Transcript of "P emmell notesmeltdown notes 2010-01-27"
Notes & Links on the Financial Meltdown
Peter Emmel -1/26/2010
… still incomplete (I ran out of steam and have not added references for many of the
players listed near the end of section 1. For sections 2 & 3 I have several good articles
but have not had time to get their web links. Also, I haven’t had time to test all the links
to make sure that the documents are still there. I have all of these and more on my
computer as pdf files, and I can put them on a CD for anyone who is interested.)
In my opinion, all the references listed here are worth reading to get an overall picture.
However, if you want to get the most out of a short time … read the two Washington Post
articles on page 3, and read the Columbia Review of Journalism pieces on pages 9 and
13. Then listen to the “Giant Pool of Money” program from This American Life (page
2). The other two TAL programs are just as interesting and cover different aspects. (The
TAL site offers both audio and transcripts.)
I’m no financial expert, but my Dartmouth BA in economics wasn’t purely a means to
free my afternoons for skiing. The subject has a certain amount of interest for me, and I
poke around now and then in the details behind the headlines – looking for sense behind
the nonsense. This page is a collection of the most informative articles and resources I’ve
found … along with my own ramblings on the subject.
Admittedly, I have not covered the “de-regulators” point of view very well. I personally
think that the results have pretty much discredited de-regulation. However, there is a
continuum of regulation options, and the best long term solution is to reach a balance.
We do not need a wholesale return to post-depression regulation levels. Instead, we need
to back wisely away from the excessive de-regulation of the past few years. For this to
happen, we need constructive bi-partisan legislative action- to get the best of both schools
of thought. Dream on!
Areas that interest me most are:
1) Who foresaw the breakdown? What did they say/do and when? And what came of it?
We hear a lot about blame, but there must have been warnings and there must have been
missed opportunities to soften or avert the mess.
2) What are the core problems with financial institutions & credit markets?
We hear about weak mortgage borrowers, predatory/unscrupulous lending,
incompetent/dishonest bank management, excessive leverage, toxic assets, regulatory
3) What regulatory options & ideas are in play now … and who’s pushing for what?
We hear that the interests of “Wall Street” held sway during the deregulation phase that
enabled the meltdown, but where are those interests operating now as the regulation
environment is being re-tooled?
For a primer on the meltdown and its “environment” the most entertaining and
understandable reference comes from NPR’s “This American Life” show. The following
three episodes are each 1hr long but they are very useful in understanding the big picture.
You can download them via iTunes for 95 cents each or listen to them on-line for free
at the following sites:
"The Giant Pool of Money" 5/9/2008
Explains the connection between world financial institutions and grass-roots mortgages.
"Another Frightening Show About the Economy" 10/3/2008
Explains some of the issues that tangle the "bailout" and recovery outlook.
"Bad Bank" 2/27/2009
Explains banking and lending and the path to collapse.
Taken together these 3 segments pretty much explain what happened ... and why fixing it
will be an ugly process no matter what. Basically we’re seeing the contraction of a
massive and unsustainable buildup of credit and its flip side - debt. There can't possibly
be a stable solution without massive losses, and there's absolutely no equitable way to
allocate the losses since they are the comeuppance from over a decade of expansion.
Many who profited handsomely are already out of reach - along with their gains. And
many who lost money were not simply “innocent victims” either. There was rampant
speculation intermixed with shrewd investment at many levels.
Attempts to get even basic commercial credit flowing again are foiled by: (a) the web of
unresolved commitments among financial firms & investors who are all trying to
minimize their losses and who are uncertain as to how much more taxpayer money will
eventually be handed out to cover them and (b) creditors who are now more concerned
with safety than with investment returns and are suspicious of any borrower other than
Also, and I don’t know how big a deal this is, but many of the biggest players in the
financial system are ideologically interested in seeing the Obama administration and the
Democratic congress fail.
