Cause of the Financial Crisis

[kylinrouge.livejournal.com]

Apparently despite having the most detailed information available for the last 3 years, there is still some debate about the origins of the financial crisis. I hope to (who am I kidding?) put this to rest. The OWS protests in particular have spurred many pundits into declaring that they should be mad at themselves or the government, not at banks or Wall St. or anything like that. Such comments a gross revision of history, and I'm not talking about the early 1900s or 1950s, but 3 years ago!

In the beginning of the 1990s, the financial industry invented derivatives. Derivatives are bundles of different types of debt (credit card debt, student loans, mortgages, etc). The debts are bundled up and then sold to investors. These bundles of debt are called Collateralized Debt Obligations or CDOs. Investment banks then sold these CDOs to individual investors like people buying stocks with their 401k retirement funds etc.



30 years ago, if you got a home loan, you paid your money back to the lender. Since it was a long term loan, lenders were really careful about who they gave money to, they wanted to get paid back. Now, thanks to these CDOs, banks sold your debt to investors, so when you paid your mortgage payment, you were paying the investors back.

By the end of the 1990s, derivatives was a 50 trillion dollar unregulated market. Some attempts were made to regulate them but the bankers fought heavily against this. In December of 2000, the banks successfully lobbied Congress to pass the "Commodity Futures Modernization Act" officially banning any and all regulation of derivatives, and the bankers went hog wild raping the fuck out of the country.

This system was a ticking time bomb. Lenders didn't care anymore whether borrowers could repay, so they started making riskier loans. The investment banks didn't care either - the more CDOs they sold, the higher their profits. And the ratings agencies which were paid by the investment banks had no liability if their ratings of CDOs proved wrong. Since CDOs were unregulated, the banks did not have to set any money aside to cover the loans. If they went bad they actually still made money anyway, it was the investors who got fucked (your grandma's retirement fund).

Then the sub prime mess kicked in. In the early 2000s these banks were trying to make as many loans as possible. This lead to an increase in predatory lending. They started doing more and more sub prime loans with a variable interest rate, which was much higher than regular loans. Bankers made a higher commission for these because it made more money for the bank so they would even give these loans to people, even when they could have afforded a better, lower interest loan. They also gave these out to people they knew for a fact couldn't repay them, because again they were not responsible for the loan going bad, they still made a profit even if that happened thanks to the CDOs. Sub prime loans increased from $30 billion a year to over $600 billion a year over 10 years. Two thirds of the loans were rated AAA meaning they were as safe as government securities.

In 2004 the FBI was alerting looking into wide spread mortgage fraud abuses, inflated appraisals, doctored loan documentation, and other fraudulent activity. In 2005 the International Monetary Fund issued warnings of the crisis. In 2006 and 2007 Alan Sloan from Fortune Magazine started reporting on the housing bubble. In 2008 another top economist published a book about the pending crisis. Foreclosures skyrocketed, but meanwhile banks kept doing these scam mortgages -> CDO -> dogshit loans more than ever.

Then it all collapsed. Conveniently, at the same time these big banks were selling triple-A rated CDOs to investors, they were making huuuuge bets that they would fail, because they knew they were dogshit. So even as all of this started collapsing they were making record profits. In fact other big companies having to pay these winning bets is what made the whole economic collapse start (AIG, Lehmen Brothers, etc).

The people who got fucked were mostly huge retirement funds from all over the world. When this all collapsed countless teachers, firemen, policemen, and pretty much everyone under the sun with a 401k retirement fund got fucked over. People who were about to retire in a year or two now have to work another 10 or 20 to make up for it, at least.

No bankers who knew all of this was a scam and bound to collapse have been punished. In fact the highest paid CEO ever who was in on this mess big time, Henry Paulson, was the Secretary of the Treasury who arranged the huge bank bailouts. In the first half of 2006 (2 years after the FBI started warning people of this scam), he was still CEO of Goldman Sachs when they sold another 3.1 billion of these shitty CDOs. Then he became Bush's Secretary of the Treasury, and bailed out these big banks a couple years later. He even asked for there to be absolutely zero oversight and accountability for the trillions of dollars he was giving out. Even better, when he became Secretary of Treasury, he was required by law to sell all of his stock in Goldman Sachs (conveniently right before it collapsed), and thanks to a law passed by the first president Bush he didn't have to pay taxes on it saving him $52 million dollars.

