WHY WALL STREET ALWAYS BLOWS IT (and where the money went)

Atlantic Article Submitted by multiple readers, I read this as soon as my issue was delivered. It’s true.

And to add insult to injury, the answer to the question on everyone’s mind: Where did the money go? $350 billion disappeared down a black hole. The banks and investment banks got the money under the presumption that they would start lending again and they didn’t because neither congress nor Bush made that a condition to receipt. The money is sitting in “contingency accounts” basically off balance sheet or with a corresponding liability producing zero effect on the balance sheet and obviously off the income statement because if they ever had the temerity to declare the money as profit, they would be hanged. In some cases the money is being doled out to investors who could cause even more trouble. The interesting thing behind all this is that there is a branch of law enforcement at the Federal level that nobody ever thinks of when it comes to economic crimes like the meltdown, but the perpetrators know it. This law enforcement agency is currently investigating and will likely uncover everything we suspect, with prosecutions not only likely but successful too. I won’t say any more than that now.

December 2008

The magnitude of the current bust seems almost unfathomable—and it was unfathomable, to even the most sophisticated financial professionals, until the moment the bubble popped. How could this happen? And what’s to stop it from happening again? A former Wall Street insider explains how the financial industry got it so badly wrong, why it always will—and why all of us are to blame.

by Henry Blodget


Image credit: John Ritter

Well, we did it again. Only eight years after the last big financial boom ended in disaster, we’re now in the migraine hangover of an even bigger one—a global housing and debt bubble whose bursting has wiped out tens of trillions of dollars of wealth and brought the world to the edge of a second Great Depression.

Millions have lost their houses. Millions more have lost their retirement savings. Tens of millions have had their portfolios smashed. And the carnage in the “real economy” has only just begun.

What the hell happened? After decades of increasing financial sophistication, weren’t we supposed to be done with these things? Weren’t we supposed to know better?

Yes, of course. Every time this happens, we think it will be the last time. But it never will be.

First things first: for better and worse, I have had more professional experience with financial bubbles than I would ever wish on anyone. During the dot-com episode, as you may unfortunately recall, I was a famous tech-stock analyst at Merrill Lynch. I was famous because I was on the right side of the boom through the late 1990s, when stocks were storming to record-high prices every year—Internet stocks, especially. By late 1998, I was cautioning clients that “what looks like a bubble probably is,” but this didn’t save me. Fifteen months later, I missed the top and drove my clients right over the cliff.

Later, in the smoldering aftermath, as you may also unfortunately recall, I was accused by Eliot Spitzer, then New York’s attorney general, of having hung on too long in order to curry favor with the companies I was analyzing, some of which were also Merrill banking clients. This allegation led to my banishment from the industry, though it didn’t explain why I had followed my own advice and blown my own portfolio to smithereens (more on this later).

I experienced the next bubble differently—as a journalist and homeowner. Having already learned the most obvious lesson about bubbles, which is that you don’t want to get out too late, I now discovered something nearly as obvious: you don’t want to get out too early. Figuring that the roaring housing market was just another tech-stock bubble in the making, I rushed to sell my house in 2003—only to watch its price nearly double over the next three years. I also predicted the demise of the Manhattan real-estate market on the cover of New York magazine in 2005. Prices are finally falling now, in 2008, but they’re still well above where they were then.

Live through enough bubbles, though, and you do eventually learn something of value. For example, I’ve learned that although getting out too early hurts, it hurts less than getting out too late. More important, I’ve learned that most of the common wisdom about financial bubbles is wrong.

Who’s to blame for the current crisis? As usually happens after a crash, the search for scapegoats has been intense, and many contenders have emerged: Wall Street swindled us; predatory lenders sold us loans we couldn’t afford; the Securities and Exchange Commission fell asleep at the switch; Alan Greenspan kept interest rates low for too long; short-sellers spread negative rumors; “experts” gave us bad advice. More-introspective folks will add other explanations: we got greedy; we went nuts; we heard what we wanted to hear.

All of these explanations have some truth to them. Predatory lenders did bamboozle some people into loans and houses they couldn’t afford. The SEC and other regulators did miss opportunities to curb some of the more egregious behavior. Alan Greenspan did keep interest rates too low for too long (and if you’re looking for the single biggest cause of the housing bubble, this is it). Some short-sellers did spread negative rumors. And, Lord knows, many of us got greedy, checked our brains at the door, and heard what we wanted to hear.

But most bubbles are the product of more than just bad faith, or incompetence, or rank stupidity; the interaction of human psychology with a market economy practically ensures that they will form. In this sense, bubbles are perfectly rational—or at least they’re a rational and unavoidable by-product of capitalism (which, as Winston Churchill might have said, is the worst economic system on the planet except for all the others). Technology and circumstances change, but the human animal doesn’t. And markets are ultimately about people.

To understand why bubble participants make the decisions they do, let’s roll back the clock to 2002. The stock­-market crash has crushed our portfolios and left us feeling vulnerable, foolish, and poor. We’re not wiped out, thankfully, but we’re chastened, and we’re certainly not going to go blow our extra money on Cisco Systems again. So where should we put it? What’s safe? How about a house?

House prices, we are told by our helpful neighborhood real-estate agent, almost never go down. This sounds right, and they certainly didn’t go down in the stock-market crash. In fact, for as long as we can remember—about 10 years, in most cases—house prices haven’t gone down. (Wait, maybe there was a slight dip, after the 1987 stock-market crash, but looming larger in our memories is what’s happened since; everyone we know who’s bought a house since the early 1990s has made gobs of money.)

We consider following our agent’s advice, but then we decide against it. House prices have doubled since the mid-1990s; we’re not going to get burned again by buying at the top. So we decide to just stay in our rent-stabilized rabbit warren and wait for house prices to collapse.