I think the real tragedy is what was allowed to happen to ordinary people around the
country – and not just in the "building boom" regions of Florida, California, Arizona and
Nevada – as a result of the grass-roots boom in mortgages and re-financings. The frenzy
to create mortgages for re-sale to Wall Street sent financing companies to appalling lows
in their sales approach and terms. The low water mark were the "NINA loan" - No
Income No Assets – which were even worse than the so-called "Liar's Loan" because
they didn't even ask you about income or assets, they only checked your credit rating and
asked whether you had a job. The default risk was passed along to whoever bought the
mortgage ... and the "derivatives" that Wall Street produced from it ... so there was no
down-side risk for the original lender.
This is exactly the kind of thing that government regulation is supposed to discourage -
predatory business practices that take advantage of unsophisticated citizens who probably
should know better but are too easily sucked in by the "opportunity" to cash in – in this
case on the run-up in value of their homes in an "endlessly rising" market. Enough
people made money in the early years of the housing boom that it began to seem as if
"everyone" could get in on it. There were numerous TV shows and books about how best
to "flip" homes. In my opinion, that's where the most serious public pain comes from.
Investment losses are more bearable than evaporation of home equity that leads to
difficulties carrying mortgages – especially when payment levels reset after low
“introductory” terms expire. The most serious overall economic fallout from all this is
the commercial credit freeze-up - due to lack of confidence in bank balance sheets (i.e.
fear of hidden toxic assets). Inability to borrow money is a severe handicap for ordinary
businesses of all kinds.
I think the most informative articles on the build-up to the crash appeared in The
Washington Post last October (10/15) and December (12/16).
What Went Wrong? (Washington Post 10/15/2008)
The Frenzy (Washington Post 12/16/2008)
They give not only the financial industry story but also the regulatory climate that
enabled and supported it. The story begins in the late 1990s, when the Commodity
Futures Trading Commission headed by Ms. Brooksley Born became concerned about
potential problems posed by the emerging (unregulated) “over-the-counter” trade in
"derivatives" - especially Credit Default Swaps (CDS), which eventually grew into the
biggest-ever engine of leverage. The CFTC proposed regulating them through exchange
trading, but the idea was shot down at the time by Fed Chairman Greenspan and
Clinton’s financial/economic brain trust. The idea sputtered along in Congress but never
got another chance after the Bush administration arrived. It’s hard to get a handle on the
numbers, but it appears that at one point there were some $60 trillion in CDS contracts
outstanding on less than $2 trillion in underlying debt. That's like having your home
insured separately by 30 different people! Who in their right mind ever thought that
could last ??? The answer, of course, is that none of them ever though (publicly, at least)
that it would ever come to a crunch.
Personally, I think it’s time to stop pumping money and start opening up the books.
Auditing and publishing balance sheets of banks and major corporations would now do
more to facilitate credit than all that money. It would restore trust in trustworthy outfits
and identify firms that actually should be shunned and perhaps allowed to fail - or at least
be put on a “balance sheet clean-up” regimen. If it could be done as part of the re-
habilitation process for the recently-discredited rating agencies that were a big part of the
problem, so much the better. Just a thought.
There’s more from the Washington Post at:
This is actually the “main page” for the full set of articles that includes the two referred to
above (which constitute parts I and III of the set). The other parts refer to dubious actions
by specific regulators (Part II) and the fascinating play-by-play on the rise and fall of
AIG’s Financial Products operation (Part IV).
An interesting bit from the AIG story is the role that then-NY-Atty-General Elliot
Spitzer’s investigation played. He had evidence of fraud (that later led to convictions) in
AIG deals that apparently had nothing to do with the now-notorious FP group. However,
the resulting 2005 ouster of long-time CEO Hank Greenberg and the simultaneous down-
grading of AIG’s credit rating began a cascade of CDS collateral calls that eventually
swamped the company.
