Money or Service? Goldman Sachs Exposed

After almost twelve years at the Wall Street firm Goldman Sachs, Greg Smith resigned yesterday.

People quit jobs every day, but this executive director at one of the biggest global financing firms published his complaints against his former employer on today's op-ed page of the New York Times. Needless to say, he's making a splash in the world of high finance.

One way to interpret what he's saying is that the film "Margin Call" could have been a documentary. In that minor Hollywood release, Jeremy Irons' character (John Tuld) utters a memorable line (a far more subtle one than Gordon Gekko's famous "greed is good" from Oliver Stone's Wall Street):

"There are three ways to make a living in this business: be first, be smarter, or cheat."

According to Smith, this ruthless logic has taken hold at Goldman Sachs.

Consider this exchange from Margin Call:

Sam Rogers [Spacey]: And you're selling something that you know has no value?

John Tuld [Irons]: We are selling to willing buyers at the current, fair market price.

This kind of mindset, according to Greg Smith, has taken hold at Goldman Sachs, which was once the envy of the financial world for its customer care, humility, and integrity.

According to Smith, Goldman is now morally bankrupt.  As he puts it in today's Times (underlining is mine),

Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them. . . .

It makes me ill how callously people talk about ripping their clients off.

. . .

These days, the most common question I get from junior analysts about derivatives is, “How much money did we make off the client?” It bothers me every time I hear it, because it is a clear reflection of what they are observing from their leaders about the way they should behave.  

. . .

I hope this can be a wake-up call to the board of directors. Make the client the focal point of your business again. Without clients you will not make money. In fact, you will not exist. Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons. People who care only about making money will not sustain this firm — or the trust of its clients — for very much longer. 

This is exactly the heart of the problem (as I've put it before): the pursuit of money, a good external to the actual welfare of one's customers, is trumping the goods intrinsic to the pursuit of one's business, which would be devoted to providing the best service to one's customers.

Smith is right--and we should all applaud him. He didn't just tell the boss to "take this job and shove it." He blew the whistle on corruption at the heart of Wall Street, while pointing to a better way.

Alone in a Dark Room With a Pile of Money: What Would You Do?

Review of Michael Lewis, Boomerang: Travels in the New Third World (New York: W.W. Norton, 2011)

Michael Lewis, author of Moneyball and The Blind Side, first came to prominence with Liar's Poker, his memoir of going to work for the Wall Street bond trading firm Salomon Brothers in the mid-1980s (a book I finally read this summer). Liar's Poker is a hillarious send-up of the big shots who ran Salomon by someone who saw their greed and recklessness firsthand. Lewis was close enough to be on the inside, but critical enough to keep his distance; his account turns out to be readable introduction to Wall Street, specifically the bond market, in the 1980s.

An art history major at Princeton who ended up making a tremendous amount of money shortly after graduation, thanks to Salomon Brothers, Lewis maintains a bemused and detached tone throughout Liar's Poker. It's as if he never believed that he was smart enough to work there. His detachment was evident when he quit while he was still young. (Of course, it didn't hurt that he had a nice financial cushion.)

Twenty years later, his knowledge of the global bond market--including the introduction of mortgage-backed bonds--would help him later unravel parts of the global financial crisis of 2007-2009. His first book on the crisis, The Big Short (reviewed last year in this blog), explained how several smart investors predicted the crisis and were able to "short" collateralized mortgage bonds when their value crashed. ("Shorting" is basically betting that the value of an asset will fall in the future, by borrowing it and selling it in the present. If indeed the investor is correct, then they benefit by buying the same asset at a lower price in the future.)  Hedge fund investors like John Paulson and Kyle Bass made out like bandits when the mortgage-backed bond market collapsed, because they had essentially shorted these bonds by investing in credit-default swaps.

Lewis starts Boomerang by confessing that he ignored some of what Kyle Bass, a Texas-based investor, had told him back while he was researching The Big Short. Bass had told Lewis that the next big crisis was going to be in the market for government bonds (sovereign debt). At the end of 2008, Bass was predicting that Greece would probably default within two years and possibly cause the Euro currency to collapse. "He was totally persuasive. He was also totally incredible" (xv). How could some guy in Dallas figure this out when almost no one else could? The guy seemed a little crazy. So, as Lewis puts it, "I made my excuses . . . and more or less dismissed him. When I wrote the book, I left Kyle Bass on the cutting room floor." (xvi).