Unfortunately, they don’t. A year later, they’ve risen at least another 10 percent. By 2006, we’re walking past neighborhood houses that we could have bought for about half as much four years ago; we wave to happy new neighbors who are already deep in the money. One neighbor has “unlocked the value in his house” by taking out a cheap home-equity loan, and he’s using the proceeds to build a swimming pool. He is also doing well, along with two visionary friends, by buying and flipping other houses—so well, in fact, that he’s considering quitting his job and becoming a full-time real-estate developer. After four years of resistance, we finally concede—houses might be a good investment after all—and call our neighborhood real-estate agent. She’s jammed (and driving a new BMW), but she agrees to fit us in.

We see five houses: two were on the market two years ago for 30 percent less (we just can’t handle the pain of that); two are dumps; and the fifth, which we love, is listed at a positively ridiculous price. The agent tells us to hurry—if we don’t bid now, we’ll lose the house. But we’re still hesitant: last week, we read an article in which some economist was predicting a housing crash, and that made us nervous. (Our agent counters that Greenspan says the housing market’s in good shape, and he isn’t known as “The Maestro” for nothing.)

When we get home, we call our neighborhood mortgage broker, who gives us a surprisingly reasonable quote—with a surprisingly small down payment. It’s a new kind of loan, he says, called an adjustable-rate mortgage, which is the same kind our neighbor has. The payments will “reset” in three years, but, as the mortgage broker suggests, we’ll probably have moved up to a bigger house by then. We discuss the house during dinner and breakfast. We review our finances to make sure we can afford it. Then, the next afternoon, we call the agent to place a bid. And the house is already gone—at 10 percent above the asking price.

By the spring of 2007, we’ve finally caught up to the market reality, and our luck finally changes: We make an instant, aggressive bid on a huge house, with almost no money down. And we get it! We’re finally members of the ownership society.

You know the rest. Eighteen months later, our down payment has been wiped out and we owe more on the house than it’s worth. We’re still able to make the payments, but our mortgage rate is about to reset. And we’ve already heard rumors about coming layoffs at our jobs. How on Earth did we get into this mess?

The exact answer is different in every case, of course. But let’s round up the usual suspects:

• The predatory mortgage broker? Well, we’re certainly not happy with the bastard, given that he sold us a loan that is now a ticking time bomb. But we did ask him to show us a range of options, and he didn’t make us pick this one. We picked it because it had the lowest payment.

• Our sleazy real-estate agent? We’re not speaking to her anymore, either (and we’re secretly stoked that her BMW just got repossessed), but again, she didn’t lie to us. She just kept saying that houses are usually a good investment. And she is, after all, a saleswoman; that was never very hard to figure out.

• Wall Street fat cats? Boy, do we hate those guys, especially now that our tax dollars are bailing them out. But we didn’t complain when our lender asked for such a small down payment without bothering to check how much money we made. At the time, we thought that was pretty great.

• The SEC? We’re furious that our government let this happen to us, and we’re sure someone is to blame. We’re not really sure who that someone is, though. Whoever is responsible for making sure that something like this never happens to us, we guess.

• Alan “The Maestro” Greenspan? We’re pissed at him too. If he hadn’t been out there saying everything was fine, we might have believed that economist who said it wasn’t.

• Bad advice? Hell, yes, we got bad advice. Our real-estate agent. That mortgage guy. Our neighbor. Greenspan. The media. They all gave us horrendous advice. We should have just waited for the market to crash. But everyone said it was different this time.

Still, except in cases involving outright fraud—a small minority—the buck stops with us. Not knowing that the market would crash isn’t an excuse. No one knew the market would crash, even the analysts who predicted that it would. (Just as important, no one knew when prices would go down, or how fast.) And for years, most of the skeptics looked—and felt—like fools.

Everyone else on that list above bears some responsibility too. But in the case I have described, it would be hard to say that any of them acted criminally. Or irrationally. Or even irresponsibly. In fact, almost everyone on that list acted just the way you would expect them to act under the circumstances.

That’s especially true for the professionals on Wall Street, who’ve come in for more criticism than anyone in recent months, and understandably so. It was Wall Street, after all, that chose not only to feed the housing bubble, but ultimately to bet so heavily on it as to put the entire financial system at risk. How did the experts who are paid to obsess about the direction of the market—allegedly the most financially sophisticated among us—get it so badly wrong? The answer is that the typical financial professional is a lot more like our hypothetical home buyer than anyone on Wall Street would care to admit. Given the intersection of experience, uncertainty, and self-interest within the finance industry, it should be no surprise that Wall Street blew it—or that it will do so again.

Take experience (or the lack thereof). Boom-and-bust cycles like the one we just went through take a long time to complete. The really big busts, in fact, the ones that affect the whole market and economy, are usually separated by more than 30 years—think 1929, 1966, and 2000. (Why did the housing bubble follow the tech bubble so closely? Because both were really just parts of a larger credit bubble, which had been building since the late 1980s. That bubble didn’t deflate after the 2000 crash, in part thanks to Greenspan’s attempts to save the economy.) By the time the next Great Bubble rolls around, a lot of us will be as dead and gone as Richard Whitney, Jesse Livermore, Charles Mitchell, and the other giants of the 1929 crash. (Never heard of them? Exactly.)

Since Wall Street replenishes itself with a new crop of fresh faces every year—many of the professionals at the elite firms either flame out or retire by age 40—most of the industry doesn’t usually have experience with both booms and busts. In the 1990s, I and thousands of young Wall Street analysts and investors like me hadn’t seen anything but a 15-year bull market. The only market shocks that we knew much about—the 1987 crash, say, or Mexico’s 1994 financial crisis—had immediately been followed by strong recoveries (and exhortations to “buy the dip”).

