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.

"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.

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.

In Defense of Actual Reality (as opposed to financial numbers)

Today, a chunk of General Motors shares are going on sale at $33 a piece, which should allow GM to pay back billions of dollars to the Federal Government and cut the government's ownership share to 26 from a previous 61 percent. Good economic news for once.

Which may be why yesterday Warren Buffet issued a thank you note to Uncle Sam, giving credit to the Feds for helping rescue the U.S. (and world) economy from possible collapse. We usually complain about government, but Buffet points out that both the Bush and Obama administrations have done a lot to keep banks and businesses alive. Meanwhile, the citizenry thanked the incumbent regime by electing the Tea Party.

But the supposed good news about GM also prompted author Paul Clemens, a Detroit resident and former autoworker, to reflect on the difference between actual reality and the numbers games of financiers, in a piece on today's New York Times Op-Ed page. As part of the bankruptcy restructuring, a part of GM was shunted off into an "old GM," which is designed to sell off old assets, i.e., the many plants that are being shuttered forever--or being dismantled.

Like Michael Moore, who will forever be saddened about GM's abandoning Flint, Clemens is troubled by the abandonment of Detroit. (Full disclosure: Like Clemens, I was born in the Detroit area and grew up in Michigan during the 1970s and 80s, so I feel deeply for communities devastated by the loss of car manufacturing plants.)

I encourage you to read the whole piece, but the concluding paragraphs capture Clemens' main theme in a powerful way (I'll underline the best part):

ACROSS the nation, as in Detroit, there is an economic disconnect, a split between what the economic numbers say and how things feel on the ground. The economy is growing, but the unemployment rate hasn’t budged. The recession officially ended in June 2009, but more jobs have been lost than have been added since that “ending.”

Handling this disconnect requires political acuity. It brings to mind something Philip Roth once said about those who have little feel for literature and the texture of lived experience it provides and so “theorize” it. Mr. Roth imagined a scene of a father giving his son this advice while attending a baseball game: “Now, what I want you to do is watch the scoreboard. Stop watching the field. Just watch what happens when the numbers change on the scoreboard. Isn’t that great?” Then Mr. Roth asks: “Is that politicizing the baseball game? Is that theorizing the baseball game? No, it’s having not the foggiest idea in the world what baseball is.”

It’ll be fun, for a day or two, to look at the scoreboard, and to see what G.M.’s shares are going for: $26? $29? $33? $35? The numbers on the exchange will change; it’ll be great, and a welcome, temporary relief from the numbers, still difficult to comprehend, of jobs lost and plants closed. Soon enough, though, we’ll have to go back to watching what’s actually happening on the field, where there’s still a blowout in progress, with the home team way behind, and no one, seemingly, with the foggiest idea what to do about it.

Like Clemens, I want to defend those of us who live on the ground, in actual material reality, next door to car plants, on the field, playing the game--as opposed to the financiers who think that their numbers games are more real. (Chapter 3 of the book attempts to make this case.) A purely quantitative analysis of society is like "having the not the foggiest idea in the world" what social life is.

The Pontiac dealership just down the road from me is now closed (due to GM's restructuring plan). Should I celebrate today?

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).

Who Really Owns Your House?

Who really owns your house? If your mortgage was securitized (used as collateral to back bonds that were sold worldwide) and you still owe on it, then the answer may be no one. Literally no one. As a matter of law, it isn't clear if the legal entities used to securitize mortgages can really assert ownership and foreclose on your house. Neither you, nor they, nor a bank, nor a diffuse group of bondholders can claim title. 

So how can banks foreclose on you if you go into default? Legally, they can't. This is the real reason why some of the big banks stopped foreclosure proceedings recently. Although recent stories focued on "robo-signers" signing tens of thousands of foreclosure notices a month, the story of this deeper legal morass is the real reason that bank shares are tumbling: investors are terrified that banks might not even be able to sell off foreclosed properties to cut their losses on mortgage-backed securities. The banks don't own the the underlying mortgages. Nobody does.

Floyd Norris of the New York Times, leads his column on Tuesday with this question: 

Was the great securitization machine that made hundreds of billions of dollars in mortgage loans based on a legal foundation of sand?

And the answer is Yes. 

