It's not hard to understand.
Oct. 23rd, 2011 02:14 pmDavid Levine, in his review of Margin Call, says that the film "barely attempts to explain the insanely complex financial shenanigans that caused the crisis." He says that's a positive, because the film is a solid movie that doesn't need to explain it.
The problem with this is that I think it's wrong to tell people that what happened is "hard to understand." There were no "insanely complex financial shenanigans." Once you believe that, you will discover that the entire problem was actually quite simple to grasp.
There were "insanely complex financial instruments" created in the period leading up to the crisis. These instruments were deliberately designed to be opaque and hard to trace; this forced the credit rating agencies to try and understand them, and allowed the manufacturers of those instruments to get the AAA ratings they wanted despite the fact that the underlying real-world components of those instruments were utter crap. But deliberately designing a maze to be impossible, and understanding the intentions of the maze-maker, are two different things.
Many people believe you need a PhD in economics to understand what went wrong in 2008. This is a myth. It doesn't take a PhD to:
1) understand that mortgage companies engaged in fraud, misrepresentation, and misprison to build up their portfolios of mortgages. They did this by selling people mortgages they couldn't possibly pay for, using those misrepresented mortgages on their books as assets to get loans from banks. When the mortgages went bad, the brokers offered "refinancing" that would hold off foreclosure for another year, but at a higher rate with higher starting points. This made the brokers' accounting books look great. The banks, some of which knew but most of which didn't, eagerly participated in this new form of mortgage brokering known as "sub-prime," especially since they didn't have to manage the mortgages and foreclosures themselves.
2) Wall Street banks saw the "money" being generated by small banks taking "risks" (i.e. joining the fraud, or being taken in by fraudulent numbers) and felt they had to get in before their competitors did
3) Operatives in Wall Street knew what was going on but since they were conduits for these transactions with no risks of their own, they kept playing because the cash was amazing.
4) The Wall Street banks didn't want to hold and manage mortgages either, so they repackaged the mortgages into huge blocks and sold them as bonds. AAA-rated mortgages are fine as bonds: bonds are expected to pay off at a given rate, and so are AAA-rated mortgages. But these weren't AAA-rated mortgages, so Wall Street sliced them (using the French word for slice, 'tranche', to give it some, er, cachet, and to hide what it really was.) These things become known as a Collateralized Debt Obligation (CDO). They gamed the system to make the top slices AAA, and then repackaged the sub-AAA into new "synthetic CDOs". The ratings agencies, unfamiliar with these products, graded on a curve: the top was always AAA. Played long enough, and even the crappiest of bond packages could be made to seem like a AAA-bond. (It's like taking the worst baseball player at every high-school, putting them all onto one team, and then saying the best player from that team would make a great major-leaguer.)
5) A commonplace tool for avoiding the risk of default was the Credit Default Swap (CDS). It was called a 'swap' rather than an 'insurance' because using the word 'insurance' would trigger an SEC regulation. The issuer would take in a set amount of money every month, comfortable that few CDOs would go bust, and the risk of them doing so was low. Few of these institutions knew about the fraud in (1) above. Those that did, jumped into step (3). The money was just that good.
6) All of this would have been fine if the issuers of CDSs hadn't then bundled the CDSs and resold them in bond packages. The CDSs were then themselves sliced into even more "synthetic CDOs". They were assumed to be safe because their underlying assets were supposed to be safe. They were thus rated on the same curve as (4).
7) People in (3), and there were starting to be a few of them, took out CDSs on bonds they didn't even own. While legal at the time (and it still is!), this was essentially a form of gambling: betting against the CDS issuer that a third-party obligation would fail. The government, then run by the Bush administration secure in the knowledge that the market knew what it was doing, looked the other way.
8) The banks saw the brokerages in (7) make their move, and saw the demand for these assets, and starting selling them synthetic CDSs based on the synthetic CDOs mentioned in step (6). This was the beginning of the death spiral. These were the insanely toxic assets that nobody understood, because for every level down, the number of assets you needed to track exploded. Worse, those assets were held by an exploding number of institutions. This was the evil hyper-leveraging where everyone starting putting unrealistic figures on the amount of money they were supposedly commanding.
10) One day, the mortgage sellers in (1) just couldn't find another person willing to upsell another bad mortgage another day. They defaulted. When people started demanding cash value, there wasn't enough cash in the world to support the unwinding. It didn't exist. The whole synthesis death spiral had created obligations thirty times greater than all the money in the world.
11) Worse, six months prior to (10), several brokerage houses knew what was going on. They could see the end coming. They borrowed stock in the banks and brokerage houses involved, and immediately sold them. They made a bet that the stock's values would plummet and within a year they'd be able to buy back the stock of those companies at a much reduced value, give the stocks back to the institutions they'd borrowed them from, and pocket the difference. This is the basis of short selling. When the shit hit the fan, people owed them billions of dollars, and didn't even want the stocks back.
There. That's basically what happened. Ten easy steps, with vultures looking on at (11). You can look up all sorts of things about how deregulation led to the mortgage madness, and how the Savings And Loan Crisis of the 1980s led to the deregulation as a way of re-inflating a suppressed housing market in the 1990s, and so on. But it comes down to this: the positive incentive of money was there to do crazy stuff with people's lives and homes, and the negative incentive of criminal prosecution was virtually non-existent.
