I’ve just finished All the Devils Are Here: The Hidden History of the Financial Crisis
and it shows that just when you think you know everything sleazy that happened up to and during the 2008 financial collapse you still have a lot to learn.
One of the authors is Bethany McLean, a journalist famous for helping to expose Enron’s accounting fraud. Her partner is Joe Nocera, a New York Times reporter. They concentrate on telling the story rather than offering suggestions for cleaning up the system.
Much of the reporting on Fannie Mae’s lobbying efforts was new to me. Up to the point of collapse, Fannie Mae earned most of its profits by holding onto consumer mortgages that paid, say, 6 percent, and borrowing short-term funds at lower interest rates thanks to its presumed status as an arm of the U.S. government whose debt would be federally guaranteed (as in fact it was). This was a way to make almost unlimited profits that a lot of high school graduates could have managed, yet managers helped themselves to billions of dollars in compensation for running this scheme that was guaranteed to blow up and wipe out shareholders if ever interest rates rose or homeowners began to default.
How did Fannie Mae protect its special status? They would open “partnership offices” in the districts of important House committee members. Those offices would be run by children of senators and other important politicians and would hold ribbon-cutting ceremonies, studded with politicians, to celebrate Fannie Mae putting money into a senior citizen center or whatever. Fannie gave high-paying jobs to former top officials in the Clinton administrations. By paying an above-market salary to the child of a senator or a former Democratic appointee, Fannie Mae was able to stave off Bush administration hospitality and enrich its managers permanently and its shareholders temporarily (until they were all wiped out when the government took over).
This was not the only example of the spectacular returns on investment from lobbying. One of the biggest and sleaziest subprime companies, Ameriquest, hired Deval Patrick, currently governor of Massachusetts, to serve as a board member of the parent company (ACC). Patrick was paid $360,000 per year and in exchange lobbied politicians such as Barack Obama so effectively that Ameriquest’s founder was eventually confirmed by the Senate as America’s ambassador to the Netherlands.
The book helps answer the question “Why does everyone hate Goldman Sachs?” An example is on page 338, in which Goldman Sachs put together a $1.5 billion CDO in 2004 called “Davis Square III”. This was stuffed full of mortgages from early in the decade of mortgage madness, before credit standards fell and fraud by loan officers became the general rule. The credit ratings agencies gave the CDO a triple A rating. AIG agreed to insure this CDO against default for a minimal percentage. Goldman meanwhile directed the manager of the CDO to swap out some of the better quality mortgages with 2006 and 2007 subprime loans, which were virtually guaranteed to default. There was some fine print in the CDO structure that enabled the manager to do this. Goldman then bought insurance on this crippled CDO from AIG. The ratings agencies finally woke up and downgraded the CDO in May 2008, “costing AIG $616 million in additional collateral calls–which came, of course, from Goldman Sachs.”
Stan O’Neal, the former CEO of Merrill Lynch, is featured in a chapter called “The Dumb Guys”. He took on $55 billion in exposure to subprime loans and didn’t even realize it, wiping out the shareholders who’d paid him hundreds of millions of dollars in salary. His top executives, also paid a fortune by the shareholders, were equally clueless. In July 2007, they estimated that Merrill’s total subprime losses would be no more than $82 million (about half of O’Neal’s golden parachute payment after he was fired). By October the losses were figured as at least $7.9 billion. O’Neal and his cronies at Merrill are featured as truly, adjusted for income and position, the dumbest people in the Collapse of 2008. Of course, sitting in your fully paid-for $50 million Greenwich, Connecticut mansion, a couple of journalists accusing you of being dumb might not sting too badly…
Alan Greenspan takes a beating in a chapter chronicling his refusal to look at any of the facts on the ground, i.e., that mortgage brokers were issuing loans to people who would never pay them back, then having Wall Street banks securitize those loans and sell them to unsuspecting pension funds. Greenspan was convinced that if these loans were truly so bad then Wall Street wouldn’t be buying and selling them. The Fed had the authority to deflate the subprime bubble but it did not exercise that authority. By contrast, Hank Paulson, who left Goldman Sachs to become Bush’s Treasury Secretary, is lauded for his practical approach and attempts to improve regulation (all blocked by Congress, basically). If you’re kicking yourself for not having figured out that inflated house prices would eventually wipe out years of growth in the U.S. economy, take heart. Paulson, according to the authors, had a similar blind spot: “Paulson didn’t suspect that housing or mortgages could be the catalyst for a crisis. … he thought the way others on Wall Street did and the way economists did: Housing prices hadn’t declined on a nationwide basis since the Great Depression! … for all of Paulson’s worries about derivatives, he didn’t understand the dangerous potential of credit default swaps on mortgages.”
Are there any fundamental problems identified in All the Devils Are Here: The Hidden History of the Financial Crisis? One them cutting through the book is that consumer-facing finance companies, if given the chance, will always try to cheat consumers with complex contracts filled with fine print. The basis of the subprime industry’s profit was that they gulled consumers who would have qualified for a reasonably priced standard loan into signing up for a subprime loan with vastly higher fees, sometimes more than 20 percent of the value of the house. These fees were rolled into the loan along with the principal, so the consumer didn’t pay the fee all at once. With low teaser interest rates, the monthly payment might be lower than on a standard mortgage even as the consumer was handing over his life savings to the subprime lender and its Wall Street investment bankers. The authors don’t quite come out and say it, but they imply that this is why it is necessary to regulate consumer lending much more tightly than it had been during the 1990s and 2000s.
Another theme is that Wall Street investment banks will, if given the opportunity, cheat “real money” investors with fine print and complexity, supplemented by optimistic ratings purchased from corrupt ratings agencies such as Moody’s, Standard and Poors, and Fitch. Sometimes the complexity gets too much even for a bank’s own employees who, despite their stratospheric salaries, aren’t very good at understanding risk. When this happens, the investment bank fails and shareholders and taxpayers are left to pay for the managers’ mistakes. Again, the authors don’t come out and say it, but they imply that this is why the government needs to regulate investment banks.
Overall the picture painted by All the Devils Are Here is of a nation whose population is nowhere near smart enough to use or operate the financial services industry that we have. Once things get to a certain level of complexity, fraud and confusion dominate.
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