I recently interviewed Liar's Poker author Michael Lewis, and I didn't even ask him if the Moneyball movie was on again. (Apparently it is, with Aaron Sorkin doing a re-write.) We talked about his new book, Home Game: An Accidental Guide to Fatherhood, but we also got into his take on the financial meltdown and the bailout. This is Part One of some excerpts. You can hear the full podcast at terrencemcnally.net.
As a former Salomon Brothers trader, Lewis could understand how individuals got caught up in the high-risk bubble.
ML: There's a machine out there and a market... and as a trader you can borrow money cheaply, buy sub-prime mortgage bonds, and make the spread between the two.Let's say you're a really smart guy who's sort of detached and intelligent about what's going on, and you see that this thing is totally irresponsible. The loans being made are likely to go bad; the lending standards are collapsing. The intelligent thing to do is not to buy sub-prime mortgage bonds but to bet against them, to sell them short.
As a trader inside a big Wall Street firm...you would face a decision: Do I exercise my independent judgment and bet against this market, or do I just keep going along with what my firm is doing? If you exercise your independent judgment and bet against sub-prime mortgage bonds, you not only probably run into some political conflict within your firm, but you'd never make the big score for yourself... The minute you make a bunch of money from your bet, your firm is doomed. They couldn't pay you. So the smart thing was just to go along and hope it lasted long enough for you to get rich.
So that accounts for single players and their firms, but what about the ratings agencies? We heard a lot of sports talk in the Sotomayor hearings. Weren't they supposed to be the impartial referees?
ML: The sub-prime mortgage bonds were rated triple A by Moody's and Standard and Poor's. Why? Well, they could give you an argument, but in retrospect, it looks like a very foolish argument.TM: It looks worse than foolish to me, it looks corrupt.
ML: When you think about corruption, there's the simple kind where I give you $1000 to interview me on the radio so it will promote my book. That's corrupt and we both know it. But there's a different sort of corruption where we're all part of a system that is rewarding us very well to pay attention to certain things and not pay attention to others. We're paid to have blind spots. There's an awful lot of that kind of corruption in the financial system because people's incentives are all screwed up.
Ratings agencies were paid by the people who issued the bonds to put the triple A rating on them. Their incentive is to please the people who are issuing the securities. They can't at the same time independently judge the securities.
TM: Arthur Andersen went out of business for doing basically the same thing with Enron. How could someone not see that they were recreating something which had already failed in a huge way?
ML: Some people did see...The people I find most riveting are the people who saw the magnitude of the coming disaster. They were sane men in an insane world. They would call Standard and Poor's and Moody's and say, "How are you rating these things? Our models show that if house prices even go flat, all these bonds will be worthless." To the question of what happens to these bonds if house prices go down, Standard and Poor's would say, "We actually don't know because there's no place in our model to put a negative number."
TM: Obama, Geithner and the administration are putting out plans for new regulations. This isn't in there?
ML: No. It should be illegal for issuers to pay raters for ratings. It's a bribe. Instead the administration says they're going to give the regulators more authority to evaluate ratings agencies. That doesn't do anything; they already had that authority.
Lewis cited another example of a conflict-of-incentives that's nowhere to be found in the regulatory reform conversation.
ML: How can you possibly have a Wall Street firm that is at once owning securities, making bets on stocks and bonds for itself, and that it is also selling to customers? Inevitably, it will trade against its customers. It will deceive its customers for the sake of itself.There's no reason both these functions have to be inside one place. You can have firms that provide financial advice but that don't take any positions in securities. Then you could have other firms that have their own trading accounts, but aren't allowed to deal with customers. Those functions should not be in the same place. It creates endless problems.
TM: And this also isn't in the Obama administration's reform plans?
ML: No it's not in there, and no one's even brought it up.
When Lewis suggests that the deeper problem is in "the air we breathe," he's not talking about the environment.
ML: Arthur Andersen was in place to examine Enron, the credit rating agencies were meant to be examining bonds. In both cases they had the incentive to exercise bad judgment because they were being paid by the wrong people. The rules of the game were totally screwed up.Well, why are the rules of the game totally screwed up? This is the deeper problem, I think, and it goes back to the days of Liar's Poker. In the last 25 years, our economy has created this beast, the financial industry, that is much, much too big; that is doing lots of things that have nothing to do with productive enterprise; in which the rewards are so outlandish, they've distorted the upper tier of the income structure. The reason CEO's get paid as much as they do is that Wall Street taught them how to do it.
You get a huge sum of money for doing something is actually socially and economically counter-productive. People made fortunes out of the sub-prime mortgage bond market. That's insane.
So our society has created this very strange economic value system, where really smart people, the leadership class, thinks it's the done thing to go to Goldman Sachs or Morgan Stanley and get paid three or four million dollars a year -- even though you don't actually add value in any way. Now it's in the air we breathe.