It's a myth, and a harmful one, to portray what happened on Wall Street as an "insanely complex event nobody could understand." It's easy to understand. Really. You just need to see past the alphabet soup bullroar to see what was really going on.
The problem with this is that I think it's wrong to tell people that what happened is "hard to understand." There were no "insanely complex financial shenanigans." Once you believe that, you will discover that the entire problem was actually quite simple to grasp.
There were "insanely complex financial instruments" created in the period leading up to the crisis. These instruments were deliberately designed to be opaque and hard to trace; this forced the credit rating agencies to try and understand them, and allowed the manufacturers of those instruments to get the AAA ratings they wanted despite the fact that the underlying real-world components of those instruments were utter crap. But deliberately designing a maze to be impossible, and understanding the intentions of the maze-maker, are two different things.
Many people believe you need a PhD in economics to understand what went wrong in 2008. This is a myth. It doesn't take a PhD to:
1) understand that mortgage companies engaged in fraud, misrepresentation, and misprison to build up their portfolios of mortgages. They did this by selling people mortgages they couldn't possibly pay for, using those misrepresented mortgages on their books as assets to get loans from banks. When the mortgages went bad, the brokers offered "refinancing" that would hold off foreclosure for another year, but at a higher rate with higher starting points. This made the brokers' accounting books look great. The banks, some of which knew but most of which didn't, eagerly participated in this new form of mortgage brokering known as "sub-prime," especially since they didn't have to manage the mortgages and foreclosures themselves.
2) Wall Street banks saw the "money" being generated by small banks taking "risks" (i.e. joining the fraud, or being taken in by fraudulent numbers) and felt they had to get in before their competitors did
3) Operatives in Wall Street knew what was going on but since they were conduits for these transactions with no risks of their own, they kept playing because the cash was amazing.
4) The Wall Street banks didn't want to hold and manage mortgages either, so they repackaged the mortgages into huge blocks and sold them as bonds. AAA-rated mortgages are fine as bonds: bonds are expected to pay off at a given rate, and so are AAA-rated mortgages. But these weren't AAA-rated mortgages, so Wall Street sliced them (using the French word for slice, 'tranche', to give it some, er, cachet, and to hide what it really was.) These things become known as a Collateralized Debt Obligation (CDO). They gamed the system to make the top slices AAA, and then repackaged the sub-AAA into new "synthetic CDOs". The ratings agencies, unfamiliar with these products, graded on a curve: the top was always AAA. Played long enough, and even the crappiest of bond packages could be made to seem like a AAA-bond. (It's like taking the worst baseball player at every high-school, putting them all onto one team, and then saying the best player from that team would make a great major-leaguer.)
5) A commonplace tool for avoiding the risk of default was the Credit Default Swap (CDS). It was called a 'swap' rather than an 'insurance' because using the word 'insurance' would trigger an SEC regulation. The issuer would take in a set amount of money every month, comfortable that few CDOs would go bust, and the risk of them doing so was low. Few of these institutions knew about the fraud in (1) above. Those that did, jumped into step (3). The money was just that good.
6) All of this would have been fine if the issuers of CDSs hadn't then bundled the CDSs and resold them in bond packages. The CDSs were then themselves sliced into even more "synthetic CDOs". They were assumed to be safe because their underlying assets were supposed to be safe. They were thus rated on the same curve as (4).
7) People in (3), and there were starting to be a few of them, took out CDSs on bonds they didn't even own. While legal at the time (and it still is!), this was essentially a form of gambling: betting against the CDS issuer that a third-party obligation would fail. The government, then run by the Bush administration secure in the knowledge that the market knew what it was doing, looked the other way.
8) The banks saw the brokerages in (7) make their move, and saw the demand for these assets, and starting selling them synthetic CDSs based on the synthetic CDOs mentioned in step (6). This was the beginning of the death spiral. These were the insanely toxic assets that nobody understood, because for every level down, the number of assets you needed to track exploded. Worse, those assets were held by an exploding number of institutions. This was the evil hyper-leveraging where everyone starting putting unrealistic figures on the amount of money they were supposedly commanding.
10) One day, the mortgage sellers in (1) just couldn't find another person willing to upsell another bad mortgage another day. They defaulted. When people started demanding cash value, there wasn't enough cash in the world to support the unwinding. It didn't exist. The whole synthesis death spiral had created obligations thirty times greater than all the money in the world.
11) Worse, six months prior to (10), several brokerage houses knew what was going on. They could see the end coming. They borrowed stock in the banks and brokerage houses involved, and immediately sold them. They made a bet that the stock's values would plummet and within a year they'd be able to buy back the stock of those companies at a much reduced value, give the stocks back to the institutions they'd borrowed them from, and pocket the difference. This is the basis of short selling. When the shit hit the fan, people owed them billions of dollars, and didn't even want the stocks back.
There. That's basically what happened. Ten easy steps, with vultures looking on at (11). You can look up all sorts of things about how deregulation led to the mortgage madness, and how the Savings And Loan Crisis of the 1980s led to the deregulation as a way of re-inflating a suppressed housing market in the 1990s, and so on. But it comes down to this: the positive incentive of money was there to do crazy stuff with people's lives and homes, and the negative incentive of criminal prosecution was virtually non-existent.
It's a myth, and a harmful one, to portray what happened on Wall Street as an "insanely complex event nobody could understand." It's easy to understand. Really. You just need to see past the alphabet soup bullroar to see what was really going on.
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