In chapter 3 of my book, I made a passing reference to a judge's ruling in Cleveland that mortgage "trusts" couldn't actually claim title to homes. It turns out this is a major problem for any mortgages that were processed through MERS, the Mortgage Electronic Registration System, which is really a shell company set up by banks in the 1990s designed to bypass the traditional title registration process. (If you know anyone whose mortgage was processed through this system and who might be headed toward default, now is a good time to alert them to their rights.)

For those who want to delve into the legal details on this, Norris' column refers to a forthcoming paper by Christopher Peterson of the University of Utah Law School (click on the PDF download to read it)  that picks apart the fraudulent legal fiction called MERS, whose slogan is

As Peterson puts it, 

MERS is two-faced: impenetrably claiming to both own mortgages and act as an agent for others that also claim ownership.

MERS no legal right to both foreclose on you (as if it owns your mortgage) and act on behalf of banks (as if it is an agent of banks or trusts, to whom you owe a promissory note, promising to pay off what you owe). It cannot both assert property rights over your house and claim to be acting as a trustee of banks or bondholders who have a lien on your home. It has to be one or the other, but cannot be both. Yet MERS tries to do both. 

When financiers talk to investors, they claim to own mortgages in order to convey the sense that they own what they are selling. But when financiers talk to the government they claim not to own what they are selling so as to not be obliged to pay fees associated with owning it. MERS and its members prevent recording fees from being paid on assignments—that was the whole point of MERS—but then attempt avail themselves of the protection that having taken such an action would have afforded. 

The "whole point of MERS" was attempt to privatize and speed up the process of recording property rights and titles, bypassing local governments and their fees. Meanwhile, as Peterson says, the same giant banks that set up this shell company received massive bailouts while local governments were 

laying off teachers, firefighters, police officers, infectious disease clinic workers, closing criminal detention centers for violent juveniles, and shuttering courthouses.

Maybe this is why people are so mad at incumbent politicians. They know that something is deeply wrong with our institutions. They see that massive global banks continue to profit while ordinary people struggle to get by in local communities. 

Now, thanks to Professor Peterson and others like him, we can see that monied interests captured our institutions and no one really noticed. Globalized finance ran amok while we slept.

Can we wake up and figure out who owns our houses?

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.

A Clear Analysis of New Global Financial Regulations

As the global sub-prime meltdown of 2007-08 showed, the financial systems of the world's major countries have been tightly integrated over the last 30 years. When U.S. banks wanted investors to buy bonds linked to subprime mortgages, they found them overseas. When overseas investors wanted to get higher returns on bonds, they bought supposedly safe subprime mortgage CDOs. Capital is global and mobile.

Meanwhile, banks and investment firms were able to leverage their assets, borrowing far more than they should have been able to, against the supposed value of their supposedly safe portfolios. It's clear to everyone that stricter capital requirements on banks would help. And that's exactly what the major players in global finance have agreed to in the so-called Basel III agreement. It's "so-called" because it's the third major agreement on global banking negotiated through the Bank of International Settlements in Basel, Switzerland. 

For a wonderfully clear and insightful analysis of this new deal, see a new article written by my former student, Dan McDowell. Dan makes the point that the enforcement of these new standards, which require banks to "keep more cash on hand" (as Dan puts it so clearly) will be voluntary. No international body will monitor compliance with the new Basel III standards, so the various participants might be tempted to cheat.

Basel III is a classic case study of global "governance without government" (which I discuss in chapter 9 of my book). There are standards, but there is no global authority to punish those who violate them (despite the misplaced fears of those who imagine that "a one world government" is just around the corner). Thanks to Dan, this is now clear. Nice work, Mr. McDowell!

Even More Summer Reading on the Global Financial Crisis

First off, thanks to Google for making a new template available that works well for a blog about "the flat world." For those who've seen the blog before, this should be a less cluttered look and a better pairing of medium with content. (Let me know if you disagree!)

And now on to my post-World Cup summer obsession: reading interesting books about the global financial crisis. (Yes, such things exist!) I just finished two more books that help explain the mess the world economy got into by 2007 or 2008. The first, although prophetic, is now slightly dated and probably too technical for the average reader; the second is a current and compelling story that most people would grasp.

