One of the enduring questions of our time is “what caused our current financial crisis/meltdown/catastrophe/snafu/disaster”. No one seems to know for sure, but everyone has a lot to say on the subject. It probably won’t surprise you, but I know the answer, and I’m going to tell you, but not right away. First, you’re gonna have to suffer through a little erudite discourse before I get to the bottom line.
Let me start by asking rhetorically if there really is a problem? You may think it odd that I spend any energy on this question, but given the fact that we live in a society wherein some still think that Neil Armstrong didn’t really walk on the moon, that the CIA conspired to assassinate JFK, or that Obama is a deep plant from the Muslim Brotherhood, the question deserves some attention. Yes, Sally, we did have and are still having a financial crisis of enormous proportions. The symptoms manifest themselves in different ways for different segments of our society. Let me list but a few of the effects. Jobs, or lack thereof, sharply reduced value of personal savings and retirement accounts, bankrupt businesses, mortgage defaults and lost homes, big bonuses to bankers, endless speeches for politicians, reduced government revenues and concomitant reductions in government services, sharply increased work for bankruptcy lawyers, mounting national debts to be paid by our grandchildren, and, finally, a loss of hope for a better future. Enough said.
The smart guys who know about this stuff weave the following scenario as a way of explaining what happened. You have every right to raise your eyebrow as you read.
1. In 2004 the SEC amended their regulatory stance on broker dealer leverage ratios. They allowed five major banks, three of whom subsequently failed,(Merrill Lynch, Bear Stearns, Lehman Bros) to increase the amount of leverage on their balance sheets from 12:1 to 40:1. That is to say in an effort to increase profits they dramatically increased debt and risk to finance assets, i.e. loans.
2. The much maligned Community Redevelopment Act initially passed in 1977 with the laudable purpose of “helping to meet the credit needs” of certain members of our society was continually tweeked to make it easier for participating lenders to justify making riskier and riskier home loans to more and more people who could only afford to pay the mortgages if they had a job and the value of the underlying asset (their homestead) at least stayed constant.
3. Increased cheap money inflows from non-US sources, in particular China. In early 2009 China became the US’s largest lender nation increasing their purchase of US Treasury Bonds to almost $800 billion. So what you say? Read on.
4. Federal Reserve adopted and reinforced a policy of cheap money keeping bank borrowing rates unrealistically low and indirectly encouraging financial institutions to look for more investments to earn more returns resulting in lowering risk thresholds. This is enabled, in part, by three above.
5. More people buy more homes they can’t afford. The words “subprime mortgage” were crafted to obscure the reality of the bad credit risks that were being taken in increasing numbers. Traditional credit standards are ignored. Some loans were granted at values in excess of the value of the underlying asset. Some clever fellow invented “teaser” loans often with balloon payments and rapidly increasing interest rates.
6. Banks syndicated their loan portfolios and sold them on to other financial institutions higher in the food chain and “reinvested” the proceeds in more risky loans.
7. Harvard MBA’s and their fellow travelers created and refined new and old exotic financial instruments such as collateralized debt obligations (CDO’s) and sold them to “sophisticated” investors seeking higher returns.
8. The aforementioned “sophisticated” investors demanded downside protection on their investments, and AIG invented and sold credit default swaps which purported to hedge the risk on the underlying real estate assets. In due course, it became clear AIG was selling something they couldn’t deliver on. Sounds like fraud to me, but no one went to jail.
9. The default rate on mortgage securities underwritten in 2005-2007 turned out to be multiples higher that expected.
10. Rating agencies granted high (low risk) ratings for mortgage securities lulling investors into a false sense of security in what they were buying.
11. And finally, the rating agencies pulled the plug on AIG by issuing downgrades based on the write-offs AIG was taking on soaring losses attributed directly to….you guessed it…credit default swaps. AIG was unable to come up with the 10’s of billions of collateral it needed, nor could it raise any more capital to repay the additional billions it owed to its trading partners. AIG was bankrupt and the dominos started to fall. It almost took us to the mats.
That pretty much covers it. Oh sure, there are some details I’ve left out, but you get the gist of it. Everyone, and I mean everyone, played a role in the greatest financial fiasco of the last three generations. There is clearly a common thread that runs through the culpability of the parties involved. From consumers to mortgage brokers, to bankers, to politicians to regulators. It is Greed. There I’ve said it. I’ve even invented a new term for it. Egregious Personal Greed (EPG for short) is at the root of this mess, and no one has clean hands. The greed of putative home owners who wanted what they couldn’t afford. The greed of mortgage brokers selling squirrelly mortgages to earn more and more commissions. The greed of bankers putting more cheap money to work to increase earnings to create more value in their stock options. The greed of politicians and regulators currying favor with business interests so they could raise the money necessary to stay in power. The greed of investment bankers in creating even more exotic financial instruments to sell to greedy investors who wanted more and more returns on their investments. The greed of AIG to create earnings to fuel huge bonuses by selling what they didn’t have and could never have. GREED. GREED. GREED.
So this then is the truth that every one knows, but no one talks about. We did it to ourselves. We are hoisted on our own petard. We have been shot with the Polish rifle. We behaved as if our investment trees would grow to the sky. We wanted to eat two steaks a day. We wanted more, more, more.
Greed: an inordinate or insatiate longing, especially for wealth; avaricious or covetous desire. Constantly wanting more than you have.
There is another point of view, and in the interest of completeness, I’m going to offer it for your consideration. I think the best expression of this point of view is contained in Gordon Gekko’s fictional soliloquy in support of greed in the 1987 epic film Wall Street wherein he opined, “The point is, ladies and gentlemen, that greed…is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of evolutionary spirit. Greed, in all its forms, greed for life, for money, for love, and knowledge has marked the upward serge of mankind”. Hmmm. Certainly one man’s point of view that seems on point with the behavior of current society. Yes, I know Gordon Gekko is not a real person, but Ivan Boesky is. I don’t know whether he said the following before or after he was convicted of bilking investors and spending several years in the federal pokey, but he actually said….”I think greed is healthy. You can be greedy and still feel good about yourself. And greed, you mark my words, will not only save us, but that other malfunctioning entity called the US of A”. Huh?
I’m not buying it though. Greed isn’t good. If you don’t believe me, it says so right here in the Good Book. Luke 12:15. Then he said to them, “Watch out! Be on your guard against all kinds of greed; a man’s life does not consist in the abundance of his possessions”. It says a lot of other stuff about greed as well, but it get pretty theological, so I’m gonna leave it out. OK, perhaps I’m not the best one to be quoting the bible in support of a point of view, but then what about my man Bill Maher. He did a whole segment on the evils of greed which he concluded by commenting that “greed is the common thread that runs through all of our problems”, and then muses that obsession with money is a uniquely American trait. Wow, talk about odd bedfellows, Bill Maher and Jesus. I’m definitely throwing in with their side. Greed, especially, Egregious Personal Greed is just no damn good. Just think, Bill Maher, Jesus, and me….all on the same page.
The question that I leave you with is if our personal greed is at the heart of the problem, and all of the institutions of society are complicit, who then can we rely on to protect ourselves from ourselves?