No significant laws have been passed to prevent this from happening again. Just some weak bullshit that doesn't really help, and even that is getting crippled more and more.

Yay America!

Note: I had a lawyer friend help me write this, mainly confirmation of the many facts.

Comments

[pastorlenny.livejournal.com]

The problem with this country isn't ratings agencies that give crap paper the thumbs up because they depend on the issuers of that paper for revenue. It's unemployed Communications majors from Queens sitting in a park having a generational moment instead of jumping on that cashier's position at CVS.

Why do you hate America?

[telemann.livejournal.com]

CVS has those automated check out thingeys now. I hate them. :P

[devil-ad-vocate.livejournal.com]

And every last one of them has peed on a police car.

[gunslnger.livejournal.com]

Actually, that's just two distinct problems, they don't counter each other.

[notmrgarrison.livejournal.com]

at the same time these big banks were selling triple-A rated CDOs to investors, they were making huuuuge bets that they would fail, because they knew they were dogshit. So even as all of this started collapsing they were making record profits.

So the banks made out like bandits, so why did they need bailing out?
And AIG, Lehman Brothers, and those banks that went under were just to stupid to see what the banks knew?

[meus-ovatio.livejournal.com]

Do you have any idea what you're discussing? When all the calls came in, AIG got swamped, so it had to be saved in order to save the financial sector. This is because the financial investment sector had assets in default swaps, except their insurer, AIG, had so many default swap contracts that they couldn't possibly pay what they owed. This is why people were angry about AIG being a pass-through entity to Goldman Sachs, because Goldman Sachs made money on both ends, using tax payer dollars.

[telemann.livejournal.com]

at the same time these big banks were selling triple-A rated CDOs to investors, they were making huuuuge bets that they would fail, because they knew they were dogshit. So even as all of this started collapsing they were making record profits.

Your question indicates you are either ignoring Senate testimony after a 2 year investigation proving this point, or you are unaware of the evidence. The Senate chairman when he issued the committee's report stated: "The overwhelming evidence is that those institutions deceived their clients and deceived the public, and they were aided and abetted by deferential regulators and credit ratings agencies who had conflicts of interest." Specifically for Goldman-Sachs:

The report uncovered a new aspect of Goldman’s mortgage activity during 2007. That year, as Goldman tried to build its bet against housing, the report says, it drove down the cost of shorting the mortgage market by squeezing those who had made negative bets. Goldman tried to put on the squeeze, the report noted, so that it could add to its negative bets more cheaply and protect itself against the housing collapse.

Because Goldman was a large dealer in the marketplace, it had the power to drive prices in a certain direction. The report quotes from the self-evaluation of Deeb Salem, a mortgage trader, who wrote: “We began to encourage this squeeze, with plans of getting very short again.” He added, “This strategy seemed do-able and brilliant.”

There really isn't anything over the top in this post, despite your misleading questions. If you want to read more specifically about Goldman Sachs, refer to page 318. (http://www.nytimes.com/interactive/2011/04/14/business/14crisis-docviewer.html)

[underlankers.livejournal.com]

Why does anyone invest in the latest bubble to come along when every single last historical one of them has popped and the latest one adds another example? Surely someone would see this as a bad idea from the first, but history keeps repeating itself. Are humans irrational actors and thus the free market cannot regulate itself, or is it that the free market as a cyclic system must be treated as such, which US conservatism reflexively refuses to do?

[anfalicious.livejournal.com]

I *hate* the "people bought houses they couldn't afford" excuse. If it were a handful of people, maybe, but it was millions. This points to a lack of regulatory oversight and the banks showing why they can't be trusted to self regulate.

