Book Review of “All the Devils are Here
The Hidden History of the Financial Crisis”
“Hell is empty and all the devils are here” - William Shakespeare - The Tempest
This brilliantly written book should be required reading for any registered voter in the USA. With all the misinformation “out there” about who and/or what caused the financial crisis, it is important to know where to go for answers. This book is “The Source.” The authors are Bethany McLean and Joseph Nocera. McLean was co author of the highly regarded book on the Enron crisis, “The Smartest Guys in the Room.” Nocera is an acclaimed financial writer for the New York Times. The authors’ mission is to tell the story accurately and honestly with no particular political agenda, to explain the complex in a way that can be understood by those not steeped in Wall Street “speak,” and to provide insight into the personalities and characteristics of the major players. The level of research evident in the book indicates to me that the authors were already well connected before they began their research for the book.
Why is the issue of the financial system meltdown important to those who follow the auto industry, and other sectors of the economy? In the late 1970's, consumption represented about 60% of the total economy. 30 years later, consumption was up to about 70%, despite the fact that the income of the middle class had remained stagnant during that time span. How did this occur? The additional consumption funding came from credit fueled primarily by “securitization.” Wall Street’s version of “securitization” had been invented and had grown to 40% of the total credit market by 2008. This expansion of credit fueled economic growth. When the mortgage backed securities market collapsed, it took down the entire securitization market including, credit cards, student loans, commercial loans, auto loans, dealer floor plan, and many other forms of credit. Losing a major portion of available auto credit and funding for dealer floor plan and working capital, pushed already shaky auto manufacturers over the brink, as auto sales slid and dealers dropped like flies. The resulting vicious cycle took the economy downward into recession. The Troubled Asset Relief Program (TARP) was all that stood between the economy and a major depression.
“Securitization” was the process that “allowed mortgages to be converted into a “bond” by combining numerous mortgages into one huge financial instrument. First, Wall Street invented “tranching” to divide up the securities into segments, typically three, based on the inherent risk each tranche entailed. This protected the highest risk level tranch from loss by paying off defaults from the lower rated tranches first. The next step was to devise “derivative” contracts to “insure” the risk. Based on derivative “insurance” like credit default swaps, Wall Street was now able to convince regulators that it was not necessary to “reserve capital” as a hedge against default claims. Now, if only they could get these securities rated AAA by rating agencies like Fitch and Moody, Wall Street nirvana could be achieved. Now junk could be sold around the world as high yield AAA rated securities. AAA is the rating equal to the rating of Treasury bills. To say the least, billions of dollars were made, huge bonuses paid, and many innocent people bilked.
Guarantors of risk were not required to have the money to make good if their bets didn’t pay off. Yet, traditional depository banks were still required to reserve capital, as had been the norm ongoing. This rendered traditional banks to be uncompetitive UNLES they sold their own mortgage originations to Wall Street. If a depository bank originated a mortgage, it could sell that mortgage to Wall Street, buy it back as a part of a AAA rated security, and avoid the “capital reserve requirement. Rating agencies like Fitch and Moody were paid by the Wall Street banks whose products they rated.
Junk mortgages could be assembled into a MBS (Mortgaged Backed Security), tranched into 3 segments based on “risk,” “insured” with a Credit Default Swap contract where no capital reservation was required (it was assumed that Wall Street would not take risks not in their own interests), obtain a AAA rating to represent the securities’ safety as the highest grade, which allowed them to be purchased by entities limited to AAA investments by law, like pension funds, and sold around the world . Profits were privatized on Wall Street as huge profits were made and mind boggling bonuses paid to executives. The risk, however, was socialized to U.S. taxpayers.
The U.S. government, in the form of the George W. Bush administration and it’s Treasury Secretary Hank Paulson, was put into the position of allowing the world financial system to collapse or step in with TARP. Fortunately, Congress approved TARP, which despite its imperfections, saved the world from an incomprehensible disaster. After all, it was the U.S. government’s lack of oversight that stood by and let it happen in the first place. Other countries were looking to the Americans as their own economies were severely impacted by the actions of American investment bankers.
Governments are generally expected to protect it’s citizens from avoidable disasters. The Republican Party found this out after the Great Depression. Democrats paid a price after Jimmie Carter. Even President Barack Obama has been blamed by some despite the fact he had nothing to do with the disaster, other than casting some votes while a Senator. Unfortunately, many voters lack the ability to grasp complex issues, and fall prey to simplistic explanations.
In 1979, the Wall Street version of securitization was invented and launched by Merrill Lynch. Government Sponsored Enterprises (GSE) in the form of Fannie Mae, Freddie Mac, etc., had securitized the first mortgages in previous years. The GSEs were given objectives of how many low down payment low income loans they should make at a minimum by Congress. The compensation packages of the executives of the GSEs were predicated on these objectives. Interestingly, the GSEs were already making these types of loans at a much higher rate than the objectives they were given, making huge bonuses a given. Further, the GSEs received credit just for purchasing AAA MBSs containing them from Wall Street. The GSEs thought that was safer than holding the paper themselves. In fact, Wall Street had rendered the GSEs superfluous.