But Bass was right. It turned out that private bank debts were becoming public debts in both the US and Europe, as the Fed and the European Central Bank bailed out private banks. Iceland and Ireland had already crashed. And Greece was the tipping point.

What happened? Lewis travels to Iceland, Greece, Ireland, Germany, and California to tell their stories before and after the collapse of the global bubble. In each place, he singles out cultural factors that make each place unique. This cultural approach is quite simplistic, but it does help explain how different countries react when they are "left alone in a dark room with a pile of money" (the pile of money being a huge expansion of bank lending). It also roots the financial problems in a larger context than mere government regulation. It turns out that we all have a cultural and moral problem.

Greece, on Lewis' view, simply lacks any public spiritedness and is so corrupt that even a group of Greek monks participated in the corruption. No one pays taxes and everyone is looking to bilk the government.

In Iceland, he contends, a male-dominated fishing culture led to excessive risk-taking. Once the fisherman of Iceland got rich, they needed to find something else to do. International banking and speculation was it.

"But while the Icelandic male used foreign money to conquer foreign places--trophy companies in Britain, chunks of Scandinavia--the Irish male used foreign money to conquer Ireland. Left alone in a dark room with a pile of money, the Irish decided what they really wanted to do with it was buy Ireland. From each other" (84, emphasis in original). In other words, Ireland had a massive real estate bubble that has now popped. According to one estimate, "Irish bank losses alone would absorb every penny of Irish taxes for the next four years" (85). Ouch! But the Irish are buckling down and embracing austerity to pay down the debt (quite in contrast to Greece).

The Germans, being so-rule oriented (or so Lewis argues), trusted the bond credit ratings agencies that said that mortgage-backed bonds and collateralized debt obligations were AAA (the safest of any bonds), so they ended up getting stuck buying lots of these. Too bad for them.

Finally, there are the Americans. California's dire public finances (especially at the local level) are a microcosm of the national struggle to balance budgets. But it's not just the mortgage bankers or governments who are to blame. Public-sector unions also took advantage of the financial boom to wrest huge pension guarantees from governments. And private citizens borrowed to the hilt. The problem, writes Lewis, is "with the entire society."

It's what happened on Wall Street in the run-up to the subprime crisis. It's a problem of people taking what they can, just because they can, without regard to the larger social consequences. It's not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They'd been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans (202).

Lewis, usually a hillarious and light-hearted story-teller, ends up in prophetic mode, issuing a jeremiad: "Everywhere you turn," he writes, "you see Americans sacrifice their long-term interests for a short-term reward. What happens when a society loses its ability to self-regulate, and insists on sacrificing its long-term self-interest for short-term rewards? How does the story end?" (205)

In the end, Lewis' book offers a sober diagnosis of the American character, covering Wall Street bankers, politicians, unions, and households. We're all in this together, but how in the world do we get ourselves back on track in living for the long-term?

Let us know if you figure that out.

"Margin Call" Challenges Wall Street Ethics

I woke up this morning to Kenneth Turan's positive review on NPR of the just-released Hollywood drama, Margin Call, which is based on the collapse of the Wall Street firm Lehman Brothers in 2008. (Also see Turan's review for the LA Times and the HBO film Too Big to Fail.)

That radio story was quickly followed by my reading of A.O. Scott's glowing review in the New York Times. In light of both reviews, I was hoping to see this movie tonight (in violation of my usual policy of waiting until movies make it to the dollar theater or DVD). It's not often that I would willingly part with $9.00 for a movie; I have to be persuaded by multiple sources. Sadly, though, Margin Call isn't playing in our area yet.

That's a bit surprising, because you would think that the continuing Occupy Wall Street protests and the Academy Award winning documentary Inside Job would warrant a nationwide release. While Inside Job marshals enough evidence to outrage even the most indifferent citizen (see earlier posts), Margin Call is said to take a subtler approach. As in Kevin Spacey's portrait of Jack Abramoff in Casino Jack (another ripped-from-the headlines drama), we get to see real people making real choices in morally compromising situations. These are flesh-and-blood human beings--not crude caricatures like Oliver Stone's evil Gordon Gekko in the two Wall Street films.

A very telling exchange quoted in Turan's review is between Kevin Spacey's character and Jeremy Irons' character (the CEO):

Sam Rogers [Spacey]: And you're selling something that you know has no value?