When you go to the doctor, you trust what they say, because they're the expert. When you go to the mechanic, you trust what they say because they're the expert. When you go to a lawyer, you trust what they say because they're the expert. If any of these professionals give you less than good advice for their own personal gain, they get in trouble. Why do we expect Joe Sixpack to be an expert in mortgages? If your bank says you can afford the loan, why shouldn't you trust them? Especially when the understanding was that banks were tight with their money and wouldn't risk it on a dodgy investment. The whole system has been run for decades on this understanding; expecting the man in the street to know that the whole system had changed in a matter of years is ridiculous.

I used to be a mortgage broker. I saw these people first hand. The event that led me to quit the industry was a young couple who the bank said they could afford the house they wanted; they were sold by the romance of owning a house (thanks to the mass hysteria around home ownership that came largely through reality TV in this country) and weren't considering the long term effects. He was a car washer, she was a professional; they were reliant on her wage, yet they also wanted to have kids in the next few years. I told them I didn't think it was practical, but I still did their loan. It made me feel ethically and morally dirty; I knew I was putting these people in a bad spot. So I quit. They lost their house within 3 years.

[badlydrawnjeff.livejournal.com]

I *hate* the "people bought houses they couldn't afford" excuse. If it were a handful of people, maybe, but it was millions. This points to a lack of regulatory oversight and the banks showing why they can't be trusted to self regulate.

"Millions" in the US is still only a couple percent of homeowners.

Why do we expect Joe Sixpack to be an expert in mortgages? If your bank says you can afford the loan, why shouldn't you trust them?

Because if you're buying a home, you should have a grasp on your own finances. The bank told me I could afford $200k in mortgage payments - they may have been right, but I had my own budget. Is it the bank's fault if the lendee is not budgeting properly?

[harry-beast.livejournal.com]

Joe Sixpack knows how much he earns, he knows how secure his job is and he knows how much the mortgage payments are. This is simple high school math and a bit of adult responsibility.

A couple clarifications:

[meus-ovatio.livejournal.com]

The subprime mortgage market pretty much avoided the banks all together, by the end. There was a direct pipeline from mortgage originators, utilizing Wall St. investment funds, to the investment firms, who then sold them to the banks. The banks were fucked in the sense that they were predated by Wall St. as much as anyone else... the distinction between retail and investment banking, of course, is now moot.

(I call a "bank" a bank and an investment firm an investment firm. I maintain the distinction, regardless.) I didn't object to bailing out banks, as long as I felt that Glas-Steagal would be reinstated, and that the investment firms went back to their own bullshit. Of course I wouldn't object to bailing out the banks, since they had all our money.

The proper anger towards banks originated from the fact that they got bailed out, and quickly clamped up and refused to do anything to help anybody. People felt that since we bailed them out, to protect them and ourselves, they should be more flexible with mortgage terms and refinancing and adjusting principal values. Of course, they're not. Subsequent to this, banks are also in the doghouse because of robo-signing fake documents in foreclosure proceedings. So they're just fucking us over, after we saved them.

Re: A couple clarifications:

[meus-ovatio.livejournal.com]

It's really important to get as best a grip as we can, with our limited time and resources, on the different elements of the system, so we can at least read newspapers with a semblance of understanding, rather than just a shotgun mess of a flood of information, and responding to everything piece-meal.

For instance, we can decry or rally around slogans of "regulation!" or "deregulation!" but it really helps to understand the original pressures involved. Commercial banks were feeling incredibly put-out, because they were attempting to compete with Wall St. firms which didn't have their regulatory environment. Commercial banks were losing to Wall St. Every thing follows the path of least resistance, so while commercial banks were allowed to get into the game somewhat like Wall St, they had an entire host of regulations and responsibilities that Wall St didn't.

But if you're a mortgage originator and you're trying to make money, you're just going to avoid the commercial banking system and go straight to Wall St. It's easier, faster and far more plentiful in funds for mortgages. Private hedge funds provided billions and billions of dollars for mortgage originators, and private hedge funds have no rules, so private hedge funds can provide all the leveraged capital they want. And there are no rules or reserve requirements or limits or anything.