Dated and a bit technical, but prophetic
Charles Morris' 2008 book The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash was one of the first books published on the mess, coming out even before the full scope of the disaster was apparent. Morris was a former banker, with some high-level Wall Street connections (he thanks Nouriel Roubini, an early prophet of doom; George Soros, a world-famous currency speculator and intellectual; and Satyajit Das, an expert on the crazy financial products called derivatives, for helping him). Interestingly, Morris blames the free market ideology of the so-called Chicago School and of former Fed Board of Governors Chairman Alan Greenspan for a hands-off approach to regulating finance. In Morris' view, the roots of the crisis go back to the rise of "monetarism"--the belief that money supply drives inflation--in the 1980s. Deregulation was in, so financiers were left alone to police themselves.

But he goes beyond ideological polemics to explain the history that preceded the current mess. Three precedents are the 1987 "Black Monday" stock market crash, the 1998 Long Term Capital Management collapse, and the 2000 popping of the dot-com stock market bubble--all of which illustrated the flaws of applying mathematical models to manage the risk of market downturns. History doesn't obey the law of averages but has a way of coming up with never-before-anticipated events--events that don't fit on a "normal" bell-shaped curve. Globalized finance is not like physics and its mathematical expression:

The mathematics of big portfolios analogizes price movements to models of heat diffusion and the motions of gas molecules, in which uncountable randomized micro-interactions lead to highly predictable macro-results. Although it's theoretically possible that all the air molecules in my room will shift to one corner . . . the laws of large numbers ensure that the actual frequency of such events is way beyond never. Large securities portfolios usually do behave more or less as the mathematics suggest. But the analogies break down in a time of stress. For shares to truly mirror gas molecules, trading would have to be costless, instantaneous, and continuous. In fact, it is lumpy, expensive, and intermittent. Trading is also driven by human choices that often make no sense in terms that models understand. Humans hate losing money more than they like making it. Humans are subject to fads. . . . [I]n real financial markets, air molecules [real human beings] have a disturbing knack for clumping on one side of the room (pp. 56-57).

Even though the crisis was just beginning to unfold, Morris identifies several new financial products that contributed to making the crisis so massive: collateralized mortgage obligations, collateralized debt obligations, and credit default swaps. If all these terms confuse the heck out of you, then try watching the "Crisis of Credit Visualized" video, which is very helpful. Credit default swaps are what led to the Fall 2008 near-collapse and $85 billion bailout of AIG, a giant global insurance firm, which had not yet happened when Morris was writing, but he could claim to have seen it coming (at least in general). Which just goes to show you that this thing was entirely possible to anticipate. While it took a while for President George W. Bush to realize that "this sucker could go down," people like Morris saw it coming well ahead of time.

A compelling story for most readers
David Faber, a reporter for CNBC, has the courage to say that he honestly missed this story as it was unfolding. But thanks to a hedge fund manager in Texas named Kyle Bass, who called him to clue him in, he eventually started piecing together what was really happening at multiple levels. In other words, Faber figured out the story that only a few experts on the edges of Wall Street like Bass (the same people that are heroes in Michael Lewis' The Big Short) had told up to that point. Once he "got it," he needed to tell the story.

As a result, Faber's book And Then the Roof Caved In (2009) does a nice job framing the crisis as a compelling narrative, with real characters taking actions that drove the story from its beginning to its end. It looks like Faber basically converted his reporting for the CNBC documentary House of Cards into book form. Unlike Morris, he limits to the story to the critical period between 2001 and 2008, focusing on the links between 1) ordinary homebuyers who were trying to use increasing house prices to get ahead financially, 2) unregulated subprime mortgage lenders who were eager to lend at high rates of interest, 3) Wall Street banks desperate to buy up "physical" mortgages to pool into mortgage-backed bonds, 4) global investors desperate for high returns above the low interest rates set by the Federal Reserve (Fed), 5) credit rating agencies (Moody's, Standard & Poor's, and Fitch) that were complicit with the Wall Street firms that paid them to rate bonds issued by the same firms, 6) a Fed that failed to regulate the subprime mortgage market or take action to ease the housing bubble (the steady increase in housing prices and the flow of overseas capital into the mortgage bond market), and 7) Wall Street bankers (like Stan O'Neal, the head of Merrill Lynch) who were more interested in playing golf and paying themselves huge bonuses than in what was going on.

