. Mr. Greenberg, Howie Smith the CFO, Bernie Adenoff, retired from Sullivan and Cromwell, and Nani Feldstein. Hank was pushed out because my relationship with these people, they put their arms out and kept me away, as others, and they were successful in doing it because Hank supported them being separate. I don’t know what kind of oversight was being carried on when we were redoing the Annual Report in 2005 and afterwards. I’m happy to say, the trades were put on after I left, but I wouldn’t have known about it anyway the way it was run.
And I also don’t have a full understanding of what happened with risk management. AIG was perhaps one of the few firms that early on had market risk at both the level of the profit center and in the holding company. What did happen is that the Senior Market Risk Officer retired. There was a reorganization and he was going to report to somebody, and I think he decided that he’d rather not report to someone. He had been reporting directly to Hank and had a good rapport with Hank and he had a feel for financial products and he was tough enough to deal with him. With him gone, I suspect we lost some edge, and with Hank gone, we lost an edge. And so the thought about the massive bailout because of the needs of collateral, I don’t know why all those trades were put on.
But what we’re seeing now is, for many of them, the risk was market value risk. It was the same thing as long-term capital management. At AIG, Berkshire Hathaway and Goldman Sachs were going to buy Long-Term Capital Management’s book. The book would be in the money at maturity. It was baked-in-the-cake profit, it just didn’t have the capital to get there and we didn’t get a chance to do the transaction because of a meeting at the New York Fed. In the same way, I’m guessing now, I don’t know, that the financial products book may well be in the money. Yes, there probably are some bad credit default swaps, but some of that collateral was starting to come back.
So, it was the need for massive amounts of – the way FP ran is, every transaction was guaranteed by the holding company, by AIG, which was then AAA, which was then AA, and there were triggers in the swaps, so when AIG was downgraded, it affected FP. Put all of those events together and the massive need for collateral the banks were unwilling to put up, maybe it was just too much for them or they couldn’t see it all, but that was a shock to the system in terms of size, but not a big a shock to the system as Lehman. I think AIG was sort of gravy. I think the real massive amount was the Lehman shock to the system of the Lehman failure after the Bear Sterns bailout.
Question: After 2006, what was the thinking among regulators and financial professionals concerning a scenario in which housing prices fell significantly in many areas of the country? (Arnold Kling, Econlog)
Ernest Patrikis: I think they both had a mistaken view. And I think – the thought really, if I can recall correctly, really is that the product could withstand it. That the investors who invested in these products were all mature adults, able to invest buy side investors. Many of the AAA tranches were acquired by banking organizations who thought they were safe. And they bought credit default swap insurance on it. I think there was just too much of an assumption that the product would take care of itself. That if there were defaults the risk was spread.
The whole thought of credit default swap and securitization was the spreading of risk and I think that what we’ve learned is that, yes, you can spread it, but the other part of it was, you couldn’t get rid of it because of the lack of liquidity in the market. And I really see the major issue and the major signal for me was early on when there was no 30, 60, 90-day money in the market and people with positions couldn’t finance themselves. And I think the Fed was a little slow to pick that up. But I think too much assuredness in the product.
It will be interesting to see when the product does come back in a major way, will it just come back again in the same way? There won’t be any features on it that will yield control in the banking organization so they can get these off balance sheet, not have some of them come back like they are coming back. But I think there was just too much of an assumption that this product worked. I guess we’d have to look back to the last recession and say, there really weren’t a lot of issues in housing of a great degree – securitized housing in the last recession, so we lacked experience.
And the major concern on securitizations was in a market of falling interest rates, people doing refinancing, and we didn’t see that in this market. Perhaps we’re seeing a little now when people can do it. But I think the answer is to be a little more skeptical of the product. I’m disappointed in the buy-side. We’ve had a lot of criticism of the sell side, which is deserved, but a lot of the people buying these products were institutional investors.
Recorded on November 9, 2009
AIG’s former head council Ernie Patrikis thinks society should take the blame.
Higher education faces challenges that are unlike any other industry. What path will ASU, and universities like ASU, take in a post-COVID world?
- Everywhere you turn, the idea that coronavirus has brought on a "new normal" is present and true. But for higher education, COVID-19 exposes a long list of pernicious old problems more than it presents new problems.
- It was widely known, yet ignored, that digital instruction must be embraced. When combined with traditional, in-person teaching, it can enhance student learning outcomes at scale.
- COVID-19 has forced institutions to understand that far too many higher education outcomes are determined by a student's family income, and in the context of COVID-19 this means that lower-income students, first-generation students and students of color will be disproportionately afflicted.