John Tuld [Irons]: We are selling to willing buyers at the current, fair market price.

One lesson of this snippet? The winners are those who can get away with peddling junk; the losers are the ordinary suckers who aren't smart enough to see how the winners have gamed the system. Too bad for the losers: it's a free market. If they lost, it was because they got out of the game too late. They were "the last one holding the bag." They were the fools who bought the junk. Hey, it's a free market; they just failed to do their due diligence. The market punishes fools.

The real lesson: A free market economy full of unethical people like Irons' CEO is no longer a free market. It's a system that allows the slick, smart, greedy, and unethical to dupe unsuspecting, trusting people. Such a system is predatory and enslaving: the opposite of free. And saying this is not "class warfare." It's just describing Wall Street and the global financial system for what they have become: a group of people cloaking their knowing misdeeds in the rhetoric of the free market.

Capital Reserves? No Thanks, Say the Banks

Joe Nocera, a business-reporter-turned columnist for the New York Times, ran an informative column yesterday about raising the required amounts of capital that international banks must have in reserve to cover their lending. As he notes, the Basel III agreement being negotiated in Switzerland would require the banks to have 7 to 10 percent of reserve capital on hand, far less than the 14 percent preferred by Federal Reserve Governor Daniel Tarullo. (Nocera is a co-author of one of the best books on the mortgage meltdown, reviewed in this space in a previous post.)

Naturally, of course, the big Wall Street banks and their allies in Congress are resisting this push, citing the dangers of "over-regulation." But we've tried de-regulation of the financial industry over the last 30 years and ended up with the worst financial crisis since the Great Depression (and it may yet equal the Great Depression).

Which raises a rhetorical question. Why can't the banks and politicians do the right thing for the nation and the world, even it means some modest sacrifice?

"Inside Job" Won Best Documentary

Semi-regular readers of this blog (all two of you) might remember that Charles Ferguson's documentary film Inside Job has interested me for awhile now (see previous posts here and here.)

For those of you, like me, who don't obsess over the winners of the Academy Awards, I'm pleased to report (a little late) that Inside Job won this year's award for best documentary feature.

It's nice to see the Academy of Motion Picture Arts and Sciences rewarding a great and important film that all Americans should see.

Back to Our Regularly Scheduled Programming: Global Finance

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?

Shocking News: The Global Financial Crisis Was Avoidable

It's not really shocking news, but in the spirit of the Onion this headline from today's New York Times  could elicit a chuckle: "Financial Crisis Was Avoidable, Inquiry Finds." (Shocking! Haha!)

As I noted in an earlier post, the now-Oscar-nominated film Inside Job doles out plenty of blame to people who caused the crisis (primarily Wall Street bankers and regulators). Likewise, a host of books reviewed on this blog explain the many things that people could have done differently to avoid the crisis. 

But today's story is news because the Financial Crisis Inquiry Commission, a government study group set up by President Obama and Congress, is set to issue its report tomorrow morning. And the theme of this 576-page report, according to Sewell Chan of the Times, is that real human beings are to blame. According to Chan, the report states that 

the crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. . . . The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss, not a stumble.

It's highly likely that the chair of the commission leaked a copy of the report's conclusions in advance to build interest in tomorrow's press conference announcing the release. 

But there will be some Republican complaints about this report, because the report was approved along party lines. The six Democrats on the panel voted to approve it, but the four Republicans rejected it.

We now have two main interpretations of the crisis: the canonical Democratic view, best expressed in Inside Job, that blames alleged Wall Street greed and an alleged lack of regulation; and the dissenting Republican view, which blames Fannie Mae and Freddie Mac, the two Federal government-supported (and now government-owned) mortgage guarantors, for allegedly pushing poorer, sub-prime borrowers to purchase to take on risky mortgages. 

In the Republican view, individual borrowers demanded cheap credit and caused the crisis. We can call this the demand-side explanation.

In the Democratic view, it was the flood of global money pouring into Wall Street that created an excess supply of capital looking for a return on investment. Wall Street firms were dying to make huge money for themselves and their clients, so they pushed subprime lending. We can call this the supply-side explanation.

Who's right? As I'll explain in a later post, probably both parties. As I tell students, whenever you are presented with Option A and Option B, always choose Option C! 

Charles Ferguson is Pissed!

Filmmaker Ferguson is an angry Ph.D.