These seven are the main characters in any accurate rendering of the drama (is it a tragedy or comedy?). I want to comment briefly on ordinary people, Wall Street banks, and global investors.

I was especially glad to see the attention paid to the impact of all this financial maneuvering on ordinary people (#1 above). Faber focuses on the story of Arturo Trevilla, an upwardly mobile Mexican immigrant to California, and his family. They bought a house for $584,000, signing papers that said he took home $16,000 a month when he really earned $3,600 a month. (Arturo's English wasn't great, and even if it was, loan papers are hard to understand.) He also borrowed money for the down payment (a so-called "piggyback" loan). He was hoping to get out of his subprime loan in the future by borrowing against the expected future value of his home, which he, like everyone, assumed would keep increasing. Then he could borrow $70,000 of his home equity and start the embroidery business he was dreaming of. Unfortunately, by the time his adjustable rate mortgage payments zoomed up to $5,000 a month, he was in trouble. Then he lost his job, and he, his wife, his three kids) moved into an apartment with another family. Predatory lending or irresponsibility? A little of the latter, but mostly the first, I think.

The issue of ordinary people "flipping" homes for profit was also a major contributor to the crisis. Kyle Bass, the hedge fund guy, knew there was a problem when he chatted with a bartender in Las Vegas in 2007 who told him that he wasn't doing so well because his "three houses are killing me" (151). He'd been borrowing to buy and flip houses but couldn't sell them. Yes, a regular old bartender was doing that. And, yes, the inability to sell suggested that the real estate price bubble had popped--especially in places like Las Vegas (or California, Arizona, or Florida).

Why was Wall Street so stupid? In passing, Faber mentions a study of 24 housing busts that had happened since the 1970s (p. 175). In the last post, I reviewed John Lanchester's I.O.U., who had lived through a real estate bubble in England And yet really smart people all over the world were convinced that housing prices in the US would keep rising? Everyone knew that things were getting risky, so why did they keep investing in mortgage-backed bonds? According to the former CEO of Citigroup, they were afraid of losing market share (p. 168).

The global dimensions of this crisis are significant. Without the "giant pool of money" held by investors outside the U.S.--something like $70 trillion in 2008--this crisis wouldn't have started or become so widespread. According to Faber, "In 2005, 80 percent of subprime mortgages were being securitized and sold to voracious investors around the world. The subprime mortgage had become the chief export of our country" (p. 78). Message to the world from the USA: "Sorry about that."

On two controversial, politically charged points in the narrative, Faber weighs in with his own reading of the evidence.

First, he doesn't blame Fannie Mae and Freddie Mac, the two federally supported mortgage guarantors, for driving the crisis. After delving into the story, he attacks the "myth" that "the lax lending standards of Fannie and Freddie promulgated the current crisis. It is not true. Wall Street rushed into the vacuum created by the absence of Fannie and Freddie in 2003-2005 [because they were under pressure to be more cautious and accurate in their financial statements]" (p. 66). 70 percent of U.S. mortgages originated in 2003 were sold to Fannie and Freddie. By 2006, only 30 percent of mortgages were (p. 65). However, he does note that Congressman Barney Frank, the Chair of the House Financial Services Committee, later encouraged Fannie and Freddie to increase lending, on the theory that extending credit to less creditworthy borrowers would help expand the American Dream of homeownership. Still, in Faber's view, Wall Street is the one that drove the game.

Second, probably because he scored an interview with Alan Greenspan in 2008, Faber gives a wide berth to accusations that Greenspan and the Fed failed to take appropriate regulatory actions (in contrast to Morris, as noted above). However, he does point out (on pp. 50-54) that Edward Gramlich, one of the Fed's Governors, and Sheila Bair, the head of the Federal Deposit Insurance Corporation (the main regulator of banks), tried to persuade Greenspan to tighten lending requirements for mortgages. No dice.

Because of this reverence for Greenspan, Faber ends the book on a rather futile note, with no lessons for possible future corrective actions. As he puts it, in the final paragraph of the book,

Greed is the fuel that makes our capitalist system run. It is a powerful emotion. When I asked Alan Greenspan about it, he agreed, and then he gave me a sideways look from that famous 82-year-old face and said: "And you're going to outlaw that? Go ahead and try it."