As for the mortgages themselves, the mortgage agents get higher commissions for more expensive loans, so the whole thing is fucked from the very beginning. The mortgage agents aren't acting in the fiduciary interests of Wall St. Wall St. isn't acting in the fiduciary interests of the commercial banks or anyone else, and the whole incentive system is designed to self-destruct.

Re: A couple clarifications:

[anfalicious.livejournal.com]

Instead of bailing out the banks, they should have nationalised the mortgages. The banks get paid, people don't become homeless, and you don't have a social collapse that's going to take decades to overcome.

Re: A couple clarifications:

[geezer-also.livejournal.com]

I know it's not as much fun, but you can do reasonableness as well or better than anyone else ;)

Re: A couple clarifications:

[allhatnocattle.livejournal.com]

Investment firms are most often subsidiaries, wings, or alumni of banks, and/or visa versa. For example TD Waterhouse is a sibling to TD bank and visa versa.

To make this distinction that makes out like banks are the victims in this whole sorry mess is not entirely bullshit, but it's extremely misleading.

[ytterbius.livejournal.com]

Good write-up!

I'll add a couple items:

Recommended reading "FIASCO... Wall Street Trader" Excellent book that describes the Derivatives trade back in the 90's. The author describes the process well, and makes clear that the ramifications of these deals are long term. One of the reasons that we're still in so much trouble is that there are still alot of bad contracts out there that will be held for 30 years or so. Any change in the variables that they're based on could trigger new waves of losses (particularly such variables like Interest Rates).

"Lenders didn't care anymore whether borrowers could repay, so they started making riskier loans. "

Not only that, since the ones making the risky bets were making so much money, then responsible people got forced out of the system by the profit motive. If you were not on the edge pulling in immediate profits like your competitors, you were out.

Last item (for now): I heard what I think is a great answer to the question "are we in a bubble?" The answer is, you're in a bubble if you and everybody around accepts that whatever they're buying isn't worth the price, but it's a safe bet that there will be somebody else (a sucker) that will buy it for higher.

[mikeyxw.livejournal.com]

"Apparently despite having the most detailed information available for the last 3 years, there is still some debate about the origins of the financial crisis."

People are still arguing about why the Roman Empire collapsed for the same reson.

[underlankers.livejournal.com]

Actually people only argue about that one because of a reflexive refusal of the people who fap to military might uber alles to admit that societies rooted in sola milites might be fragile.

[underlankers.livejournal.com]

Of course there are no laws passed. One cannot worship liberty and Mammon at the same time, and current politicians worship Mammon because Mammon is the one that ensures they have private islands and lakes.

[whoasksfinds.livejournal.com]

i noticed you didn't mention anything about fannie and freddie, and government regulations that encouraged subprime lending in the name of 'fairness'. in fact the government spent the past decade investing in the financial meltdown by insuring bad loans.

[meus-ovatio.livejournal.com]

Fannie and Freddie are businesses. Why does blaming them make conservatives feel better? Fannie and Freddie had stricter subprime requirements for purchase than the other non-GSE entities. What is your opinion regarding Fannie and Freddie in this and their role in the secondary market?

[peristaltor.livejournal.com]

Nice summation, but I would include the de-facto repeal of the Glass-Steagall restrictions in the mid-eighties followed by the actual repeal after passage of the Gramm-Leach-Bliley Act. This allowed banks to create the wealth that needed bubble-esque investment in securities and later mortgages and the related crud you describe.

Bubbles most always start with an severe increase in leverage. Gramm-Leach-Bliley allowed banks to create their own.

[kylinrouge.livejournal.com]

Yo jeff thanks for freezing the replies of meuv_ovatio owning that kid, I think fozzy bear was about to have a heart attack from all the ignorance.

[badlydrawnjeff.livejournal.com]

Anytime. One can pwn to their hearts content without it devolving into insults.