Here’s a concise summary from the NY Superintendent of Insurance, Eric Dinallo
in the 3/30/09 Financial Times:
Here’s an overall timeline – in excruciating detail:
1a) WHO FORESAW BIG PROBLEMS AND WHAT DID THEY DO ABOUT IT?
Many people foresaw problems with the expansion of credit in general and the growth of
credit derivative securities in particular. A 1994 analysis and report by the GAO
(Government Accountability Office) focused on the dangers of derivative securities, and
many voices were heard on the subject. Warnings were all around (see links below), but
those calling for increased regulation and transparency were discredited in various ways
by those with either an ideological opposition to regulation or a specific vested interest in
There were even dramatic cautionary events to point to and say “SEE!” In 1998 the near-
collapse of a giant hedge fund (Long Term Capital Management) was triggered mainly
by over-exposure to derivative securities. The Federal Reserve convinced financial
institutions to pool together in a private bailout … and to tighten their “voluntary”
controls on excessive risk-taking.
Greenspan and others hailed the move as a demonstration of the industry’s ability to
police itself. Legislation (such as amendments to the Commodity Exchange Act) that
looked like a response to concerns about credit risk was actually designed to shelter
financial firms from regulation.
The following links give an idea of what was said by some of the many who foresaw
problems and tried to do something about them.
Brooksley Born (CFTC chief 1996 - 1999)
Prophet & Loss – Stanford Alumni News 2009- Biography and in-depth interview, with
details surrounding her warnings and the steps that Greenspan, Rubin, Summers and
others took to bury them:
The Woman Greenspan, Rubin & Summers Silenced – The Nation 10/9/2008:
Brooksley Born Vindicated as Swap Rules Take Shape – Bloomberg 11/13/2008:
Born’s congressional testimony to Senate subcommittee on 2/11/1997 regarding a bill to
amend the Commodity Exchange Act (S157) – warning that the bill (promoted by the
financial industry and its powerful friends) would lead to trouble:
Born’s congressional testimony on the corresponding House bill (H.R. 467) on
Byron Dorgan (D-N.D. Senate ____-present)
Fought for improved regulation and oversight legislation:
Dorgan’s book “Reckless” – about the meltdown – was a big letdown to me. I was
expecting a tell-all about the legislative headwinds he fought against and the people and
arguments on both sides. But I could not finish it because it is page after page of polemic
Ed Gramlich (Fed Governor from _____ - ______)
Brighton native who lobbied for better regulation:
Ed Markey (D-MA House of Representatives)
Sponsored regulation bill(s) that died in debate due to strong head-winds from free-
market proponents and financial industry lobbying.
Warren Buffet (Very successful investor - Berkshire Hathaway)
Commentary on derivative securities from Warren Buffet’s 2002 annual report to share
holders in his company:
George Soros (Very successful investor)
Sheila Bair (FDIC chief ______ - present)
“Fix Rates to Save Loans” NYT 10/19/2007
Sheila Bair’s prescription for helping out homeowners with problem mortgages
Sheila Bair interviewed on Frontline (12/3/2008):
Sean Egan (Egan-Jones Rating Co)
Principal of one of the few “independent” bond rating agencies (as opposed to Standard
& Poor’s, Moody’s and Fitch). He testified numerous times in congress and wrote
extensively about the problem of having bond-rating agencies paid by the firms whose
bonds they are rating. His firm is paid by the investors who depend on ratings in
assessing the risk levels in bonds they invest in.
<I have several of Egan’s congressional testimony transcripts but have not been able to
get the web links>
1b) WHO DISMISSED OR RESISTED THE WARNINGS – thereby letting the
problems grow and multiply?