Well, there's nothing we can do. There is No Alternative to letting the market run. You might as well try to pass a law against gravity.

Do you buy that?

More Summer Reading on the Global Financial Meltdown

After surviving the World Cup (too late to blog about) and a couple of weeks at Calvin College in a seminar on "Faith and Globalization," I've gone back to my summer reading on the causes of the global financial crisis.

This time, I turned to British novelist John Lanchester's I.O.U.: Why Everyone Owes Everyone and No One Can Pay. It's the clearest, funniest, and most helpful examination of the crisis yet. Not only does he do a good job bringing the whole crisis down to earth, explaining it well, but he also thinks clearly about the larger context in which the crisis took place. And he makes the reader laugh along the way.

He correctly observes that one of the biggest gaps of cultures today is between those who understand global finance (very few) and those who don't (most of us). By trying to bridge this gap, he serves both cultures: the culture of global finance experts and the culture of the rest of us.

As I did in my last post, I'm going to focus on the overlapping points in his analysis and my own in chapter three of the book. At several points, he makes observations paralleling those in The Fullness of Time.

• The collapse of the Communist bloc (pp. 12-24) as the opening for the triumph of global finance (i.e., "the end of history"means that there are no ideological competitors to challenge capitalism).
• ATMs and "frictionless" money: He starts out his first chapter (not unlike my third chapter), with a story of going to an ATM in Hong Kong with his father in the 1970s and being bothered. "The sheer frictionlessness with which money moves around the world is frightening; it can induce a kind of vertigo" (p. 8).
• Money as an abstraction: He points out that we have a hard time grasping what money is, until realities intrude on us (pp. 8-9). He even points out that the way that money began to operate was like postmodern theories about the "play of signifers," and so on.
• The role of arrogance and quantitative abstraction in underestimating risks: In chapter 4 of I.O.U., Lanchester observes how the quantitative "geniuses" were building a system that depended on subprime borrowers:

By 2006, "more than half of all applications for mortgages were either 'piggback' loans, meaning that they were double loans taken out to buy the same property, or 'liar loans,' in which applicants were invited to state their own income, or 'no doc' loans, in which the borrower produced no paperwork. Gee, what could possibly go wrong" (p. 132)?

• Mathematical abstractions replacing common sense and a concrete sense of what's going on: 

"Consider the case of Lawshawn Wilson in Baltimore, with no job and no income, supposedly making mortgage payments to the trustee who was the ultimate owner of her mortgage, Citigroup Mortgage Loan Trust Inc., 2007-WFHE2. How likely is a problem with that and similar mortgages? Not too unlikely, one would have thought. But by the time the market had finished with its packaging and securitization and CDOs [collateralized debt obligations] and CDSs [credit default swaps, or insurance against failures]  . . . the CFO of Goldman Sachs, David Viniar, described  [it] like this: 'We were seeing things [subprime defaults and collapsing real estate prices] that were 25-standard deviation moves, several days in a row.' It is almost impossible to put into words how big a number 25 sigma is, expressed as odds to one . . . . It's equivalent to winning the U.K. national lottery twenty-one times in a row. That's the probability of a single 25-sigma event. Goldman were claiming to experience them several days in a row" (p. 164) . . . . They weren't just wrong in practice, the way you are wrong if you call heads and a coin lands tails; they were philosophically wrong. They [global financial firms] were exposed as doing something which was contrary to the nature of reality" (p. 167).

• The failure of regulators to ask simple questions of global financial firms like "I don't understand, please explain"(p. 181)--something that humility and a sense of groundedness in concrete realities might have promoted. Instead regulators in the UK and US trusted firms to police themselves with "market discipline" and instead used "light touch regulation."

