RSS Feed MenuAndrew Redleaf and Richard Vigilante’s new book, Panic: The Betrayal of Capitalism by Wall Street and Washington is the perfect antidote to the political and mainstream media sensationalism that have drown out rational explanations of what actually transpired to take us to the edge of the abyss. To the Left, deregulation, greedy Wall Street bankers and predatory lenders were the main culprits; to Main Street and the Tea Party movement, greedy bankers and corrupt public policies combined forces to lend mortgages to Americans who just didn’t deserve to own a home; and, to the casual but rational observer, there was just too much leverage in the system, particularly mortgage debt carried by American homeowners. All of these observations may be valid, but true accountability lies deeper within the American financial culture.
In language that is clever and accessible, the authors lay out a longer view of the roots of the crisis, striking at the heart of “modern finance ideology” – the acceptance of “efficient markets” as a replacement for human judgment that has characterized the American financial system over the past several decades. Once the engines and operators of the global financial system delegated risk management to statistically-driven algorithmic models, they abandoned the human curiosity and self-doubt that are required to monitor and challenge the very assumptions that feed the models. Remember the 1983 movie War Games with Matthew Broderick? If no human being periodically challenges and provokes the system, we end up with the financial equivalent of global thermonuclear war.
If only the investors – Wall Street firms, pension funds, foreign central banks – were the only ones who embraced the notion of efficient markets then perhaps some of the damage could have been contained. But what made this latest crisis catastrophic and inevitable, the authors argue, is that the regulators (and ratings agencies) all believed the same assumptions. Innovation of financial instruments and corresponding accounting practices outpaced the regulatory frameworks in place to monitor and prevent systemic failure. The result was that regulators (and most Wall Street analysts) reached the same conclusion as the banks themselves – that risk was sufficiently spread around to accommodate any major shocks. We know that to be true because the models said so.
In the wake of behind-the-scenes accounts of the events leading up to crisis such as Andrew Ross Sorkin’s Too Big to Fail and former Treasury Secretary Henry Paulson’s On the Brink, which focused largely on the powerful personalities at the center of the storm, it is refreshing to read a straight-forward, pragmatic assessment of how and why the system experienced such utter failure. To their credit, the authors and some well known investors like John Paulson identified systemic risks early on, made huge bets and reaped enormous rewards shorting the housing and mortgage markets. This early contrarian position provides Panic with market credibility that is lacking in more academically-oriented competing views.
But if there is a broad weakness in Panic, it is the authors’ failure to address where we go from here. Don’t we have the very embodiment of an anti-capitalist, “inefficient market” when there is only one real participant in housing finance (the U.S. government)? Through trillions of dollars of TARP, RMBS purchase programs and FDIC/FHA/GSE guarantees, banks have been deleveraged and risk shifted to the taxpayer. FHA-insured loans have become the new subprime and Fannie/Freddie have choked off credit to all but the best borrowers while implementing appraisal rules that perpetuate downward pressure on home prices. The financial crisis of 2008 was created by cheap credit beginning with Fed rate cuts in 2001, faulty model assumptions, poor regulation, a cognitive belief that risk was permanently contained and by widespread fraud.
Today, we are in more or less the same place. Rates are at all-time lows, Wall Street models assume housing prices fall, financial regulatory reform bills are stuck in Congress and banks are still holding mortgages at artificially high values, paying bonuses on profits that are at best exaggerated and at worst outright lies. Instead of a housing bubble, we have a housing crater. Default risk? What default risk? U.S. government guarantees are considered to be “risk-free.” In the authors’ words, “U.S. home mortgages remained the foundation of the U.S. banking system and thus of the American economy and the dollar itself.” This statement has never more true than today – just insert “government-insured” before mortgages. What has changed? Only the model assumptions, and now they all point downward.
balconesfault // Mar 12, 2010 at 2:01 pm
Matt Taibbi said it best about a year ago in his Rolling Stone article The Big Takeover: How Wall Street Insiders are Using the Bailout to Stage a Revolution :
The best way to understand the financial crisis is to understand the meltdown at AIG. AIG is what happens when short, bald managers of otherwise boring financial bureaucracies start seeing Brad Pitt in the mirror. This is a company that built a giant fortune across more than a century by betting on safety-conscious policyholders – people who wear seat belts and build houses on high ground – and then blew it all in a year or two by turning their entire balance sheet over to a guy who acted like making huge bets with other people’s money would make his dick bigger.
