Wednesday, September 24, 2008

Economic Disasters and Stupid Evil People

Mark C. Chu-Carroll explains how utterly stupid the Wall Street bankers have been in simple language. It's rather long, but Mark has much of the story wrapped up.

I've written about a lot of it, but I have not explained how insurance got mixed up into the rather fetid mess. This, however, it the kind of thinking that you can expect from investment bankers to whom the only thing that matters is how much the traffic will bear. The problem was that there were no regulators reviewing the banking system and pointing out the fact that securities being sold as safe investments were not and could not possibly be safe.

Mark starts out explaining how investors world wide wanted safe, secure investments that paid a decent return. So the investment bankers took mortgages (which home owners will do almost anything to pay first to keep their homes) and repackaged large numbers of them as big money securities. But there weren't enough mortgages to meet the demand, so the bankers lowered the standards for who could get mortgages so that the number of mortgages to securitize got larger. That worked so well they lowered the standards even more. The bankers needed more mortgages to meet the demand and lowering the standards for who could get a mortgage gave them more product to sell. Alan Greenspan had the authority to regulate the mortgage industry, but as a Libertarian banker he refused to do so.

The adjustments in standards might have caused the investors to question the safety of the mortgages, so the bankers creating the massive securities got other companies to provide sham insurance against mortgage default and then paid security ratings agencies to rate them as high grade secure investments. Of course, since the rating agencies got paid only when they provided a rating, they competed with each other to provide the highest possible ratings. Why not? The rating agencies had no skin in the game if the ratings were too high. Then they broke the securities up into what are called "tranches" - groups of mortgages of similar risk levels - which they sold separately from the overall security. The finance experts convinced the investors buying the tranches that they were getting safety through that magic financial word "diversification."

Then, operating on the theory that they were buying safe, secure, insured, highly rated investments, they began to leverage the purchases. The investors put up a small amount of money themselves and borrowed a lot more to buy these safe, secure investments. As long as the interest they paid was lower than the interest on their loons, they made ungodly amount of money and got equally ungodly bonuses every year.

Then they repackaged the loans they had bought with largely borrowed money and sold those packages to other investors who also borrowed money buy the new securities. Bear Stearns was borrowing $33 for every $1 of their own, and Lehman Brothers were also leveraged at 33 to 1. No regulator would have allowed that degree of leverage.

But the mortgages at the base of all this structure were not as secure as they were alleged to be, the ratings agencies were rating them too high, and the companies who sold the default insurance did not have the needed money to cover the losses if the defaults built up. This one paragraph summarizes the last two years of Wall Street as the wheels came off the entire set of scams.

Most of the people in the game were stupid. A few know what was going on and were simply evil. Most of the Wall Street people were too involved in their own little worlds and accepted what they were told about the security of the mortgages and the securities based on them. Some clearly knew how bad the information was - probably at the rating agencies and at the companies selling insurance. But there was not overall regulator responsible for seeing how all the pieces fit together, and no one who was selling those products could have kept their (extremely well-paid) jobs if they had told the public or their customers the truth.

Stupidity, greed, and a great deal of evil intent pushed the ideology of the free unregulated financial markets which was adopted by the individuals in the Reagan Revolution. That ideology was sold as offering a route to great prosperity, a route not offered by merely working hard and building products and businesses. But it's an ideology that inevitably leads to economic boom and bust, with each boom and each bust larger than the previous ones. That led to the bank and security regulations put into place in the 1930's after the Great Depression showed the failure of an unregulated financial industry.

But a lot of financial sales people with a lot of money found themselves frustrated by those regulations. Libertarians like Senator Phil Gramm worked to remove those regulations and the regulators (leading to among other things the collapse of Enron after a great deal of illegality and corruption.) And they have brought their inevitable financial disaster back to America and around the world. Again.

Among other things, America has specialized in banking while underpaying and underrating engineers and technicians who build and maintain real products.

Think anyone will get the message that conservatism is bad news?

[ H/T to Digby ]

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