• The difference between the pursuit of money and the practice of industry (similar to the central theme in a recent article of mine):

"There is a profound anthropological and cultural difference between an industry and a business. An industry is an entity which as its primary purpose makes or does something and makes money as a by-product. The car industry makes cars, the television industry makes TV programs, the publishing industry makes books, and with a bit of luck they all make money too, but for the most part the people engaged in them don't regard money as the ultimate purpose and justification of what they do. Money is a by-product of the business, rather than its fundamental raison d'etre. Who goes to work in the morning thinking that the most important thing he's going to do that day is maximize shareholder value? Ideologists of capital sometimes seem to think that that's what we should be doing--which only goes to show how out of touch they are. Most human enterprises, especially the most worthwhile and meaningful ones, are in that sense industries, focused primarily on doing what they do; health care and education are both, from this anthropological perspective, both industries . . . . Money doesn't care what industry it is involved in, i just wants to make more money, and the specifics of how it does are, if not exactly a source of unconcern, very much a means to an end: the return on capital is the most important fact, and the human or cultural details involved are just that, no more than details" (pp. 197-98). 

• Summing up his thesis: 

"The credit crunch was based on a climate (the post-Cold War victory party of free-market capitalism), a problem (the subprime mortgages), a mistake (the mathematical models of risk), and a failure (that of the regulators) . . . . But that failure wasn't due so much to the absence of attention to details as it was to an entire culture of the primacy of business, of money, of deregulation, of putting the interests of the financial sector first. This brought us to a point in which a belief in the free market became a kind of secular religion" (p. 202).

When he gets to his final chapter, on where to go from here, he doesn't have a lot to say, but I think we can be hopeful that the god of Mammon failed to deliver on all of his promises, opening us up to hopeful alternatives. The Christmas story provides one such alternative, as it re-enacts (among other things) the paradoxical triumph of humility, concreteness, and embodied relationships.

Summer Reading on the Financial Meltdown

On my summer reading list were a couple of books on Wall Street's subprime mortgage meltdown: Michael Lewis' The Big Short, which is a readable, personality-driven narrative; and Roger Lowenstein's The End of Wall Street, which is a more detailed, less entertaining, journalistic analysis of the major Wall Street firms' mistakes. Neither would make great beach reading, but if you are interested in understanding recent history both would be worthwhile reads.

Given that chapter 3 of The Fullness of Time touches on the roots of this crisis (at least in my view), I was curious to see how these authors interpreted the mess, and to see how well I understood it. 

Lewis really doesn't offer much of an analysis, preferring instead to let his sources spin a story of greed, excess, and blindness. And these sources are the heroes who didn't succumb to the blindness -- analysts and traders who saw the crisis coming and bet against collateralized debt obligations (CDOs) backed by subprime mortgages. By selling these bonds "short" -- borrowing to sell them first and buying them back later at a low price, while pocketing the difference -- these characters made astronomical profits. It's an interesting story but it doesn't help most of us understand the crisis a whole lot better. Greed still wins out, just on the other side of the trade.

By contrast, Lowenstein tries to analyze deeper roots of the crisis and offer more general lessons along the way. While his narrative is confusing at times, he makes telling comments about what was happening. Two passages in particular struck me.

The first was a passage where he talked about the use of quantitative methods within Wall Street firms, based on inadequate historical data. They thought they had quantified and mastered the risks of mortgages defaulting:

Historical data, such as stock prices and mortgage default statistics, were seen as evidence of immutable truths: the stock market is relatively stable; the housing market doesn't crash; home mortgages default at a rate of 1 percent per annum. Wall Street adopted quantitative strategies because they afforded more precision than old-fashioned judgment--they seemed to convert financial gambles into hard science . . . . The problem was that homeowners weren't molecules, and finance wasn't physics (p. 45).

I argue in chapter 3 (and also in a 2008 Christian Scholar's Review article that I adapted into part of that chapter) that arrogance and abstraction (cutting oneself off from concrete reality) were two key roots of the crisis. Both of these are evident in this passage. Lowenstein goes on to describe the precision with which Merrill Lynch estimated its potential lossses from subprime CDOs at "$71.3 million." As he puts it, "This was absurd--not because the number was high or low, but because of the arrogance and self-delusion embedded in such fine, decimal-point precision" (p. 46).

Abstraction was evident throughout the process, as traders forgot that the entire system was based on loaning ever-increasing amounts of money to borrowers who were likely to default. They forgot what their money was actually doing on the ground. Michael Lewis notes that a Mexican grape picker who made less than $20,000 a year was approved for a loan to buy a house worth more than $500,000. Loans were given to NINA (no income, no assets) borrowers and then packaged into these CDOs. Thus, the very foundation of these CDOs was shaky from the start, and anyone who could have thought concretely about where their money was actually going could have seen this (as Lewis' heroes did).

