I haven’t seen The Big Short, which opens tomorrow, but I’ve read (and own a copy of) the book and cite it in American Nightmare. Based on the trailer, the movie appears to focus on the notion that the financial crisis was caused by greed and lack of bank regulation, an idea endorsed by Paul Krugman.
As both Krugman and New York Times writer Neil Irwin point out, the movie’s notion that only a few people were able to figure out there was a housing bubble is wrong; many people realized there was a bubble (or bubbles). What the heroes or antiheroes in Michael Lewis’ The Big Short figured out was a way to profit from the bursting of the bubble. While it is possible to “short” stocks, i.e., bet that their price will go down, it normally isn’t possible to short bonds, such as the packages of mortgage bonds that banks were selling.
A new paper from the Buckeye Institute affirms what the Antiplanner has said about the Obama administration’s “bailout” of the auto industry: it did more harm than good. “The auto bailout transferred over $25 billion in taxpayer dollars to the United Autoworkers labor union,” says the paper, “while actually hindering the kind of ‘fresh start’ that is necessary for the industry’s future success and that normal bankruptcy procedures, without political meddling, provide.”
“When a public policy produces worse results than doing nothing, it properly should be described as a failure,” the paper adds. “The Obama Administration auto bailout is such a failure.”
The administration’s “claim that the auto bailout saved 1.5 million jobs is demonstrably false,” the paper continues, as it is based on an assumption that, not only would GM and Chrysler have completely shut down without the bailout, so would Ford, Toyota, Honda, and other U.S. factories owned by foreign carmakers. As the Antiplanner has done, the paper also accuses the administration of violating the rule of law in order to favor some interests (unions) over others (creditors).
By “injecting politics into the reorganization process,” the paper concludes, the administration actually hindered the industry’s recovery. The lesson is not that a Bush or Romney would have done any better, but that future administration’s should keep their hands off of floundering industry’s and let the bankruptcy process and rule of law sort things out.
In the Antiplanner’s recent review of Margin Call, I wrote, “No bank secretly realized that mortgage-backed securities were worthless and unscrupulously sold them to unsuspecting buyers.” The authors of All the Devils Are Here would apparently disagree.
Unlike most of the books about the financial crisis that the Antiplanner reviewed last year, which each tended to focus on one slice of the crisis, All the Devils attempts to track the entire crisis, from the beginnings of the mortgage securities market in the 1980s to the crash in September 2008. It relies heavily on many of the same books the Antiplanner reviewed, including Tett’s Fool’s Gold, Cohan’s House of Cards, and more. However, the lack of footnotes makes it difficult to tell which claims are based on which sources. Although one of the co-authors claims that they interviewed lots of people, virtually all of them supposedly asked for anonymity, so little can be verified. The book doesn’t even come with a bibliography.
Margin Call opened four months ago, so this review isn’t exactly timely, but for readers who haven’t seen it, it purports to be about the 2008 financial crisis. Since the Antiplanner has written extensively about this crisis, I found the movie intriguing enough to watch the DVD.
The entire picture takes place during about 27 hours in the life of an investment bank loosely modeled after Lehman Brothers, which went bankrupt in September, 2008. While the bank in the movie is never named, it has many parallels to Lehman. Lehman’s CEO, Richard Fuld, though out of touch with his employees, was at one time worth a billion dollars based on the value of his Lehman Brothers stock. The movie CEO, cleverly named John Tuld, is similarly remote but is also said to be worth a billion. Lehman’s chief financial officer in charge of risk management was a beautiful blonde who some whispered gained her position more because of a never-proven affair with the company’s executive VP than because of her skills. The movie’s chief risk manager, played by Demi Moore, is a beautiful brunette who apparently has a close but not fully disclosed relationship with the bank’s number two person. The blonde and her boss end up losing their jobs a few months before Lehman’s goes bankrupt; here the movie breaks from reality in that only Moore loses her job.
One of the more common notions about the housing bubble is that it was caused by political pressures to increase homeownership. The Antiplanner’s view is that it would be more accurate to say that the bubble was caused by the conflict between policies aimed at increasing homeownership and policies aimed at reducing homeownership (or, at least, single-family home construction). It would be even more accurate to say that the policies aimed at reducing single-family home construction started the bubble, while some of the policies aimed at increasing homeownership made it worse.
As the Antiplanner noted in recent posts, a lot of factors contributed to the recent housing bubble and subsequent financial crisis. But only two factors were so crucial that, without them, the crisis would not have happened.