Look for Q&A with Michael Lewis (Part 2): There's a Real Chance There's Going to Be an Uprising about This
Joseph A. Palermo: Half Measures and Lukewarm "Reform" Won't Save the Middle Class
Let's hope that when Obama speaks Congress he outlines not only a bold program to provide health care for all Americans, but also a set of proposals to lift the middle class out of its currently dismal economic condition.
I recently interviewed Liar's Poker author Michael Lewis. In Part 2, we look at some implications from the financial crisis for American society at large.
Les Leopold: Calpers Sues Rating Agencies: Where's Obama? Where's Congress?
Fantasy finance inevitably leads to financial crashes, which are a disaster for the real economy. Along the way, bankers get filthy rich. But when the game goes bust, we are the ones picking up the tab.
Sheldon Filger: Bernard Madoff and the Art of Financial Self-Delusion
Among the multitude of Madoff clients who were literally picked clean of their life savings, I was struck by the contradiction between their apparent intelligence and acute naiveté.
Add nothing of real value, and strip good, hardworking people of their livelihoods -- can we have more instant karma soon please?
About an attempted national health care program. The goal is urgent because the insurance companies have gone mad making profit for share holders insead of their mandate of insuring at a reasonable cost. Our entire unregulated capitalism has resulted in monopolistic and concentrated wealth capitalism. Such a system destroys civilizations.
Obama's first priority was to put people back to work. Instead, he has made health care his first priority. I wish him and our poor country the very best. Confusing the order of importance of tasks can have dire consequences.
You may have missed it, as it didn't get much press.
Until President Obama cleanses his Administration of Bernacke, Geithner, Summers and those other Wall Street Bankers of covert allegiance, this country will continue to careen downward without any chance of recovery and redirection. Every day he wastes in inaction is a day of deeper retreat into disaster and national ruin.
Ben Bernanke is brilliant and has been wizardly adept since the day Obama took office.
More clearly stated: our financial industry got too big BECAUSE our productivity (manufacturing base) has shrunk and left us with nothing else productive to do.
And no one is mentioning that. Or doing anything about how it hurts the little guy. Only the banksters are getting help and attention and their way. Are the millions of unemployed suddenly going to get jobs? Are their unemployment benefits going to last through the many years it takes to grow new jobs -- even IF the gov't. were working feverishly NOW to make sure that happens in a sustained way? The slow and temporary cash infusion of the so-called "Stimulus" won't create sustained job growth. Not the kind we need -- to rebuild a 1st World balanced GDP.
And now we've got this further diversion of limp health-care "reform" that further delays REAL financial reform...
At the core of our problem is what I can "Constituency Leadership." For example, I live in Long Beach California. Once the city council members where elected at large. The result was that the overall success of the city came first. Now each council member represents a district, which at first seems right, until you need to get something done. Then it turns into tribal warfare. This is the heart of our problem as a nation. We have some of the greatest minds in the world, but they are sitting on the sidelines because of Constituency Leadership at every level. The game is falling apart and we cannot agree on a solution.
Democracy is the worst form of government except for all those others that have been tried.
Winston Churchill
From http://wiki.answers.com/Q/Who_said_democracy_is_the_worst_form_of_government
I'm too tired to get livid anymore. I frequently believe that our nation is on a downward spiral...and will emerge as a #3 or 4 power in the world....(healthcare puts us near...the bottom 50% percentile...find the W. VA story..and you'll see..I think "Wise" ?, W. VA...health tents...look like...the Congo
_____________
And that is a ridiculous model that NO ONE should have used. The BIS/Basel II accords allowed this to happen. The banks/investment firms got to use their own "internal risk models" instead of external risk models. They knew the models only allowed for real estate to go up and never provided for the distinct possibility it would go down. That's where the credit default swaps came in; they allowed investors to "hedge" their bets because they paid off if the loan defaulted. That's still the case and one of the key reasons why foreclosures continue.
Geithner is trying to torp-edo the nascent reform-effort by proposing bogus fixes that preserve the banks monopoly on the derivatives issuance. He's the banks main water-carrier. Now we can see why the financial industry is consistently the largest contributor of any group to political campaigns. They need friends in high places so they can continue their scams without interruption.
The real problem is separating healthy financial institutions from insolvent ones now that the whole system is stitched together in a complex net of counterparty deals. Credit default swaps form the bulk of those counterparty transactions, which makes them the main source of systemic risk. To fix the problem, current contracts must be either unwound or allowed to lapse, while new contracts must be traded on a central clearinghouse where regulators can decide whether sellers are adequately capitalized or not. The Fed's solution--underwriting the entire financial system to prevent another Lehman Bros. fiasco---doesn't address the fundamental problem; it just puts more pressure on the dollar which is already beginning to buckle.
http://moralphilosophyofcurrentevents.blogspot.com/2009/05/credit-default-swaps-poison-in-system.html
When Hank Paulson held his little meeting where they discussed lowering capital requirements, the proposal was put out for comment. There was one dissent. It came from a programmer who wrote some of the models. What he said was the model results were unreliable when a systemic failure was modeled, so he did not think they could know the consequences of moving to a riskier capital ratio.