What conditions of the new normal were already appreciated widely?<p>First, we understand that higher education is unique among industries. Some industries are governed by markets. Others are run by governments. Most operate under the influence of both markets and governments. And then there's higher education. Higher education as an "industry" involves public, private, and for-profit universities operating at small, medium, large, and now massive scales. Some higher education industry actors are intense specialists; others are adept generalists. Some are fantastically wealthy; others are tragically poor. Some are embedded in large cities; others are carefully situated near farms and frontiers.</p> <p>These differences demonstrate just some of the complexities that shape higher education. Still, we understand that change in the industry is underway, and we must be active in directing it. Yet because of higher education's unique (and sometimes vexing) operational and structural conditions, many of the lessons from change management and the science of industrial transformation are only applicable in limited or highly modified ways. For evidence of this, one can look at various perspectives, including those that we have offered, on such topics as <a href="https://www.insidehighered.com/digital-learning/blogs/rethinking-higher-education/lessons-disruption" target="_blank">disruption</a>, <a href="https://www.nytimes.com/2020/02/20/education/learning/education-technology.html" target="_blank">technology management</a>, and so-called "<a href="https://www.insidehighered.com/sites/default/server_files/media/Excerpt_IHESpecialReport_Growing-Role-of-Mergers-in-Higher-Ed.pdf" target="_blank">mergers and acquisitions</a>" in higher education. In each of these spaces, the "market forces" and "market rules" for higher education are different than they are in business, or even in government. This has always been the case and it is made more obvious by COVID-19.</p> <p>Second, with so much excitement about innovation in higher education, we sometimes lose sight of the fact that students are—and should remain—the core cause for innovation. Higher education's capacity to absorb new ideas is strong. But the ideas that endure are those designed to benefit students, and therefore society. This is important to remember because not all innovations are designed with students in mind. The recent history of innovation in higher education includes several cautionary tales of what can happen when institutional interests—or worse, <a href="https://www.insidehighered.com/news/2016/02/09/apollos-new-owners-seek-fresh-start-beleaguered-company" target="_blank">shareholder</a> interests—are placed above student well-being.</p>
Photo: Getty Images<p>Third, it is abundantly apparent that universities must leverage technology to increase educational quality and access. The rapid shift to delivering an education that complies with social distancing guidelines speaks volumes about the adaptability of higher education institutions, but this transition has also posed unique difficulties for colleges and universities that had been slow to adopt digital education. The last decade has shown that online education, implemented effectively, can meet or even surpass the quality of in-person <a href="https://link-springer-com.ezproxy1.lib.asu.edu/article/10.1007/s10639-019-10027-z" target="_blank">instruction</a>.</p><p>Digital instruction, broadly defined, leverages online capabilities and integrates adaptive learning methodologies, predictive analytics, and innovations in instructional design to enable increased student engagement, personalized learning experiences, and improved learning outcomes. The ability of these technologies to transcend geographic barriers and to shrink the marginal cost of educating additional students makes them essential for delivering education at scale.</p><p>As a bonus, and it is no small thing given that they are the core cause for innovation, students embrace and enjoy digital instruction. It is their preference to learn in a format that leverages technology. This should not be a surprise; it is now how we live in all facets of life.</p><p>Still, we have only barely begun to conceive of the impact digital education will have. For example, emerging virtual and augmented reality technologies that facilitate interactive, hands-on learning will transform the way that learners acquire and apply new knowledge. Technology-enabled learning cannot replace the traditional college experience or ensure the survival of any specific college, but it can enhance student learning outcomes at scale. This has always been the case, and it is made more obvious by COVID-19.</p>
What conditions of the new normal were emerging suspicions?<p>Our collective thinking about the role of institutional or university-to-university collaboration and networking has benefitted from a new clarity in light of COVID-19. We now recognize more than ever that colleges and universities must work together to ensure that the American higher education system is resilient and sufficiently robust to meet the needs of students and their families.</p> <p>In recent weeks, various commentators have suggested that higher education will face a wave of institutional <a href="https://www.businessinsider.com/scott-galloway-predicts-colleges-will-close-due-to-pandemic-2020-5" target="_blank">closures</a> and consolidations and that large institutions with significant online instruction capacity will become dominant.</p> <p>While ASU is the largest public university in the United States by enrollment and among the most well-equipped in online education, we strongly oppose "let them fail" mindsets. The strength of American higher education relies on its institutional diversity, and on the ability of colleges and universities to meet the needs of their local communities and educate local students. The needs of learners are highly individualized, demanding a wide range of options to accommodate the aspirations and learning styles of every kind of student. Education will become less relevant and meaningful to students, and less responsive to local needs, if institutions of higher learning are allowed to fail. </p> <p>Preventing this outcome demands that colleges and universities work together to establish greater capacity for remote, distributed education. This will help institutions with fewer resources adapt to our new normal and continue to fulfill their mission of serving students, their families, and their communities. Many had suspected that collaboration and networking were preferable over letting vulnerable colleges fail. COVID-19's new normal seems to be confirming this.</p>
President Barack Obama delivers the commencement address during the Arizona State University graduation ceremony at Sun Devil Stadium May 13, 2009 in Tempe, Arizona. Over 65,000 people attended the graduation.