Thanks to the Canton Palace Theatre Thursday art film series, tonight I finally got to see Inside Job, the documentary film on the global financial crisis of 2007-2008 that I called "The Most Important Film of 2010" in an earlier post (even though I hadn't seen it yet).

Thankfully, now I can say that my judgment, however premature, was warranted. This is an amazing, devastating, illuminating, captivating, and compelling film. Anyone who cares about what happened to our economy in the last few decades needs to see this.

What drives the film and gives it such power is the barely concealed rage of its sole interviewer, writer, director, and producer: Charles Ferguson, who should be nominated not only for an Oscar for best documentary, but also for the title of "the academic Michael Moore."

Ferguson, who has a Ph.D. in political science from MIT and went on to make some money in the software industry before an early buyout/retirement, made his first-ever film on the bungled postwar occupation of Iraq. He got curious and started interviewing people with a camera, and pretty soon he had a film on his hands.

Despite being broadly supportive of regime change in Iraq into early 2003, he was appalled at the disasters that followed: looting, suicide bombings, insurgency, economic collapse, and so on. So, like a good political scientist, he tried to figure out what had gone wrong in the policy process, by interviewing as many decision-makers as he could. With their help, he made the counterfactual argument that it could have been different. Instead of agreeing with then-Secretary of Defense Donald Rumsfeld that "stuff happens" and that looting was the price of freedom, Ferguson assembled dozens of interviews to show that officials of the U.S. government made several critical errors that, if avoided, would have prevented the disasters that followed.

Ferguson has taken the same approach with Inside Job, right away dismantling the lazy assumption that the economic crisis that began in late 2007 was somehow either inevitable or unexpected. Instead, he plays clips from interviews of Charles Morris and Nouriel Roubini, who both predicted the crisis beforehand (or at least understood its main causes in the very early stages). Later, he shows Ben Bernanke denying to a TV anchorwoman in 2005 that a housing market problem could contribute to a recession (oops, sorry about that).

And he makes the convincing case that a number of people knowingly contributed to the crisis through their appalling action or inaction. This wasn't an accident of history but the result of greedy people pursuing their own private gain--at the expense of the public treasury and the public good.

While making his case, Ferguson has a series of testy exchanges with Glenn Hubbard, former economic adviser to President George W. Bush; Martin Feldstein, professor of economics at Harvard; John Campbell, chair of the economics department at Harvard; Scott Talbott, chief lobbyist for the Financial Services Roundtable; Frederic Mishkin, ex-Federal Reserve Board Governor; and David McCormick, former U.S. Treasury Under Secretary for International Affairs. (Watch the trailer for the best ones.)

Apart from these Michael Moore-like, on-camera confrontations, Ferguson tells a good story. For his hook, he starts with Iceland's parallel economic collapse and a short synopsis of the onset of the crisis in the September 15, 2008 bankruptcy of Lehman Brothers. Peter Gabriel's punchy song "Big Time" is the perfect accompaniment to aerial shots of the financial district in Manhattan, evoking upbeat emotions, with lyrics that could be telling the story of Wall Street bankers making it "Big Time".  From there he tells the story in five chapters.

Part I is "How We Got Here." Short answer: our political leaders allowed the financial industry to concentrate its operations and get too big, without proper oversight, especially in the $70 billion a year "derivatives" market, where the famous collateralized debt obligations and credit-default swaps were hatched, all without supervision. Alan Greenspan comes in for special scrutiny here.

Part II is about the housing bubble of 2001-2007, which a number of observers were able to detect by 2005 (although not Ben Bernanke, by then the new Chairman of the Federal Reserve Board of Governors). Among these high-level observers and on-camera interviewees were both the managing director and the chief economist of the International Monetary Fund, hedge fund founder George Soros, journalist Allan Sloan (who documented mortgage-related rot in an October 2007 article), and French Finance Minister Christine Lagarde. This bubble was entirely predictable.

Part III is a straightforward narration of the crisis of September-October 2008, stemming from the bankruptcy of Lehman Brothers and the near-collapse of the giant insurer AIG. Henry Paulson, Secretary of the Treasury, and former CEO of Goldman Sachs doesn't look so great by the end of this section.

