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Just before the Egyptian Revolution broke out, I was preparing to review more books on the global financial crisis.

Today's book is Bethany McLean's and Joe Nocera's All the Devils Are Here: The Hidden History of the Financial Crisis--an important contribution to the conversation about what happened to the US and global financial systems in 2007 and 2008 (click here for more posts on this topic). This book makes a great companion to the film Inside Job.

"Hell is empty, and all the devils are here," wrote Shakespeare in The Tempest. Borrowing his phrase for the title is an apt move, since the authors (former colleagues at Forbes magazine) attempt to interview all of the culprits who contributed to this caper. Unlike the cooler historical and analytical overview provided by Nouriel Roubini in Crisis Economics, this is a vivid, human drama, filled with characters who have stories.

Although I occasionally got bogged down in blizzards of names and esoteric financial terms, I found All the Devils to be the clearest and most comprehensive overview of the crisis out there. By interviewing most of the key players, McLean and Nocera help us to see the complexity of the crisis through their eyes. In the process, they clarify several points that have been disputed in analyzing the crisis. Among them are the following:

1. The government-supported mortgage guarantors (Fannie Mae and Freddie Mac) were not responsible for the crisis, although they tried to profit from it and were dragged down by it.
This criticism has been a standard conservative criticism, blaming the Clinton administration and Democratic politicians for leaning on Fannie and Freddie to push mortgages on unqualified borrowers (in order to increase homeownership). McLean and Nocera address this directly, arguing that both Fannie and Freddie got into the subprime business because Countrywide and other banks were making immense profits from it (p. 50). But they got into it late in the game, between 2005 and 2007 (p. 185), seeking to make big bucks like the Wall Street banks.

2. Quantitative analysis, which many didn't properly understand, lulled many into thinking that risks were under control when they really weren't.
McLean and Nocera describe how a J.P. Morgan analyst named Till Guldimann invented a measure called Value at Risk (or VaR), which all the other big Wall Street banks came to use. The problem was that VaR assumed normal market conditions similar to the past. "The fact that VaR told you how much your firm might lose 95 percent of the time didn't say a thing about what might happen the other five percent of the time" (p. 57). You could lose billions, but the statistic gave the misleading impression that Wall Street banks were controlling and predicting the risk to their investments. In the book, I call this arrogance. Humility means knowing that you cannot predict or control the future.

On this score, Goldman Sachs was rare among Wall Street firms: "When it came to managing risk," write McLean and Nocera, "Goldman had what can only be called a kind of humility, a belief that the model was only as good as the inputs and that faith in the model had to balanced with the informed judgment of human beings" (p. 158).

3. The private bond rating companies and government regulators were corrupted.
Moody's, Standard & Poors, and Fitch Ratings were supposed to analyze the portfolios of mortgage-backed bonds to see how risky they were as investments. Unfortunately, the Wall Street banks would go "ratings shopping" between the three companies (p. 118). If they didn't get the high ratings they wanted, they would threaten to take their business to one of the other ones. This was a classic example of a "race to the bottom" (p. 119). Furthermore, all three companies were profiting from rubber-stamping these deals. The president of Moody's took home $3.2 million in compensation in 2007 (p. 124).

Alan Greenspan, chairman of the Federal Reserve, trusted that private, self-regulation would work to keep companies in line. "Market discipline," rather than government regulation, would be effective. But that didn't work out so well in practice.

4. The supply side on Wall Street was pushing predatory, punishing subprime loans
Subprime loan originators told the authors that it was Wall Street banks that drove the trade. These banks were lending the money to mortgage firms "and then buying up their mortgages and securitizing them" (p. 134). Riskier subprime loans "were roughly seven times more profitable than prime mortgages" (p. 134). Thus, the Wall Street firms demanded that subprime brokers pushed "payment option adjustable rate mortgages" which "gave consumers the right to choose whatever rate they wanted at the start, from a very low teaser rate to a higher rate that more resembled a thirty-year fixed mortgage" (p. 135). Eventually, these loans would reset to a higher rate and borrowers would go into "payment shock." It wasn't greedy borrowers so much as greedy Wall Streeters that drove this trade. This supply-side view aligns with the Financial Crisis Inquiry Commission Report, rather than the demand-side view that blames those who pushed or sought subprime loans for the crisis.

5. Subprime lenders often encouraged borrowers to lie.
McLean and Nocera share several stories of people who pursued home loans from Countrywide and were encouraged to sign on to fraudulent documents. Although there were certainly cases of people trying to borrow more than they ought, the subprime lenders were hardly innocent victims. Score another one for the supply side argument.


6. Everyone was making so much money from the global trade in bonds derived from subprime mortgages that they didn't care.
McLean and Nocera make a statement very similar to one made by Adam Davidson on NPR right after the crisis (and quoted in chapter 3 of the book):

Here was the ultimate consequence of the delinking of borrower and lender, which securitization had made possible: no one in the chain, from broker to subprime originator to Wall Street, cared that the loans they were making and selling were likely to go bad. In truth, they were all taking huge risks in granting these terrible loans. But they were all making too much money to see it. Everyone assumed that someone else would be left holding the bag (p. 218).

7. Despite all the damage done, very few people have been or will be held legally responsible.
The authors write,

Much of what took place during the crisis was immoral, unjust, craven, delusional behavior--but it wasn't criminal. The most clear-cut cases of corruption--the brokers who tricked people into bad mortages, the Wall Street bankers who knowingly packaged bad mortgages--are in the shadows, cogs inside the wheels of firms Ameriquest, New Century, Merrill Lynch, and Goldman Sachs. We'll probably never even learn most of these people's names (362).

And on that not-so-happy note, we return to special bulletins on the aftermath of the peaceful regime change in Egypt. Speaking of which, maybe a peaceful revolt against the new oligarchy on Wall Street would be in order. If Egyptians can demand change, then why can't we?