By 1996, when Greenspan made his famous “irrational exuberance” remark, the stock market’s valuation was nearing its peak from prior bull markets, making some veteran investors nervous. Over the next few years, however, despite confident predictions of doom, stocks just kept going up. And eventually, inevitably, this led to assertions that no peak was in sight, much less a crash—you see, it was “different this time.”

Those are said to be the most expensive words in the English language, by the way: it’s different this time. You can’t have a bubble without good explanations for why it’s different this time. If everyone knew that this time wasn’t different, the market would stop going up. But the future is always uncertain—and amid uncertainty, all sorts of faith-based theories can flourish, even on Wall Street.

In the 1920s, the “differences” were said to be the miraculous new technologies (phones, cars, planes) that would speed the economy, as well as Prohibition, which was supposed to produce an ultra-efficient, ultra-responsible workforce. (Don’t laugh: one of the most respected economists of the era, Irving Fisher of Yale University, believed that one.) In the tech bubble of the 1990s, the differences were low interest rates, low inflation, a government budget surplus, the Internet revolution, and a Federal Reserve chairman apparently so divinely talented that he had made the business cycle obsolete. In the housing bubble, they were low interest rates, population growth, new mortgage products, a new ownership society, and, of course, the fact that “they aren’t making any more land.”

In hindsight, it’s obvious that all these differences were bogus (they’ve never made any more land—except in Dubai, which now has its own problems). At the time, however, with prices going up every day, things sure seemed different.

In fairness to the thousands of experts who’ve snookered themselves throughout the years, a complicating factor is always at work: the ever-present possibility that it really might have been different. Everything is obvious only after the crash.

Consider, for instance, the late 1950s, when a tried-and-true “sell signal” started flashing on Wall Street. For the first time in years, stock prices had risen so high that the dividend yield on stocks had fallen below the coupon yield on bonds. To anyone who had been around for a while, this seemed ridiculous: stocks are riskier than bonds, so a rational buyer must be paid more to own them. Wise, experienced investors sold their stocks and waited for this obvious mispricing to correct itself. They’re still waiting.

Why? Because that time, it was different. There were increasing concerns about inflation, which erodes the value of fixed bond-interest payments. Stocks offer more protection against inflation, so their value relative to bonds had increased. By the time the prudent folks who sold their stocks figured this out, however, they’d missed out on many years of a raging bull market.

When I was on Wall Street, the embryonic Inter­net sector was different, of course—at least to those of us who were used to buying staid, steady stocks that went up 10 percent in a good year. Most Internet companies didn’t have earnings, and some of them barely had revenue. But the performance of some of their stocks was spectacular.

In 1997, I recommended that my clients buy stock in a company called Yahoo; the stock finished the year up more than 500 percent. The next year, I put a $400-a-share price target on a controversial “online bookseller” called Amazon, worth about $240 a share at the time; within a month, the stock blasted through $400 en route to $600. You don’t have to make too many calls like these before people start listening to you; I soon had a global audience keenly interested in whatever I said.

One of the things I said frequently, especially after my Amazon prediction, was that the tech sector’s stock behavior sure looked like a bubble. At the end of 1998, in fact, I published a report called “Surviving (and Profiting From) Bubble.com,” in which I listed similarities between the dot-com phenomenon and previous boom-and-bust cycles in biotech, personal computers, and other sectors. But I recommended that my clients own a few high-quality Internet stocks anyway—because of the ways in which I thought the Internet was different. I won’t spell out all those ways, but I will say that they sounded less stupid then than they do now.

The bottom line is that resisting the siren call of a boom is much easier when you have already been obliterated by one. In the late 1990s, as stocks kept roaring higher, it got easier and easier to believe that something really was different. So, in early 2000, weeks before the bubble burst, I put a lot of money where my mouth was. Two years later, I had lost the equivalent of six high-end college educations.

Of course, as Eliot Spitzer and others would later observe—and as was crystal clear to most Wall Street executives at the time—being bullish in a bull market is undeniably good for business. When the market is rising, no one wants to work with a bear.

Which brings us to the last major contributor to booms and busts: self-interest.

When people look back on bubbles, many conclude that the participants must have gone stark raving mad. In most cases, nothing could be further from the truth.

In my example from the housing boom, for instance, each participant’s job was not to predict what the housing market would do but to accomplish a more concrete aim. The buyer wanted to buy a house; the real-estate agent wanted to earn a commission; the mortgage broker wanted to sell a loan; Wall Street wanted to buy loans so it could package and resell them as “mortgage-backed securities”; Alan Greenspan wanted to keep American prosperity alive; members of Congress wanted to get reelected. None of these participants, it is important to note, was paid to predict the likely future movements of the housing market. In every case (except, perhaps, the buyer’s), that was, at best, a minor concern.

This does not make the participants villains or morons. It does, however, illustrate another critical component of boom-time decision-making: the difference between investment risk and career or business risk.

Professional fund managers are paid to manage money for their clients. Most managers succeed or fail based not on how much money they make or lose but on how much they make or lose relative to the market and other fund managers.

If the market goes up 20 percent and your Fidelity fund goes up only 10 percent, for example, you probably won’t call Fidelity and say, “Thank you.” Instead, you’ll probably call and say, “What am I paying you people for, anyway?” (Or at least that’s what a lot of investors do.) And if this performance continues for a while, you might eventually fire Fidelity and hire a new fund manager.

On the other hand, if your Fidelity fund declines in value but the market drops even more, you’ll probably stick with the fund for a while (“Hey, at least I didn’t lose as much as all those suckers in index funds”). That is, until the market drops so much that you can’t take it anymore and you sell everything, which is what a lot of people did in October, when the Dow plunged below 9,000.

In the money-management business, therefore, investment risk is the risk that your bets will cost your clients money. Career or business risk, meanwhile, is the risk that your bets will cost you or your firm money or clients.