Alan Greenspan (Fed Chmn ____ - ____ )
“Taking a Hard Look at a Greenspan Legacy” – NY Times 10/9/2008
“Fed Shrugged as Subprime Crisis Spread”- NY Times 12/8/2007
Phil Gramm (R-TX Senate)
Bob Rubin (Treas Secy _____ - _____ )
Arthur Levitt (SEC chmn ____-_____)
Larry Summers (Treaury Secy _____-_____)
The “quants” who created & developed the models and deals:
Howard Sosin (co-founder of what became AIG Financial Products)
Randy Rackson (co-founder of what became AIG Financial Products)
Gary Gorton (consultant to AIGFP)
December, 1982--Garn - St Germain Depository Institutions Act of 1982 enacted.
… Reagan-era S&L deregulation that enable the S&L crisis & subsequent $600B bailout.
CONTEMPORANEOUS PRESS COVERAGE & COMMENTARY
A very good digest of what the press said as the situation developed – with editorial
comment in hindsight – can be found in these links from the Columbia Review of
…includes links to an important 1994 GAO study of derivative investment securities that
identified many of the potential problems that later became keys to the meltdown.
Debate over this report triggered the legislative activities of the late nineties, in which
promoters of greater transparency and oversight lost to the de-regulators. Also has a link
to a now-famous commentary – known as “derivatives-as-WMD”- by Warren Buffet.
NY Times (12/15/1998) on regulating derivative securities following the near
collapse & (private) bailout of Long Term Capital Management (giant hedge fund
with huge investments in “derivatives”):
NY Times (9/5/1999) reports on repeal of Glass-Steagall Act of1933
NY Times (9/30/1999) reports on easing of credit standards by Fannie Mae
Clarence Page (Chicago Tribune 8/28/2008):
Good intentions fed the housing side of the crisis…
One of many “we told you so” reports all over the web:
Multinational Monitor Editor’s Blog:
Refers to long article by the same author called ”Sold Out” published through Wall
Street Watch and tag-lined “$5 BILLION IN POLITICAL CONTRIBUTIONS
BOUGHT WALL STREET FREEDOM FROM REGULATION, RESTRAINT”
… this site has links to the full (3MB) report and an “executive summary.” I don’t know
if this is accurate or complete but it focuses on one important aspect, namely the
relationship between public interest and political influence.
2) WHAT ARE THE CORE PROBLEMS WITH FINANCIAL INSTITUTIONS &
It never made sense that a few billion dollars worth of mortgage loans to under-qualified
homebuyers could bring down the global financial system. Our son is one of the
”players” in global commercial property finance. In 2007-8 he kept trying to explain to
me how “securitization” leveraged these debts and shifted their risk up the food chain
into the financial world. He also explained how these securities buried the original loans
inside “layered” packages of bonds that would be impossible to unravel in a hurry. The
result was a multi-trillion dollar credit market floating on a relatively small number of
original loans. Things were fine as long as defaults stayed within the assumptions built
into the bond pricing, but “teaser” mortgage rates began to reset and put stress on weaker
borrowers. Excesses built up in the housing market and prices stopped rising, which took
away the relief valve of selling the building to pay the mortgage. Defaults and
foreclosures exceeded bond market assumptions and began to trigger credit default
insurance payouts among investment banks. Big insurers like AIG turned out to be
under-capitalized and eventually were not able to pay off their contracts. The
interconnectedness of these contracts put most of the worlds major banks at risk of
serious losses and possible bankruptcy from inability to maintain their cash flows. This
crisis-level situation developed very quickly in the summer of 2008, as the depth and
breadth of co-dependency became clear.
In retrospect, it seems clear that the “invisibility” of this co-dependency was a major
problem that should be addressed by regulation. However, another view is that if banks
were privately held (instead of having publicly-traded stock) they would have self-
regulated this – presumably because they would have feared the consequences for ”their
own” money from excessive leverage.
Everyone has a diagnosis and a prescription, but how can you tell which ones are on the
right track. The answer is that we’ll never know for sure. I hope that Hank Paulson
writes a complete and honest memoir of his role. I think he saw matters clearly (though
he was in the dark about the details of what was on the balance sheets of key financial
players – and the interconnectedness that was buried there).