WillyP // Mar 12, 2010 at 3:01 pm
yup, to solve a problem created by unaccountability and loose money, we’ve:
created less accountability
dramatically expanded credit EVEN FURTHER
everything is going just swell now! on the road to recovery! says the Fed… until we’re not
Independent // Mar 12, 2010 at 9:44 pm
Let’s leave aside those who quote Rolling Stone as if it were an authorative rag and recall that it wasn’t greedy bankers that did in the Bush Expansion. It was subprime mortgages that formed various deriatives which, in some Fannie products, were leveraged 70:1.
The problem was that those derivatives were packaged and sold to just about every institutional portfolio and investor with the proviso that it was US Govt backed product that couldn’t ever fail –Uncle Sam will step in and pay it off, no matter the cost.
The problem and responsibility for the housing bubble imploding and banks failing wasn’t because bankers, investors or anyone else was greedy… it was because the Democrats wouldn’t listen to the sirens Geo Bush was wailing about enacting serious reforms to reign in Fannie and Freddie’s massive run up of debt… and the Democrats weren’t listening because Fannie and Freddie were their babies –like the GOP has the military and natl defense… Democrats had the GSEs, peopled them with ex-Democrat staffers and lovers, protected them from the reformers’ ax, ran interference when anyone asked questions… and took mortgage bribes and campaign cash for their political enforcer role.
Dodd, Frank, Obama.
It wasn’t some programmer’s nifty machinations. It wasn’t Wall St or Main St that caused the collapse.
It was the housing bubble’s implosion thanks to years of effective protection rackets run by Democrats ad Fannie’s reckless run up of worthless debt.
mike farmer // Mar 13, 2010 at 11:16 am
Wallstreet should learn one lesson — resist government influence with every fiber of their being.
sinz54 // Mar 13, 2010 at 11:31 am
Independent: It was subprime mortgages that formed various derivatives which, in some Fannie products, were leveraged 70:1.
Those mortgages would never have seemed profitable–and no one would have invested in them–if interest rates had been higher.
The Fed had been keeping interest rates artificially low, to keep the country from falling into recession after the 9-11 attack.
But the Fed seems to be permanently biased toward artificially low interest rates. And as you know, artificially low interest rates breed speculation, bubbles, manias–and eventual crashes. That happened in the late 1990s too. Alan Greenspan then warned of “irrational exuberance” as the dot.com bubble grew–yet the Fed didn’t do anything till it was too late. Why?
I believe the root cause is the Humphrey-Hawkins Full Employment Act of 1968. That Act required the Federal Reserve, for the first time in its history, to use its policies to maintain high employment and low unemployment. Since the major tool the Fed has to stimulate the economy is low interest rates, they are forced to keep rates artificially low over time to keep employment high.
Repeal that Act, and the Fed would no longer be reluctant to raise interest rates to head off speculative bubbles and manias, even if unemployment rose.
We do indeed have a major problem with structural unemployment in this country: The rise of foreign competitors like Japan and India; the poor quality of much public school education; etc. Those problems should be attacked directly, rather than putting a Band-Aid of low interest rates on them.
Shining Light on Our Financial Markets | FrumForum // Apr 23, 2010 at 7:28 am
[...] to a friend of mine here in the Washington area who writes and trades mortgages for a living. Here’s what he had to say about Panic: [W]hat made this latest crisis catastrophic and inevitable, [...]