Part IV--"Accountability"--seeks to figure out who should have taken action during or after the crisis. Stan O'Neal, the former head of Merrill Lynch, which tanked and had to be bought out by Bank of America, walked away with a total compensation package of $161 million. Who is allowing this? It turns out that the board of Merrill Lynch and other corporations' boards are not very effective checks. What about the government? The financial industry has the equivalent of five lobbyists for every member of Congress. The Obama Administration appointed Tim Geithner and Larry Summers, both with close ties to the financial services industry, to top positions. What about the economics profession in top universities? Here Ferguson digs up some of his juiciest material, pointing out that many top economists draw up to 80% of their income from sitting on financial service companies' corporate boards, consulting with them, or collecting speakers' fees from them. So much for truth-seeking academics speaking to power!

Part V--"Where Are We Now"--helps us assess the situation as of early 2010--a situation that, sadly, has barely improved. Unemployment has dropped a bit from the 10% level but we definitely suffered through a global recession that has devastated the lives of the poorest people more than the lives of people like me. (One of the more haunting segments in this section of the film is a small Chinese plant with empty tables, a vivid picture of how this worldwide recession affects migrant laborers in China making $80 a month.)

Ferguson ends with a shot of the Statue of Liberty and the hope that someone will fight to bring Wall Street bankers to justice. Could we imagine criminal or civil prosecutions of these characters? It's hard to imagine, when we have what one interviewee called "a Wall Street Government."

The Best Book (Yet) on the Global Meltdown

It's the Christmas season. And that has me thinking again about the global financial crisis, the subject of several earlier posts (just click on the chapter 3 tag here or at the bottom of this post).

The links there might not be entirely obvious, but there are two good reasons why this is a good time to dwell on financial globalization. First, Chapter 3 of my book is about lessons from the Christmas season for global finance, where I feature the 2007-2008 crisis as a case study. Second, the holiday season allows for more time to catch up on reading, and I've just had time to review Nouriel Roubini and Stephen Mihm's Crisis Economics: A Crash Course in the Future of Finance.

In a series of three posts in July and early August, I reviewed five other books that diagnose the crisis and explain it to readers. All of them were worth reading. Compared to these, however, I think Roubini's book is the best analysis, combining well-researched rigor with clear writing. It's a serious tome of 300 pages, and it certainly lacks the humor of John Lancaster's I.O.U. and the storytelling of Michael Lewis' Big Short or David Faber's And Then the Roof Caved In.

But it makes up for these deficits with helpful historical analogies drawn from previous financial crises and with sharply realistic prose devoid of ideology or wishful thinking. Other than a little chest-thumping at the beginning (crediting Roubini with predicting the crisis well before it began), the book rebuts the presumption that our current financial crisis was completely unexpected or unique. Instead, the authors argue, what happened from 2006 to late 2008 was entirely predictable; indeed, Roubini himself predicted much of what followed.

They argue in Chapter 2 that the crisis nicely fits Hyman Minsky's model of financial crises--a model made famous in Charles Kindleberger's Manias, Panics, and Crashes. Like Joseph Schumpeter and other Austrian economists, Minsky believed that booms and busts were a recurrent reality of the financial sector in global capitalism. This time was no different.

The authors spend five chapters in the middle of the book describing the long-term structural causes, the string of bank failures from 2006 to 2008, the spread of the crisis globally, the Fed's response, and the responses of the Bush Administration and Congress.

But a real strength of the book, which goes beyond its predecessors, lies in its final third, where the authors lay out a program of reforms and policies that could help prevent another nasty meltdown. As their subtitle suggests, they want to offer some guidance on the "future of finance." It's doubtful that we'll be able to predict the future in detail, but these two have given us a good grasp of what just happened, along with some thoughts on how to prevent it from happening again (or at least contain the damage). With the benefit of a little more time, they've given us insight that earlier books couldn't offer.

Right now I'm thinking that this will be the text of choice for covering global finance in my international political economy course next fall--unless a reader out there discovers a text that might be better. If you do find a better book, please let me know.

The Mortgage Mess: Worse Than We Thought

It turns out that using mortgages as collateral to back bonds sold globally was a bad idea. Financiers sold mortgage-backed securities as lucrative, risk-free investment vehicles. It was supposed to be a win-win for everyone.

But now it appears that these wonderful new financial products could undermine a large chunk of the U.S. housing market. A new report issued today by the Congressional Oversight Panel that oversees the Troubled Asset Relief Program (TARP bailout) suggests that the electronic mortgage-processing systems at the heart of this mess may call into question 33 million mortgage loans. Oops, sorry about that.

