Henry Kaufman has never been a fan of floating-rate financing, and to illustrate why, he related an anecdote about Alan Greenspan.
The former Federal Reserve chairman famously suggested in 2004 that some families might save money by opting for adjustable-rate mortgages. In an interview at his Midtown Manhattan office last week, Kaufman, the renowned economist and a longtime critic of the Fed and its response to the credit crisis, recalled asking Greenspan about his tacit advocacy of floating-rate financing.
"He blurted out, 'Well, I guess I said that, but in my own housing finance I have always used the fixed rate,' " Kaufman said.
As everyone in the industry now knows, in the current maelstrom many homeowners have been trapped in mortgages with higher rates because they wrongly expected to be able to readily refinance out of one ARM into another.
But Kaufman, 81, has been wary of floating-rate loans since the 1980s.
"My first concern then was that floating financing rates would take commercial banks out of the credit-restraint process," he said. "When it comes to floating-rate financing, the only sector that can really pay the floating rate is the federal government because it can always raise taxes."
Kaufman is a former economist with the Fed and the former vice chairman and head of research at Salomon Brothers. He has been referred to as Dr. Doom long before Nouriel Roubini earned the sobriquet.
One of his criticisms of the Fed is that like other regulators, it has been too chummy with financial services firms.
"The supervisor and the regulator cannot be a folk hero. He can't be a friend of financial institutions and markets," Kaufman said. "Good supervisors and regulators are like parents to a child. They are not friends. They are guardians who expect the child to adhere to certain standards of behavior."
Greenspan, Kaufman said, "was not a good parent."
Kaufman's belief that the Fed may have to offer some tough love and behave more like a parent crops up in his latest book, "The Road to Financial Reformation: Warnings, Consequences, Reforms." In it he republishes a series of essays warning about the dangers of debt for corporations and consumers that were first delivered in the mid-1980s.
As part of his tough-love approach, Kaufman is no fan of the Fed's gradualism — the practice of not aggressively raising rates by increments of 100 basis points and resorting to quarter-point or half-point rate increases when putting the brakes on the economy.
That approach, he said, "doesn't restrain anyone in the financial system. The financial system arbitrages that."
When it comes to the current head of the Fed, Ben Bernanke, Kaufman was more charitable: "He is somebody who studied the Great Depression at great length, but it took him quite a while before he recognized the extraordinary problem in the financial markets. He did not come and meet this problem head-on. He met it belatedly."
Kaufman said he believes securitization is here to stay but that it will be more closely regulated when it returns. Leveraged buyouts "will not come back quickly to the level we attained three or four or five years ago," he said.
LBOs have been an important tool for financiers since the 1980s, but Kaufman has never been a proponent. "The most important aspect of many LBOs were financial considerations," he said, adding that his skepticism about them was rooted in "the very simple reason it operated on the assumption that the entity that was going to be acquired was going to have a thin sliver of equity and huge amount of debt."
Kaufman said the U.S. economy remains fragile in spite of some positive signs because bank lending is still limited. With the recent gains in U.S. stock prices as well as improved credit market conditions, he also worries that lawmakers and regulators may not have the stomach to go through with reforms in banking and financial markets.
"I am a little fearful that if equity markets continue to rally … the fervor to restructure the financial system will diminish," Kaufman said.