Meanwhile we have to read what we can and pay better attention to the news – and listen
for the voices that are out of the mainstream. One thing to remember is that during the
run-up to the melt down we all were feeling good about the value of our investment
accounts and our homes. Even near the end, even though we heard noises about a credit
crunch and regulations were being debated, these rumblings were consistently dismissed
by authorities like Greenspan and others. Also we thought that Wall Street was
“somebody else’s money” and did not directly threaten us. I think we also bought the
idea that “sub-prime borrowers” were also somebody else.
As it happens, I know two people whose mortgage applications were falsified by the
lenders in ways that made the loans look better (from an investor’s point of view) than
they actually were. In one case the borrower was persistent enough to get the recurring
“errors” corrected in the final closing documents. In the other case the borrower bowed to
the bank’s encouragement to” let it go…and ended up with far more mortgage debt than
he could afford.
I think the primary issue with financial markets – and our form of capitalism in general –
is our political polarization on the question of government’s proper role. I haven’t
confirmed this, but I’m told that even the sainted Ayn Rand acknowledged the value of
regulation in the public interest, to take care of the rough edges of unfettered free
We need our politicians to bargain and compromise with one another to devise regulatory
environment that protects the public interest without hampering free enterprise. Instead,
we get obstructionism and partisanship that serves only the big-donor interests that lead
Meanwhile, here are a few links that shed light on the bigger picture:
For a numerical view of one of the most important background trends that has been at
work in our economy for the past few decades, take a look at this article:
Wealth, Income, and Power
by G. William Domhoff September 2005 (updated December 2006)
It’s not intended as a meltdown explanation but I think it’s a key fundamental underlying
factoring our economic – and political – environment. It shows the acceleration in
income and wealth gaps that coincide with the age of de-regulation.
There is a heap of books coming out on the financial meltdown. Some are reportage,
some are memoirs, some are insider narratives. Some are broad and some are narrow.
Some are scholarly and some are populist. I have only read three so far. One of those
(Dorgan’s “Reckless”) was a waste of time, but the other two are excellent. They are:
“Fool’s Gold” by Gillian Tett (2009) (Reporter and Assistant Editor at The Financial
Times). Follows the derivatives group at JP Morgan from their invention of the most
notorious credit derivative securities. It’s a fascinating narrative as well as an expose of
the practices that constituted the ”Shadow” banking system that grew up in the lax
regulatory environment of the 80s and 90s and exploded catastrophically in the “oh ohs.”
Tett had been reporting on this for years in the Financial Times, and her style is both
informative and entertaining.
Here’s an interview and an excerpt:
Here’s a review:
“Liar’s Poker” by Michael Lewis (1989) (former bond trader at Salomon Brothers, now
a reporter/commentator at Bloomberg). Highly entertaining and eye-opening personal
memoir of his years as a bond trader in the wild and woolly world of high-stakes
investments that leveraged what should have been simply a US housing bubble into a
global financial meltdown. He resigned and wrote the book in 1989, thinking that the
craziness he experienced had to come to an inevitable blowout soon. Little did he know
it would inflate for another nine years! He thought his book would be a cautionary tale,
but instead it became an inspiration for a new generation of creative financial “engineers”
Here’s a more recent follow-up article he wrote for Portfolio.com (12/2008):
It gives the flavor of the story and re-connects with some of the characters from the book.
3) WHAT REGULARTORY & LEGISLATIVE OPTIONS ARE IN PLAY NOW
… and who’s pushing for what?
I wish I had more to offer here. Opinions are all over the map, and the legislative
machinations are not in the open. With so much to lose and gain, it’s not possible to get
good objective information. Here are a couple of sources that at least give some idea of
what’s on the table and who’s behind what.
The Columbia Journalism Review has interesting commentary on reporting of the
banking lobby’s efforts to shape new regulations that should be applied. These are from
NY Times reports on banks fighting (i.e. lobbying against) new rules: