Bond market kingpin Bill Gross’s monthly screed is out, and as usual it’s got lots of interesting insights and lots of passages that don’t entirely make sense. Anyway, this may be my favorite part:
I’ve had a famous picture of J.P. Morgan on my office wall for 25 years. Even now, the old man seems to be staring at my back and taunting me with his famous quote written just below his vest with pocket watch in full view: “Lending is not based primarily on money or property. No sir, the first thing is character.” For 20 of these 25 years I thought this idea was a relic of an outdated era. How could you judge the character of a CDO or an asset-backed security? Far better to lend on well collateralized property, I reasoned. But then it became increasingly apparent that credit, when issued against the collateral of assets, had a capacity to multiply itself without restraint. The Shadow sanctioned and blessed increasing leverage under the assumption that “property” (houses) could only go up in value. “Character” had no place in such a modern-day financed-based economy. Liar loans, fraudulent appraisals, or even just the origination and resale of mortgage loans and asset-backed securities themselves proved that character was out, and property securitization was in.
Thank you JP. While it’s improbable that we can ever go back to your “know the customer” model of lending, we will likely pull back from our rating service blessed confidence in asset-backed securities. In its place will likely come the increasing reliance on government/agency guarantees as well as the explicit use of the government’s balance sheet to support and then assimilate egregious loans of the past decade.
By the Shadow, he means what he calls the Shadow Banking System–all the bank-like stuff that’s been going on outside of the actual banks in recent years. And what he seems to be saying is that, while lots of people like to bash Big Government, it’s got more “character” than modern Wall Street.