He really sounded a little too savvy to have written a risk model that allowed for no devaluation of underlying assets.
From http://edupreneursvkleptobankers.wordpress.com/
"Canonical research findings suggest that American entrepreneurs who establish popular online markets for customized education will catalyze the creation of many good jobs in America, and will end the reign of America’s kleptobankers. Some of the researchers: Clayton Christensen, Paul Romer and Paul Krugman."
December 31, 1916, Sunday: America #1 Creditor Nation
http://query.nytimes.com/gst/abstract.html?res=9906EEDC153BE633A25752C3A9649D946796D6CF
"THE United States no longer owes the world money. For several generations our indebtedness to the lending countries of Europe and the need of providing annually a great sum for interest on this borrowed capital was a commonplace of financial discussion."
________________
The FED Reserve Debt Printing System has taken America from #1 Creditor Nation to #1 Debitor Nation.
Audit the FED Reserve System of 12 privately owned Banks and it will KN0CK YOU SOCKS OFF!
________________
We must restore America to an exporting wealth building nation based on Manufacturing and High Tech Automation!
We NOW HAVE THIS:
China # 1 Creditor Nation
USA # Debtor Nation
As Wall Street and Corporatists have TRANSFERED the Great American Machine to China?
Is this the Last Great Effort of the NE0C0NS?
BUT the SILVER LINING:
G0LDMAN Bonuses are flowing like a beautiful Waterfall!
We are being destroyed by the GREEDY EL1TES who seem to have upped their take now that we all know what they are doing!
Is this the FINAL GASP of the GREEDY NE0C0N EL1TES or is more RUINATION of AMERICA in the WORKS?
Lets hope we find the POLITICAL and ECONOMIC will to rebuild America's Export Base of REAL PRODUCTS and REAL SERVICES!
(1) If a financial firm has traders putting cheap money at risk by betting on the spread between sub-prime bonds (or any other junk bond) and government bonds, then they are simply not taking into account that the spread is a measure for default risk and should be considered an insurance risk premium. The moment this is disclosed to stakeholders in the firm, they should insist that dividends, leverage and funding costs of the firm reflect this risky business. But it's not happening.
(2) Rating agencies should disclose their methodology and an evaluation of their ratings versus market-implied information. The moment they do this very few would continue to trust them. But it's not happening.
(3) The idea that being part of an ill-defined elite provides a justification for riskless rewards is anathema to the principles of capitalism itself. If entry barriers consist of high birth, or an ability to withstand pointless rankisms or other narcissistic hassles and feuds, then the whole thing is simply a value destruction mechanism. It may take a while until this can be revealed, and it may be impossible. But if the leeches get too big, there are ways of determining what it is that they are doing. But it's not happening.
It seems doubtful that will be the end result though when most of those charged with reforming the system are the very definition of Wall St. insiders. I guess nobody could design a henhouse security better than a fox could, but it seems pretty naive to believe that he wouldn't put a trapdoor in there somewhere so he could let himself back in.
http://www.squidoo.com/the_free_market_myth
Also, not saying that Arthur Anderson did not do anything wrong, but their felony conviction was vacated by a The Supreme Court - 9 justices voting to vacate, 0 justices voting to affirm the conviction.
You can't create evironments where the person paying your bill has a massive personal interest in you overlooking certain scenarios. That puts the person/company being employed in the precarious position of not wanting to p*ss off his employer.
The situation has been made far worse over the last 20 yrs or so when companies were allowed to create divisions that don't compete, but seek the same business. So they don't want to offend the client, loosing business in multiple divisions. Potentially loosing millions in billings on one client.
But even in the case of a single purpose company being paid to offer public reviews of a company by that same company. There is no benefit whatsoever to the reviewer to issue a bad review. Yet they are presented as the expert with the knowledge to perform the review. Auditing, rating bonds, etc.
He tries to compare rating agencies to public accountants, and it is not a very good comparison for a bunch of reasons. Ratings agencies do a very different task. Do they have a comparable to a CPA? Do they have an equivalent to FASB? Is there peer review?
If you want to believe that Arthur Anderson and Enron is a normal situation, fine, but you would be mistaken. It was a very different event, and it did not cause a financial crisis.
Also, it would look very bad for a company to fire its auditor over a disagreement on an audit opinion. A fairly stout disincentive.
One of my best friends worked for Arthur Anderson and was a consultant to Enron. I used to lecture her on the hazards of having a public accounting firm do both the audit of the financial statements and consultant work for the same client.
You also have all sorts of government review of these firms, and they do not have a perfect record.
If the government pays for these professional services, then you have the problem of congressmen getting bought off.
So again, who pays for it?
No wonder all of these Wall Street crooks are laughing all the way to the bank...and the bank's probably not even in the U.S. Ha! Ha! Ha! Isn't crony capitalism great?