Wall Street was allowed to create a “betting market” on almost anything. The problem was not so much deregulation, but a refusal to regulate at all. During the period of time Wall Street was “rocking and rolling” American home ownership increased only 1.7%. Yes, we have paid a terrible price for such a small increase in the percentage of those who get to experience the American dream. Yes, mortgage originators “approved” huge numbers of loans with little chance of them being paid back. And they did this because they were never going to hold the paper anyway, just as an auto dealer sells auto loans to his/her banks. It was all being sold to Wall Street because they could take the lousy paper, turn in into AAA rated securities, and sell it to anyone. But the real problem was with home refinances and home equity lines of credit.
So who caused the meltdown and who were the players? In 2008, I wrote that the meltdown was caused by an “unholy alignment between liberal and conservative political causes.” This was after watching hours of testimony on CSPAN and studying the subject intensely. After two years of additional study, including watching Hank Paulson, the Bush Treasury Secretary and author of TARP, testify before Congress under oath, I have adjusted my thinking. But my own personal opinion is not important. All of us have to satisfy ourselves. For those who want to believe the meltdown of the financial system was caused by the overly altruistic “holding a gun” on lenders, forcing them to make loans they knew would never be paid back, you will be disappointed. It’s a non issue.
Some major “players,” their roles, and some resources are listed as follows:
“All the Devils are Here,” Nocera and Mclean
“On the Brink: Inside the Race to Stop the Collapse of the Global Financial System,” By Henry Paulson”
The last chapter of Bush speech writer David Frum’s recent book: “Comeback: Conservatism That Can Win Again”
“Overhauled” by Steve Rattner
George W. Bush speech on American home ownership from 2002
George W. Bush - consciously worked to prevent anything from slowling the housing juggernaut that was fueling the economy. He also had the guts to stand up to his own party’s ideologues to move to save the economy from destruction by proposing and passing TARP along with his Treasury Secretary. Moved against Congress to bail out GM and Chrysler by using TARP funds after Congress had turned down a bailout package.
Alan Greenspan - a disciple of Ayn Rand, Chairman of the Federal Reserve, fought regulation of derivatives at every turn
Larry Summers - under the Clinton administration was an opponent of regulating derivatives. Teamed with Robert Rubin to squelch Brooksey Born’s bid to regulate derivatives. At the time, Born was Chairperson of the Commodities Futures Trading Commission. As a member of Barack Obama’s administration, Summers was a key player in the bailout of GM and Chrysler, and the direction of many TARP funds.
Robert Rubin - Treasury Secretary under Bill Clinton - worked to quell efforts to regulate derivatives
Brooksey Born - Chairman of the Commodities Futures Trading Commission - moved to regulate derivatives, and was squelched by Rubin and Summers.
J P Morgan - invented the credit default swap by paying the European Bank for Reconstruction and Development to assume it’s risk in their exposure to Exxon, which tapped 4.9 billion of it’s 5 billion dollar credit line after it’s notorious oil spill disaster. It never occurred to anyone to ensure the EBRD had the funds to make good in the case of a default. It turns out it didn’t make any difference. Years later, the were many claims to be paid and only the U.S. taxpayer to pay them.
Moodys, Standard and Poor, and Fitch Rating - Were paid by the same companies who’s products they were supposed to rate. Enabled Wall Street to sell junk as AAA level investments.
The Three Amigos - Lewis Ranieri - Salomon Brothers bond trader - “I wasn’t out to invent the biggest floating craps game of all time, but that’s what happened.” David Maxwell - CEO of Fannie Mae, formed an uneasy alliance with Ranieri and Wall Street. Larry Fink - After creating some of the first mortgage backed securities he later served as a key government advisor.
Blythe Masters - helped invent the credit default swap for J P Morgan
Joe Cassanno - Ran the Financial Products division for American Insurance Group (AIG) - Began selling credit default swaps (CDS) on collateralized debt obligations (CDOs) “Collateral triggers” built into AIG CDSs helped bring the company down.
Phil and Wendy Gramm - As Senator and later as Chairman of the Senate Banking Committee, Phil blocked attempts at regulation at every turn. Wendy Gramm, a PHD economist, was installed as Chairperson of the Commodity Futures Trading Commission (CFTC) by Geroge H W Bush when it’s current Chairman, Mark Brickell, was moving to regulate derivatives. The move stopped the move to regulate in its tracks.
Roland Arnall - Appointed to the post of Ambassador to the Netherlands by George W Bush while his company, Ameriquest, a major sub prime mortgage “lender,” was a leader in blatantly deceptive lending practices. At one point, a group of ex auto business F&I managers operated a consulting company, specializing in showing fledgling mortgage brokers how to falsify and manipulate documents. They went so far as to have a web site devoted to creating phoney pay stubs, tax returns, job letters, etc. In fact, Wall Street wasn’t really concerned about documentation, as they were able to turn lousy mortgages into AAA rated investments under most circumstances.
President Barack Obama - Was duped and gave Arnall a pass during Senate questioning regarding Arnall’s ambassadorship because a mutual friend, Deval Patrick, the current Governor of Massachusetts, sat on the Ameriquest Board of Directors. His administration inherited the economy in a dreadful condition, although without the strong and decisive action of George W Bush, Hank Paulson at Treasury, and Ben Bernanke at the Federal Reserve Bank, things would have been much worse.
These are only a few of the personalities and characters involved. Before a reader allows themselves to be intimidated by the prospect of not understanding everything in the book, please understand that the people perpetrating these evils on the world didn’t fully understand what they were doing themselves. People don’t usually buy books about business for entertainment purposes, but I couldn’t put this one down. It read like a riveting“who dunnit.” Don’t pass up the opportunity!