How We Were Ruined & What We Can Do

The Reckoning

a series of articles by Gretchen Morgenson et al.
The New York Times, September 28–December 28, 2008

Charles Morris’s informed and unusual book, The Trillion Dollar Meltdown, provides a decisive rebuttal to all such excuse-making and blame of “government.” Morris makes it clear that it was an unquenchable thirst for easy profits that led commercial and investment banks in the US and around the world—as well as hedge funds, insurance companies, private equity firms, and other financial institutions—to take unjustifiable risks for their own gain, and in so doing jeopardize the future of the nation’s credit system and now the economy itself. In fact, government-sponsored entities, Fannie Mae and Freddie Mac, did have a part in the crisis, but not because they were principally trying to help the poor buy homes. Rather, they were also trying to maximize their profits and justify large salaries and bonuses for their executives. They had been made into publicly traded companies in 1989.

It would be wrong to conclude, however, that the new investment vehicles and intricate strategies for “securitization” that developed in the last thirty years had no value. Beginning in the late 1970s, the practice of packaging mortgages together and marketing them as so-called “collateralized debt obligations” was initially designed with the sensible aim of spreading the risk of making loans, particularly residential mortgages, by selling them to many kinds of investors throughout the US and eventually around the world. If many parties share the risk, this lowers the cost of borrowing and enables more people to buy homes and businesses to invest more in research, plants, and equipment.

But over the last two decades, this innovative system was exploited to stunning excess. Charles Morris is one of the observers who, contrary to Rubin’s claim that no one foresaw the current crisis, anticipated that the increasing gathering of mortgages into highly attractive investment devices had made the financial system dangerously vulnerable. A former banker himself, and author of several excellent books on finance over the past thirty years, Morris has described the intricacies of the American investment world as clearly as anyone. At the time of his latest book’s publication at the start of 2008, it seemed far-fetched for him to say that the cost of the financial meltdown throughout the world was a trillion dollars. In fact, Morris may have underestimated the amount of financial damage. Estimates of losses by financial institutions now range between $1 trillion and $2 trillion.

Morris starts his account of the unwinding of the markets with the collapse of the housing market, as does Mark Zandi, a respected Wall Street economist, whose book Financial Shock is intelligent, useful, and a more recent if less detailed book on the crisis. But the crisis cannot be understood without looking back a couple of decades to the development and rapid spread of the investment technique on Wall Street of packaging loans, principally mortgages made by banks and savings and loan associations, into an investment vehicle in which pension funds, money managers, foreign governments, hedge funds, and others could invest. Securitizing …

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