The tension between investment risk and business risk often leads fund managers to make decisions that, to outsiders, seem bizarre. From the fund managers’ perspective, however, they’re perfectly rational.

In the late 1990s, while I was trying to figure out whether it was different this time, some of the most legendary fund managers in the industry were struggling. Since 1995, any fund managers who had been bearish had not been viewed as “wise” or “prudent”; they had been viewed as “wrong.” And because being wrong meant underperforming, many had been shown the door.

It doesn’t take very many of these firings to wake other financial professionals up to the fact that being bearish and wrong is at least as risky as being bullish and wrong. The ultimate judge of who is “right” and “wrong” on Wall Street, moreover, is the market, which posts its verdict day after day, month after month, year after year. So over time, in a long bull market, most of the bears get weeded out, through either attrition or capitulation.

By mid-1999, with mountains of money being made in tech stocks, fund owners were more impatient than ever: their friends were getting rich in Cisco, so their fund manager had better own Cisco—or he or she was an idiot. And if the fund manager thought Cisco was overvalued and was eventually going to crash? Well, in those years, fund managers usually approached this type of problem in of one of three ways: they refused to play; they played and tried to win; or they split the difference.

In the first camp was an iconic hedge-fund manager named Julian Robertson. For almost two decades, Robertson’s Tiger Management had racked up annual gains of about 30 percent by, as he put it, buying the best stocks and shorting the worst. (One of the worst, in Robertson’s opinion, was Amazon, and he used to summon me to his office and demand to know why everyone else kept buying it.)

By 1998, Robertson was short Amazon and other tech stocks, and by 2000, after the NASDAQ had jumped an astounding 86 percent the previous year, Robertson’s business and reputation had been mauled. Thanks to poor performance and investor withdrawals, Tiger’s assets under management had collapsed from about $20billion to about $6billion, and the firm’s revenues had collapsed as well. Robertson refused to change his stance, however, and in the spring of 2000, he threw in the towel: he closed Tiger’s doors and began returning what was left of his investors’ money.

Across town, meanwhile, at Soros Fund Management, a similar struggle was taking place, with another titanic fund manager’s reputation on the line. In 1998, the firm had gotten crushed as a result of its bets against technology stocks (among other reasons). Midway through 1999, however, the manager of Soros’s Quantum Fund, Stanley Druckenmiller, reversed that position and went long on technology. Why? Because unlike Robertson, Druckenmiller viewed it as his job to make money no matter what the market was doing, not to insist that the market was wrong.

At first, the bet worked: the reversal saved 1999 and got 2000 off to a good start. But by the end of April, Quantum was down a shocking 22 percent for the year, and Druckenmiller had resigned: “We thought it was the eighth inning, and it was the ninth.”

Robertson and Druckenmiller stuck to their guns and played the extremes (and lost). Another fund manager, a man I’ll call the Pragmatist, split the difference.

The Pragmatist had owned tech stocks for most of the 1990s, and their spectacular performance had made his fund famous and his firm rich. By mid-1999, however, the Pragmatist had seen a bust in the making and begun selling tech, so his fund had started to underperform. Just one quarter later, his boss, tired of watching assets flow out the door, suggested that the Pragmatist reconsider his position on tech. A quarter after that, his boss made it simpler for him: buy tech, or you’re fired.

The Pragmatist thought about quitting. But he knew what would happen if he did: his boss would hire a 25-year-old gunslinger who would immediately load up the fund with tech stocks. The Pragmatist also thought about refusing to follow the order. But that would mean he would be fired for cause (no severance or bonus), and his boss would hire the same 25-year-old gunslinger.

In the end, the Pragmatist compromised. He bought enough tech stocks to pacify his boss but not enough to entirely wipe out his fund holders if the tech bubble popped. A few months later, when the market crashed and the fund got hammered, he took his bonus and left the firm.

This tension between investment risk and career or business risk comes into play in other areas of Wall Street too. It was at the center of the decisions made in the past few years by half a dozen seemingly brilliant CEOs whose firms no longer exist.

Why did Bear Stearns, Lehman Brothers, Fannie Mae, Freddie Mac, AIG, and the rest of an ever-growing Wall Street hall of shame take so much risk that they ended up blowing their firms to kingdom come? Because in a bull market, when you borrow and bet $30 for every $1 you have in capital, as many firms did, you can do mind-bogglingly well. And when your competitors are betting the same $30 for every $1, and your shareholders are demanding that you do better, and your bonus is tied to how much money your firm makes—not over the long term, but this year, before December 31—the downside to refusing to ride the bull market comes into sharp relief. And when naysayers have been so wrong for so long, and your risk-management people assure you that you’re in good shape unless we have another Great Depression (which we won’t, of course, because it’s different this time), well, you can easily convince yourself that disaster is a possibility so remote that it’s not even worth thinking about.

It’s easy to lay the destruction of Wall Street at the feet of the CEOs and directors, and the bulk of the responsibility does lie with them. But some of it lies with shareholders and the whole model of public ownership. Wall Street never has been—and likely never will be—paid primarily for capital preservation. However, in the days when Wall Street firms were funded primarily by capital contributed by individual partners, preserving that capital in the long run was understandably a higher priority than it is today. Now Wall Street firms are primarily owned not by partners with personal capital at risk but by demanding institutional shareholders examining short-term results. When your fiduciary duty is to manage the firm for the benefit of your shareholders, you can easily persuade yourself that you’re just balancing risk and reward—when what you’re really doing is betting the firm.

As we work our way through the wreckage of this latest colossal bust, our government—at our urging—will go to great lengths to try to make sure such a bust never happens again. We will “fix” the “problems” that we decide caused the debacle; we will create new regulatory requirements and systems; we will throw a lot of people in jail. We will do whatever we must to assure ourselves that it will be different next time. And as long as the searing memory of this disaster is fresh in the public mind, it will be different. But as the bust recedes into the past, our priorities will slowly change, and we will begin to set ourselves up for the next great boom.