Along with Michael Lewis’ The Big Short, Gregory Zuckerman’s The Greatest Trade Ever shows that at least some investors were aware that the housing bubble of the mid-2000s was likely to collapse, with severe repercussions on the economy. The book (whose alternate subtitle is “How One Man Bet Against the Markets and Made $20 Billion”) focuses on John Paulson, whose Paulson & Company was considered a minor player until he shorted so many mortgage bonds that he made the company $14 billion (plus $4 billion for himself).
Believers in the “efficient market hypothesis” argue that there will always be investors willing to bet on both sides of any market. The resulting prices, they say, represent the most accurate possible evaluations of the true value of any investment. One problem with this hypothesis, Zuckerman shows, is that some investments are asymmetrical, which leads to a bias in the markets.
Greedy bankers: Changes in the banking industry caused the crisis, many writers claim, by creating perverse incentives to earn short-term profits by making long-term risks. “High leverage and risk-taking in general was fueled by the Street’s indulgent compensation practices,” says Lowenstein (p. 287). A prime example is Joseph Cassano, who ran the division of AIG that sold the mortgage bond insurance that ultimately bankrupted the company. AIG paid Cassano $280 million over eight years, including large bonuses based on profits that Cassano boosted by failing to set aside funds to pay off insurance policies should those bonds fail. Eight months before it went bankrupt, the AIG board fired him, giving him a $34 million severance bonus and then immediately rehiring him as a consultant for $1 million a month (Lowenstein p. 122).
Such pay rates are certainly questionable if not obscene. Yet there is little reason to think that they led to the crisis. Remember that all the major players–the ratings agencies, the bankers, AIG and other insurers–agreed that mortgages and mortgage bonds were, as the saying goes, as safe as houses. It is hard to imagine that people who were only getting paid five- or six-figure salaries wouldn’t have made exactly the same decisions as those who did get paid seven- and eight-figure salaries and bonuses.
Today and tomorrow, as a part of the Antiplanner’s continuing series about the 2008 economic meltdown, I am going to look at many of the supposed causes of the crisis and show that, while some of them may have made the crisis worse, none of them were the ultimate cause of the crisis. In some cases, I’ll quote a 2009 paper written by two of my colleagues at Cato. In doing so, I have to confess that, while we agree about what didn’t cause the crisis, I haven’t been able to convince all of my Cato colleagues, including at least one of the authors of this paper, about what did cause it.
I’ll also quote from William Cohan’s House of Cards, a book that is mainly about Bear Stearns. In fact, only the first third of the book is about the 2008 crisis; the rest is on the history of that company in the 75 years before that crisis. Unlike some financial writers, Cohan actually worked on Wall Street for 17 years, including a decade as a managing director at JPMorgan Chase. Perhaps this is why Cohan can supply of lot of insights and details missing from some of the other books I’ve read on the crisis.
The Antiplanner continues to read recent books about the 2008 financial crisis, but there are definite diminishing returns. I just finished Roger Lowenstein‘s The End of Wall Street and found it disappointing. It covered almost exactly the same ground as Too Big to Fail, but unlike the latter book, which was based mainly on interviews, Lowenstein’s book seems to be based heavily on articles and op eds in various newspapers and magazines.
The book is poorly referenced–sometimes a citation to a critical point lists nothing more than a person’s name–and somewhat superficial in its description of complex events. Lowenstein focuses heavily on subprime mortgages, but (as I’ll explain in detail in a later post) I don’t think they were the real problem. “Rampant speculation (and abuse) in mortgages was surely the primary cause of the bubble,” he concludes, but he doesn’t even sound like he believes it. There was just as much mortgage “abuse” in Texas as in California, yet Texas had no bubble. Rampant speculation only takes place after prices are already rapidly rising, so such speculation by itself can’t have caused the bubble.
Lots of groups have been blamed for the recent financial crisis, including the Federal Reserve, banks, and Congress for deregulating financial institutions by repealing the Glass-Steagall Act (which separated banks that accepted deposits from investment banks). One that deserves scrutiny is the ratings agencies–Moody’s, Standard & Poors, and Fitch–that gave AAA ratings to bonds made up of subprime loans.
The ratings agencies definitely have a lot to answer for. Historically, only one in 10,000 AAA bonds defaults in an average year. So banks and other financial institutions confidently invested in AAA mortgage bonds only to see the value of those bonds fall dramatically.