In an earlier post, I summarized an article by Professor Christopher Peterson of the University of Utah Law School. His analysis now sounds cautious. The new Congressional Oversight Panel report suggests that our entire financial system might be undermined: 

Clear and uncontested property rights are the foundation of the housing market. If these rights fall into question, that foundation could collapse. Borrowers may be unable to determine whether they are sending their monthly payments to the right people. Judges may block any effort to foreclose, even in cases where borrowers have failed to make regular payments. Multiple banks may attempt to foreclose upon the same property. Borrowers who have already suffered foreclosure may seek to regain title to their homes and force any new owners to move out. Would-be buyers and sellers could find themselves in limbo, unable to know with any certainty whether they can safely buy or sell a home. If such problems were to arise on a large scale, the housing market could experience even greater disruptions than have already occurred, resulting in significant harm to major financial institutions (COP "November Oversight Report," p. 5).

Oops, sorry about that. It really does come down to who owns the promissory note in your mortgage. Unfortunately, for 33 million people the answer to that question is not clear.

A Telling Foreclosure Story

In my previous post, I looked at the legal complications of using mortgage debts as collateral for additional debt. From the time I first heard about this practice--creating collateralized debt obligations or mortgage-backed bonds--in Thomas Friedman's book The Lexus and the Olive Tree (1999), I was troubled. Friedman takes a "gee-whiz-isn't that-cool" tone and looks forward to a day when "everything will be for sale" and can be turned into a bond.

But a story from Thursday's New York Times business section illustrates why turning mortgages into collateral is, in practice, a mess. At the end of the piece, the authors, Andrew Martin and Motoko Rich, tell the all-too-typical story of one family:

Charlotte and Thomas Sexton, of Carlisle, Ky., fell behind on their mortgage payments because the payments on their adjustable-rate mortgage spiked upwards and Ms. Sexton lost her job.

They tried unsuccessfully to sell the home, to refinance it and to modify their mortgage payment. When the Bank of New York Mellon filed a foreclosure notice last summer, they went to a local lawyer, Brian Canupp, who, with the help of a forensic accountant, found a problem in the foreclosure filing.

Last month, a judge tossed out a foreclosure judgment after Mr. Canupp argued that the mortgage trust that claimed to own the Sextons’ promissory note —Mortgage Pass-Through Certificates Series 2002-HE2 — did not exist.

Instead, another trust, called IXIS Real Estate Capital Trust, Series 2005-HE2, claimed to own the Sextons’ note, court records show.

Ms. Sexton said that regardless of who owns her promissory note, she just wants to stay in her home and hopes that the bank will eventually agree to a loan modification.

“We found a mistake,” she said, “that gave us a light at the end of the tunnel.”

So who owns their mortgage (or, more specifically, their promissory note)? The Bank of New York? The bondholders who own IXIS Real Estate Capital Trust Series 2005-HE2? Both? Neither?

The wizards didn't quite think through the simple question of who owns what. So our real estate market is a mish-mash of unclear title ownership, clogged courts, and messed-up foreclosures. It's going to take a long time to sort this all out--and nobody is happy about that (except maybe the Wall Street wizards who cashed out their profits a long time ago).

The Most Important Movie of 2010

In today's New York Times A.O. Scott positively reviews Inside Job, a new documentary about the global financial collapse. Produced by Charles Ferguson, who was responsible for No End in Sight, which was a brilliant analysis of the fiasco of the post-Iraq War occupation, this looks to be the most important film of the year. 

Call me a crazy globalization geek, but I cannot wait to see this as soon as possible. (If anybody knows if or when it's showing on the big screen in Northeast Ohio, please let me know. I don't want to wait until it's out on DVD.) I really do think every American citizen who cares about their country ought to watch this.

I say this because I think everyone needs to understand how our economy got into its current mess. And the way our economy got into its current mess is mainly due to the financial shock caused by aggressive, irresponsible lending by global banks.

Unlike Michael Moore, whose Capitalism: A Love Story was silly, Ferguson is not a cranky partisan. He has a PhD in political science from MIT, and he got into filmmaking by accident. He's an academic policy analyst at heart, and he applies his skills in his films. While No End in Sight was tightly focused on what happened after the Iraq invasion (in part because Ferguson actually supported Bush's policies beforehand), Inside Job delves into the deeper causes of the financial breakdown. (Here's the trailer.)

If you care about the world, you need to engage the story told in this film.