A few decades hence, when the Great Crash of 2008 is a distant memory and the economy is humming along again, our government—at our urging—will begin to weaken many of the regulatory requirements and systems we put in place now. Why? To make our economy more competitive and to unleash the power of our free-market system. We will tell ourselves it’s different, and in many ways, it will be. But the cycle will start all over again.

So what can we learn from all this? In the words of the great investor Jeremy Grantham, who saw this collapse coming and has seen just about everything else in his four-decade career: “We will learn an enormous amount in a very short time, quite a bit in the medium term, and absolutely nothing in the long term.” Of course, to paraphrase Keynes, in the long term, you and I will be dead. Until that time comes, here are three thoughts I hope we all can keep in mind.

First, bubbles are to free-market capitalism as hurricanes are to weather: regular, natural, and unavoidable. They have happened since the dawn of economic history, and they’ll keep happening for as long as humans walk the Earth, no matter how we try to stop them. We can’t legislate away the business cycle, just as we can’t eliminate the self-interest that makes the whole capitalist system work. We would do ourselves a favor if we stopped pretending we can.

Second, bubbles and their aftermaths aren’t all bad: the tech and Internet bubble, for example, helped fund the development of a global medium that will eventually be as central to society as electricity. Likewise, the latest bust will almost certainly lead to a smaller, poorer financial industry, meaning that many talented workers will go instead into other careers—that’s probably a healthy rebalancing for the economy as a whole. The current bust will also lead to at least some regulatory improvements that endure; the carnage of 1933, for example, gave rise to many of our securities laws and to the SEC, without which this bust would have been worse.

Lastly, we who have had the misfortune of learning firsthand from this experience—and in a bust this big, that group includes just about everyone—can take pains to make sure that we, personally, never make similar mistakes again. Specifically, we can save more, spend less, diversify our investments, and avoid buying things we can’t afford. Most of all, a few decades down the road, we can raise an eyebrow when our children explain that we really should get in on the new new new thing because, yes, it’s different this time.

The URL for this page is http://www.theatlantic.com/doc/200812/blodget-wall-street


COMMENTARY: am still trying to digest the assertion Blodget makes, “all of us are to blame.” Each element did what was expected of it, yes, but how about behind-the-scenes factors to which we were not privy?

Clearly, what happened, and what will again happen, is that those who predict “the sky is falling,” will be driven to the margin.

With so many conflicting opinions competing for our belief, to whose warnings and predictions will we ultimately listen? Will we be ready the next time? The next new, new, new thing? Doubtful.


24 Responses

  1. The unknown trillion dollar company would probably know where the money went.
    The DTCC or the Depository Trust and Clearing Corporation, , based primarily at 55 Water Street in New York City, is the world’s largest post-trade financial services company. It was set up to provide an efficient and safe way for buyers and sellers of securities to make their exchange, and thus “clear and settle” transactions. It also provides custody of securities.

    User-owned[1] and directed, it automates, centralizes, standardizes, and streamlines processes that are critical to the safety and soundness of the world’s capital markets. Through its subsidiaries, DTCC provides clearance, settlement, and information services for equities, corporate and municipal bonds, unit investment trusts, government and mortgage-backed securities, money market instruments, and over-the-counter derivatives. DTCC is also a leading processor of mutual funds and insurance transactions, linking funds and carriers with their distribution networks. DTCC’s DTC depository provides custody and asset servicing for 3.5 million securities issues, comprised mostly of stocks and bonds, from the United States and 110 other countries and territories, valued at $40 trillion, more than any other depository in the world.

    In 2007, DTCC settled the vast majority of securities transactions in the United States, more than $1.86 quadrillion in value. DTCC has operating facilities in New York City, and at multiple locations in and outside the U.S.

    In 2007 Chief Executive Officer Donald F. Donahue was named to the additional office of Chairman of DTCC and its subsidiaries, and Chief Operating Officer William B. Aimetti was named President.[2]

    In 2008, The Clearing Corporation and the Depository Trust & Clearing Corporation announced CCorp members will benefit from CCorp’s netting and risk management processes, and will leverage the asset servicing capabilities of DTCC’s Trade Information Warehouse for credit default swaps (CDS).

    Type Private
    Genre Holding company
    Founded DTCC (1999) – holding company for DTC (1973) and NSCC (1976)
    Headquarters New York City, U.S.
    Number of locations 4
    Key people Donald F. Donahue Chairman, CEO
    William B. Aimetti President, COO
    Industry Finance
    Services financial
    Revenue ▲ US$706,242,000 (2007)
    Net income ▲ US$ 4,375,000 (2007)
    Total assets US$30,222,740,000
    Total equity US $242,920,000
    Owner(s) NYSE, NASD, AMEX, banks, brokers
    Subsidiaries NSCC
    DTCC Solutions LLC
    EuroCCP Ltd.
    Website http://www.dtcc.com

  2. Should recipients of taxpayer favors continue to send jobs offshore?

    – –
    Where are the controls?

    Where is the common sense?



  5. Here’s a FUN, well-produced, comprehensive, on spot, timely documentary detailing the role of money through history, and to capturing what we on Planet LivingLies experience as Wall Street’s role in the SubPrime Mortgage Meltdown.

    As somebody who was with an instrumental person (my Danish uncle Ib) who helped make the opening of China possible, on those very days in February 21-28, 1972 when Nixon met with Mao Zedong and Premier Zhou Enlai, I was especially interested in the segment entitled CHIMERICA.

    Remember how the opening up of China was greeted as an opportunity for American exporters to tap a whole new market of over a billion new consumers?