The other interesting passage in The End of Wall Street strikes again at the problem of thinking that one can control risk:

The new finance was flawed because its conception of risk was flawed.  The banks modeled future default rates (and everything else) as though history could provide the odds with scientific certainty--as precisely the odds in dice or cards. But markets .  .  . are different from games of chance. The cards in history's deck keep changing. Prior to 2007 and'08, the odds of a nationwide mortgage collapse would have been seen as very low, because during the previous seventy years it had never happened. What the bust proved, or reaffirmed, was that Wall Street is (at unpredictable moments) irregular; it is subject to uncertainty (p. 288). 

As I argue, the practice of humility would have recognized this uncertainty and moderated the excessive risk taking that destroyed financial markets in 2007 and 2008. I also argue in chapter 3 that a healthy appreciation of concreteness--thinking in detail about what money is actually doing--would have prompted traders to stop what they were doing. And the practice of relationality--understanding what investment money was doing to human relationships and embedding money within those relationships--would have helped us all to recognize what was happening.

Are these utopian hopes? Or everyday virtues modeled by Christians? I think we are already practicing all three of these all the time. We just need to let them inform what we do with our money.

Information Technology Speeding Donations to Haiti

This is a followup to my last post (touching on chapter 3 of the book), on the potentially positive sides of speeding up money flows. This applies to the Haiti situation in particular. The Red Cross is making it very easy to make donations (hopefully for the relief effort in Haiti and not for administrative costs). According to an email I just received from one of the listservs I'm on:

To help, text "HAITI" to "90999" and $10 will be sent to the Red Cross, charged to your cell phone bill. Please visit the U.S. Department of State's website to read up-to-date information and to learn about more ways to offer assistance at state.gov. Please share this message as widely as possible.

That's pretty slick and fast, so there's no surprise that people had donated millions of dollars to the Red Cross already (according to NPR this morning). The only problem is that relief supplies are facing bottlenecks. The airport is not only tiny (with one runway) but it also has structural damage. The main port facility at Port au-Prince has also been destroyed, so cargo ships can't dock there, and there's only one other port facility available, and it's small. One NPR reporter tried to get in with relief experts, but their flight was deleted to the Turks and Caicos Islands.

So all the money in the world won't help if they can't figure out a way to supplies in quickly. The whole situation is deeply disturbing. The infrastructure of an entire country has crumbled. It's a total collapse of everything: both physical and social institutions. Pray for Haiti.

Information Technology as Blessing?

In chapter 3 of the book, I attack the rise of information technology in financial matters. It's a bit strong to say that I argue that it is a curse, although I do think that ATMs, websites, online banking, and pay-at-the-pump credit card scanners contribute to serious problems in our lives. In general these technologies of finance speed up the world. More specifically, they contribute to three problems: depersonalization, arrogance, and abstraction:

• De-personalization or disconnection: our human relationships suffer the more we use money. In fact, we begin to use monetary values to measure the value of those relationships. We need to build communities and attach faces to what our money is doing.
• Arrogance: we begin to think that we're in control, and we can move our money around at will. We need to practice humility with our money.
• Abstraction: we forget what money really is and what it really is for. Electronic technologies contribute to a loss of tangibility about money, which is already an abstract thing to begin with. When all we see are numbers flitting in and out of electronic accounts, we get detached from the concrete realities in which those numbers are rooted. We need to practice concreteness with our money.

But I had a new thought today, as I went online to process gifts our kids chose to give to our denominational relief relief agency. Here I was, using slick web technology to make donations to specific causes with faces attached. The technology made it extremely easy to give money away--the same technology that erodes the virtues in us. It was slick, but for a good cause.

So if I could add a footnote to chapter 3, it would say something about how the church can also tap these technologies to begin moving its members toward a healthier way of living with money. I hesitate to say that such a faster, flatter world is a blessing, but I wouldn't hesitate to say that we can carefully and prudently use these technologies toward worthy ends from time to time. 

We're not subverting the system from within, but we are witnessing to a different way of handling money, a hopeful way, a loving way.