Photo by Joshua Lott/Getty Images<p>A second condition of the new normal that many had suspected to be true in recent years is the limited role that any one university or type of university can play as an exemplar to universities more broadly. For decades, the evolution of higher education has been shaped by the widespread imitation of a small number of elite universities. Most public research universities could benefit from replicating Berkeley or Michigan. Most small private colleges did well by replicating Williams or Swarthmore. And all universities paid close attention to Harvard, Princeton, MIT, Stanford, and Yale. It is not an exaggeration to say that the logic of replication has guided the evolution of higher education for centuries, both in the US and abroad.</p><p>Only recently have we been able to move beyond replication to new strategies of change, and COVID-19 has confirmed the legitimacy of doing so. For example, cases such as <a href="https://www.washingtonpost.com/education/2020/03/10/harvard-moves-classes-online-advises-students-stay-home-after-spring-break-response-covid-19/" target="_blank">Harvard's</a> eviction of students over the course of less than one week or <a href="https://www.nhregister.com/news/coronavirus/article/Mayor-New-Haven-asks-for-coronavirus-help-Yale-15162606.php" target="_blank">Yale's apparent reluctance</a> to work with the city of New Haven, highlight that even higher education's legacy gold standards have limits and weaknesses. We are hopeful that the new normal will include a more active and earnest recognition that we need many types of universities. We think the new normal invites us to rethink the very nature of "gold standards" for higher education.</p>
A graduate student protests MIT's rejection of some evacuation exemption requests.
Photo: Maddie Meyer/Getty Images<p>Finally, and perhaps most importantly, we had started to suspect and now understand that America's colleges and universities are among the many institutions of democracy and civil society that are, by their very design, incapable of being sufficiently responsive to the full spectrum of modern challenges and opportunities they face. Far too many higher education outcomes are determined by a student's family income, and in the context of COVID-19 this means that lower-income students, first-generation students and students of color will be disproportionately afflicted. And without new designs, we can expect postsecondary success for these same students to be as elusive in the new normal, as it was in the <a href="http://pellinstitute.org/indicators/reports_2019.shtml" target="_blank">old normal</a>. This is not just because some universities fail to sufficiently recognize and engage the promise of diversity, this is because few universities have been designed from the outset to effectively serve the unique needs of lower-income students, first-generation students and students of color.</p>
Where can the new normal take us?<p>As colleges and universities face the difficult realities of adapting to COVID-19, they also face an opportunity to rethink their operations and designs in order to respond to social needs with greater agility, adopt technology that enables education to be delivered at scale, and collaborate with each other in order to maintain the dynamism and resilience of the American higher education system.</p> <p>COVID-19 raises questions about the relevance, the quality, and the accessibility of higher education—and these are the same challenges higher education has been grappling with for years. </p> <p>ASU has been able to rapidly adapt to the present circumstances because we have spent nearly two decades not just anticipating but <em>driving</em> innovation in higher education. We have adopted a <a href="https://www.asu.edu/about/charter-mission-and-values" target="_blank">charter</a> that formalizes our definition of success in terms of "who we include and how they succeed" rather than "<a href="https://www.washingtonpost.com/opinions/2019/10/17/forget-varsity-blues-madness-lets-talk-about-students-who-cant-afford-college/" target="_blank">who we exclude</a>." We adopted an entrepreneurial <a href="https://president.asu.edu/read/higher-logic" target="_blank">operating model</a> that moves at the speed of technological and social change. We have launched initiatives such as <a href="https://www.instride.com/how-it-works/" target="_blank">InStride</a>, a platform for delivering continuing education to learners already in the workforce. We developed our own robust technological capabilities in ASU <a href="https://edplus.asu.edu/" target="_blank">EdPlus</a>, a hub for research and development in digital learning that, even before the current crisis, allowed us to serve more than 45,000 fully online students. We have also created partnerships with other forward-thinking institutions in order to mutually strengthen our capabilities for educational accessibility and quality; this includes our role in co-founding the <a href="https://theuia.org/" target="_blank">University Innovation Alliance</a>, a consortium of 11 public research universities that share data and resources to serve students at scale. </p> <p>For ASU, and universities like ASU, the "new normal" of a post-COVID world looks surprisingly like the world we already knew was necessary. Our record breaking summer 2020 <a href="https://asunow.asu.edu/20200519-sun-devil-life-summer-enrollment-sets-asu-record" target="_blank">enrollment</a> speaks to this. What COVID demonstrates is that we were already headed in the right direction and necessitates that we continue forward with new intensity and, we hope, with more partners. In fact, rather than "new normal" we might just say, it's "go time." </p>
Sallie Krawcheck and Bob Kulhan will be talking money, jobs, and how the pandemic will disproportionally affect women's finances.
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