    Who knew, in the decades following, tables would be turned, and accumulated Chinese capital would play a large role in funding the securitization of mortgages that gave us the housing bubble we’re all working through?

    I ponder, would it all have happened anyway, had China not been opened up?

    Check out also the treasure of resources that come with this PBS site. Go as well to http://www.pbs.org/wnet/ascentofmoney/

    Cambrige, MA 02138

  6. Oh, and one more thing. In Florida where I write loans mortgage brokers and correspondent lenders have had to disclose YSP for a while. Banks have not have to disclose their SRPs because of the federal laws they are under. Personally, about a year ago I went to a total transparency model where we negotiate total cost of loan up front and then I find the loan and sell it at par rate (if that is the agreement). I can show my clients the actual cost of the loan at lock to demonstrate we are at agreed upon price. SRP and YSP is the dirtiest secret of the mortgage industry and at the least should be disclosed at loan lock by law (current law is 72 hours before closing here in Florida). However it is not a kickback, but part of the pricing model for loans. If consumers were smart and not so easily swayed by commercials and billboards, they would seek out those that work like I do. Just a little plug for folks who do it right!!!!!
    check out my web site and click the mortgage tab where this is discussed in a little more detail. http://www.shaferfinancial.com

    Good luck Jose, hope you keep on to your home!

  7. This is what it comes to Jose?? You making accusations on the internet against people you don’t know. All because I have the gall to point out that some of the blame goes to the people who signed the papers for a loan. Maybe you missed the point where I said I didn’t write but two sub-prime loans, both fixed rate or the point where I said as far as I know none of my loans went into foreclosure or the point where I pointed out that when mortgage buyers didn’t like what I had to say they simply went down the street and got a loan from somewhere else???
    No its just easier to fire out into cyber space some nonsense about wholesale fraud. And for about the tenth time, fraud should be prosecuted to the full extent of the law whether it was mortgage companies, banks, employees of these institutions, loan originators, appraisers, real estate agents or the borrower themselves.
    You know I worked with folks from many of those institutions you mentioned and never once did they suggest fraudulent activity. No, there was plenty of programs to get a borrower through that were very legal. I just chose the high rode. But let’s be honest, most of the originators had no basis in finance, so they just sold. Most of these guys and gals didn’t even have a college degree, let alone any ability to understand what the repurcussions of giving loans to poor people were (and that is what this was really about increasing market share by bringing folks into homes that had no business owning a home). Yes there were many people at the highest level who did make some very bad decisions that cost them companies and is now costing us. By the way CountryWide is probably the worse when it comes to this and their ubiquious commercials. So, continue on but remember this was the result of a system based on the greed of everyday people as much as greed of elites!

  8. Mr. Shafer,

    obviously your firm may have been truly isolated from all the Account Executives from all the lenders and subprimers such as Green Point, Mortgage IT, Aurora, Lend Aemrica, Option One, World Savings, Etc. Who on a daily basis coached the LO’s on how to get the loans through and had conference calls with the underwriters to assist them on how to get the loans approved. On how people from El Salvador who had great credit but were under a Temporary Protected Status by excecutive order of the President of The United States
    were give US Citizenship on loan applications for the expressed purpose of not showing their work permit. I guess that many of these people with less than a six grade education and limited English, who came from a mountain village in Central America, quickly learned in mass how to cheat the financial institutions of this great country.

    Everyone has a price and some LO’s , AE’s and lenders made huge profits. I audits loan transactions daily and interview families on a regular basis and their stories contrast greatly from your assertions.

    We need to look at it from a different perspective. This was a pyramid scheme gone wrong. A financial orgy that will bring down the players on all sides, sadly those with the least amount of resources and least prepared have fallen first and will continue to pay dearly for a system that is corrupt , unfair and manipulated by the banking industry.

    I live in the Washington Dc Metro area and have met with officials from the reserve board and asked about the Truth in Lending Act and they indicate that lenders have pressured a great deal to water down all regulations and interpretation of the Act.

    I just hope ALL your clients did get a GFE, and all disclosures, Did you calculate the APR, did you do the numbers on the TILDS?

    I can bet you most of your clients at least 80% of them got fraudulent TILA disclosures from the lenders and you had no idea that was going on.

    Did you know the table funded lenders were getting overrides on their loans from Indymac every month and those commissions and overrides were not disclosed to the consumers and even to the LO’s, they were kickbacks given to the mortgage brokers and table funded lenders to sell risky loans and higher ineterest rates. When was the last time you explained to your clients that the YSP had a monthly, yearly and term impact on the cost of the loan?. Did you give them a choice?

    There are so many thing we can argue about this, however, we need to get a solution. This country is on a free fall, and the blame game does not solve the problem.

    At least bring a solution to this blog, we are all looking for ways to mitigate the loss of home ownership and the terrible effects of this crisis over the American Dream.

    Dig deeper into this blog and you may learn a thing or two. I guess the “Maddoff” reality is just the tip of the iceberg.

  9. “a good example of speculation run amok among the people, which does happen quite often as it is a regular feature of capitalism.”

    Shafer you need to lighten up dude

    There are a whole lot of investors and investment managers out there that would not have considered a couple of years ago investing in Fannie and Freddie as speculation…I mean I understand that “past performance is not guarantee of future performance” but c’mon as far as anyone was concerned Fannie, Freddie and high dividend stocks like financial institution were considered fairly conservative…these people weren’t speculators but have had ther 401(k) reduced to a 201(k) because of the egregiousness of a few…..its reality ask Steven Spielberg with Bernie “Made Off” situation he may be a pauper….the trust has been broken, you don’t get that back overnight…it takes years or perhaps generations….you are a bit “old school” to “get” the dynamics of what is going on here take you right wing BS somewhere else…..


