The Economy: “This Too Shall Pass”

Vernon Hill, founder and former CEO of Commerce Bank, and Jack Bogle, founder and former CEO of Vanguard Mutual, had never met — until we got them together to talk about the economy, Wall Street’s excesses, ninja loans, and their dictatorial reputations.

PM: You mean things like credit default swaps, which is really insurance for these risky securities, only they couldn’t call them insurance, because then they’d be regulated?
Hill: And those are the most basic ones. They’ve got these things so complex that no one understands them. And that’s why they were afraid of AIG failing — because a lot of it went through AIG.
Bogle: I have a human way to explain it. There are around $2 trillion of credit instruments that have credit default provisions in them — where people are betting that they will either pay their interest or they won’t. Try to visualize it this way. You live in a nice little $200,000 house in your neighborhood, and you have a $200,000 mortgage on it. You have 64 neighbors betting you can’t pay it. And 64 neighbors who are betting you can pay it. What’s the matter with that? What’s the matter with that is — watch out for arsonists. [Laughter]
Hill: And the arsonist might be your wife!
Bogle: That’s what they’re doing. It’s a gambling system. It’s a casino.
Hill: Do you know how this sub-prime mortgage thing started? In the early ’90s, the government started to enforce the Community Reinvestment Act. And they ordered the banks to lend to people who couldn’t pay. They didn’t examine the credit. In fact, the worse the credit for the borrower, the better the government liked it. Banks have to report their home lending data, and the government was looking at how many loans you made — not how many good loans. So you were ordered to make loans to people with a demonstrated inability to pay.
Bogle: And so we had ninja loans, for people with no income, no job and no assets: ninja. [Laughter]
Hill: That’s a good one. What is it? Ninja?
Bogle: Yes. And then we had no-doc loans. A guy says he makes $125,000 a year and doesn’t have to show a tax return.
Hill: See, we’re a little bit protected in this market, because Philadelphia has always had relatively low housing prices. But we’re talking about the assets side of the equation, and really, the funding side is more important. I knew at Commerce that my average deposit life was 13 years. So I had very long liabilities. I’ll bet the average Merrill Lynch maturity funding is under one month. It’s not that they couldn’t get long-term funding; it’s that they chose to save money by taking short-term funding. And that’s why this issue turned into a panic — because the funding all ran out.
PM: So who do you blame for this?