  10. Why is the existence of SISA loans fraudulent?
    I’m not convinced it is really a problem. What is the prime foreclosure rate for SISA loans versus full doc? Did the added interest charge cover the excess losses? Talk about a nanny state, you want to dictate the paperwork required to get a loan?????

    I have read about Japan and it has nothing to do with what is happening here to the real estate or the stock market. But it is a good example of speculation run amok among the people, which does happen quite often as it is a regular feature of capitalism.

    I’m glad your not mad, but this statement made it appear the opposite:
    “The companies screwed me when they went to the government and started using the money I pay in taxes for protecting the existence of their failed businesses. They screwed me when my 401k tanked. They screwed my friends and family when their irresponsible risk-taking behavior lead to an economic downturn and unemployment.”

    If you call for some added regulation, than I am all for it, but you seem to be calling for extreme nanny state intervention into the credit markets. And you still haven’t provided any proof of all this fraud you suspect happened.

    Your call to put the tiger into a cage seems to be opposite of your call to let the market do its thing and watch the companies fail.

    Oh well…..we can speculate all we want about whether the bailout was needed or not….and never agree.

  11. I fail to see where there is any anger in my posts. I suppose to you, asking for people to face the consequences of their actions could be construed as “anger”. I guess I was just raised to be responsible for my actions (hence why I always pay off my credit card, etc), so it might appear to others who prefer this nanny state that I am “angry”.

    If a homeowner lied to their broker on a SISA loan, they too should be prosecuted for fraud. But the very EXISTENCE of SISA loans is itself fraud. Any broker who used SISA loans (or, worse, NINA loans) should be charged with fraud, in my opinion.

    I would PREFER that we didn’t have a bailout so that the bad companies could finally fail, rather than propping up institutions who will likely fail later anyway. Read up on Japan’s Lost Decade if you want to see what happens when you prop up sick institutions instead of letting them die off.

    Regarding the automated underwriting software, that was just JPMorgan. There are other examples, both Fannie and Freddie had such software.

    It’s not about whether *I* got screwed. Everyone was screwed by these people – everyone. You, me, our neighbors, etc. These people screwed us all and you’re just fine giving them money in return. Sure, the government will do with our tax dollars what it likes, but that doesn’t change the fact that it’s foolish to protect market participants from failure, or that it’s creating an improper incentive structure.

    “Complain when a tiger does what it does” – I like that. Now why do you prefer to let the tigers run wild, over putting them in a cage? This is, in fact, my point – that Wall Street people will continue to be careless about the damage they do to the economy so long as we protect them from facing the full consequences of their actions, as if their job is to destroy us for their own gain.

  12. Wow you are really mad. OK, so you want to punish those homeowners who lied on their SISA loans?????? Already is fraud for the loan originator and it has been prosecuted in extreme cases. They haven’t prosecuted the consumer yet…it that what you are waiting on?

    You still don’t get it, the government bailout is about your job and your 401K. Believe me it could be alot worse with no bailout.

    Some e-mail might be systemic fraud or it might be some moronic employee. The prosecuters can work that out.

    You think you got screwed, OK. So what? File a law suit if you have standing.

    The government uses OUR tax money for many things it thinks will benefit us, including this last war. Just because you don’t agree with it, doesn’t mean anything. Run for office and you can help decide where the taxes go. I don’t want my tax dollars used for this war, think is has more to do with our recession than anything else. But so what? The politicians disagree with me and have spent a trillion $ on it.

    Prosecute fraud, yes. But complain when a tiger does what it does, not me!

  13. The companies screwed me when they went to the government and started using the money I pay in taxes for protecting the existence of their failed businesses. They screwed me when my 401k tanked. They screwed my friends and family when their irresponsible risk-taking behavior lead to an economic downturn and unemployment.

    So let’s take a look at the fraud issue. Please explain to me how a No Stated Income No Stated Assets loan is not fraud. Explain to me how a piggy back loan (which uses a Home Equity Loan to make the down payment, so the primary mortgage still qualifies as only 80% of the house’s value) is not fraud. Explain how an internal email by a JPMorgan employee detailing how to manipulate their automated underwriting software to approve loans is not fraud. Explain how Moody’s and Standard and Poor’s can label bad debt to be AAA without being fraudulent. Explain how bundling a bunch of BBB debt into a CDO and re-tranching it into a “CDO squared” so that some of that junk would be rated AAA is not fraud.

    This was not just about speculation. Many of the actors in this play were perfectly aware of the consequences of their actions. Besides, speculators were not running the desks at Merrill Lynch and Bear Stearns.

    It would have been better to let the bad institutions all fail first, and then recapitalize the ones that are left. Instead we recapitalized institutions who were politically connected, and they are likely to still fail (see: Bank of America).

  14. Honesty, we come from very different perspectives. Who screwed you over? Did someone force you to invest in their companies? Someone force you to get a sub-prime mortgage? I just don’t get that statement.

    As for fraud, well we agree if there was fraud it should be punished, and I bet Madoff does! But, so far I haven’t seen whole scale fraud in Wall Street Investment firms, have you? And if it is there why isn’t the very aggressive prosecuter indicting them?

    No, what is going on here is the same story that has existed for a very long time. People speculated and got burned. Some won and some lost huge and small amounts of money. So goes the world.

    The bailout was about your job, your life savings, not about bailing out “rich folks,” as you pointed out, they already got their’s!

    I repeat myself, if these banks we bailed out don’t go out of business, we will get the money back.

  15. What isn’t to get? If someone screws you over and you give them money instead of punishing them, what do you think the chances are that they will screw you over again?

    SOME firms have failed, but their employees will likely move on to another firm. This is only a small penalty, perhaps “the cost of doing business” when you milk the economy. For the rest, as you said, they can buy new assets at pennies on the dollar – which is more of an incentive to let the market destroy itself so the survivors can buy the pieces cheap.

    The “trillions” of capital that is gone were all imaginary, anyway. Capital cannot vanish if it only existed on paper. I could tell you that I was a millionaire and now my capital is gone, but if I lied about being a millionaire then I didn’t really lose any capital, yes?

    Jobs lost? Do you seriously think the high-level officers care that they lost their job if they still have their cushy bonus? They’re set for life! They don’t need another job.

    I don’t understand how you can feasibly argue that there are incentives in place to keep people from screwing up. A few companies go down and this is your proof that corporate American can police itself? Need I remind you that the executives of AIG blew $400k at a spa the week after they were bailed out (the first time).

    When I say incentive, I mean something more like “if you have committed fraud you are going to prison.” That’s an incentive. Letting officers walk away from their ruined company with their bonuses creates an incentive for officers to screw their company; they walk away with millions and their company gets bailed out by the government.

  16. This argument I simply don’t get. Wall Street firms have failed, some have been bought for pennies on a dollar, trillions in capital gone, investor trust destroyed, jobs lost and yet you say they suffered no penalties??????

    What the bail out hopefully accomplishes is to protect us from the fall out; our jobs, our capital, our economy. Believe me with no bail out we are looking at a much worse scene.

    Also, the bail out so far has been about capitalizing banks (and AIG) in exchange for preferred stock which, if bankruptcy is avoided, will at least pay us back what we have invested!

    Incentives??????? No place else are incentives so acutely placed than in the capital of capitalism where on a daily basis the market creates and destroys capital.

    I don’t particularly like the propaganda that comes out of Wall Street, but that doesn’t mean I discount the facts of their lives!

  17. shafer, I understand the value of government programs. I’ve known some people who, without government assistance, would be screwed; for example, I knew a diabetic who had an amputated leg, and he owned a house on a steep hill before the amputation. His situation made employment extremely difficult. But he was not irresponsible…he was merely unfortunate.

    But it is not the unfortunate who are receiving government assistance. It is the irresponsible. There is no incentive to make wise decisions if the government will protect you from the consequences of foolish ones (provided you have sufficient political clout).

    For example, take the Greenspan Put. Market participants always assumed that if anything was going wrong, Greenspan would manipulate the interest rate to prevent a decline in stock prices. This lead people to believe that, no matter how bad our economy was going to get, the market would keep going up.

    Until proper incentives exist, Wall Street will always blow it, because we are teaching them that there is no penalty if they mess up.

  18. DCX2, well we live in a country where, at least at a very low level, we are all in this together. If you have never depended upon a government program for anything, good for you. But millions of Americans have used government programs from welfare to unemployment benefits to social security/medicare. Personally, I have never used these programs (yet) but I am glad they are there for folks.
    We live in a country with a mixed economy which means that we have a relationship between our capitalistic organizations and our public organizations. Each side has at some time done stupid things, but the other side has help to overcome the stupidity.

  19. Not all of us are to blame. Throughout my entire life, I have consistently been putting money into a savings account. I pay off my credit card in full every month. I have no mortgage or car loan to pay off. I live entirely within my means. And yet I will suffer for the irresponsibility of others. I have done nothing wrong, and I guess that means I won’t be getting any bailout.

  20. I originated mortgages through that period. I only wrote two sub-prime mortgages and as far as I know not a single one of my mortgages went into foreclosure.
    I would be much better off today if I had just gone along with what folks wanted. You see I wouldn’t sell a sub-prime mortgage with a variable rate, because these people were the least ability to withstand increased payments down the line. So what did they do? They went to the next lender who would sell them that lower rate,variable rate loan. I got yelled at by people when I told them they couldn’t afford a house! They got the loan from someone else and were in foreclosure before the year was out. I don’t know how many times I was told someone’s “brother-in-law or cousin” was in the business and would get them a loan better than the one I offered just to find out that their relative tacked on an extra percentage or got them into a option arm loan that was way more expensive than the fixed rate I offered.

    So when you ask would someone sign the papers if they knew how the business was operating the answer is YES they would and Yes they did.

    Foreclosures are a terrible toll on anyone. I have the greatest empathy for folks in this situation. But to not understand that folks were determined to get into a house, no matter what, is to miss the forest for the trees!

  21. Johanne: There is plenty of blame to go around. But the one who should get the LEAST blame is the one with the LEAST INFORMATION and the least access to information. That would be the borrower who knew nothing about how their signature, identity and credit worthiness were going to be used, knew nothing about the true source of the funding for the loan (and therefore is left with not knowing who to question about the loan transaction), and nothing about the appraisal fraud, the dropping of underwriting standards, the extra fees paid to mortgage brokers who were rewarded not for originating good loans but received extra rewards for creating bad loans. Do you know who YOUR “lender” is? Would you have signed papers at the loan closing if you knew the appraisal was inflated and could never be sustained? Would you have signed the papers if you knew the real lender was not being disclosed to you and that the “lender” at closing had merely rented its charter to an unregulated, unregistered, unchartered entity that was calling the shots? How would you have acted if you knew the APR was intentionally misstated?

  22. That was an interesting read that points out an issue we all don’t want to accept: we still are at fault in one way or another.

    Uncontrolled purchases and the irresponsible use of credit go hand-in-hand. And these are characteristics common in our society.

  23. Well, What can I tell you my kids college funds are wiped out.

    That is why I am fighting for my home no matter what. And that is why I share this blog with everyone I meet.

    Thanks Mr. Garfield and every one who contributes.

  24. What a great article. Of course it doesn’t point out the fact that some folks make fortunes on betting the bubble will burst if their timing or patience is right!
    And yes it is all our fault, because we all are human and incapable of predicting future events.
    What is probably the worst outcome is that the system has left most people on their own with their 401Ks for retirement that now might never come!

Contribute to the discussion!

%d bloggers like this: