There are 633 riveting pages. The 2008 Financial Crisis is a mystery no more. The icing on the cake, the crisis could have been prevented.
As crisis go, this was not your average one. It had a lot of moving parts. There was the government-gone private Fanny Mae and Freddie Mac. These twins would buy mortgages from just about anyone. They were golden because they came backed by Federal guarantees. Private businesses backed by Federal money. Hmmm.
Of course there was money in it for banks when they granted mortgages. As soon as they granted a mortgage, the bank could sell the mortgage to Freddie or Fanny. This gave the banks new money to grant another mortgage and pocket the fees associated. No risk and money in the pocket. Hmmm.
Investment bankers saw some new angles. Why not bundle these mortgages and sell bonds that promised to pay the equivalent of your money mortgage payment to bond holders. The original bank had already collected its fees and was collecting more fees for providing local service. Freddie and Fanny, as well as other lenders could sell their mortgages to the bundlers who would issue bonds. The bonds issuers, of course, made fees too. Hmmm.
The investment bankers struck another idea. What would they do with mortgages that were a little questionable? Eureka, Why not bundle a mixed bag of mortgage backed bonds into what they called a collateralized debt obligation. They would get ratings agencies (Standard and Poor’s, Moody’s, etc) to rate these CDOs. The highest rated would carry the lowest return, the riskiest the highest return. The beauty of this approach was that the assigned ratings would be all slight variations of good ratings (whether they really were or not). Hmmm.
Other creative investment bankers hit upon “slicing and dicing”. Here they created CDOs that contained pieces of high rated CDOs and pieces of lower rated ones. The idea was that by mixing (homogenizing) all types of CDOs, risk was spread out and no one would be too exposed. Sounds like a free lunch. Hmmm.
The investment banking community could not have done all this if there were not a ready market. Money was available around the world chasing attractive returns. Banks and investment firms around the world lined up to by these CDOs. Why not, home prices kept going up. Everyone was doing it. Hmmm.
Not everyone was convinced that home price would go up forever. Further, the creators of CDOs began to become worried. They could not sell all of their CDOs. What was not sold was parked on the banks books. This required the financial institutions to reserve money they might otherwise have used to generate more income. How to get these obligations off their books? Hmmm.
The answer came in the form of credit default swaps. CDSs are sort of insurance. Their beauty is that they are not official insurance so they are not regulated. CDSs are bets that some obligation will default. One side bets they will default, the other side bets they will not fail. Their attractiveness is that one side pays the other side money now on the bet that in the future the obligation will default. Bird in the hand…? Hmmm.
Before anyone could react the financial sector was awash in CDSs. Holders of CDOs claimed they had mitigated their risk by purchasing CDSs. CDS issuers did not have to report the issuance of a CDS since these instruments were not regulated. And no one check to see what might happen if the CDS issuer could not pay. Hmmm.
This arrangement grew while house sales continued to grow and feed new mortgages. When the housing bubble burst, the flow of fresh fees dried up. In addition, weak housing sales translated into job losses and the onset of a recession.
The next domino was mortgages defaults. Mortgage backed bonds lost value. CDO’s became less valuable and in time, CDSs were called on for payment. Suddenly everyone could see the king had no clothes. Hmmm.
Banks and financial institutions are one thing if they are anything. They are distrustful to a fault when their greed is not satisfied. If there was a chance they would lose money, they would first shut down their money lending operations and attempt to be the last man standing. The world economy soon felt the impact. It was not pretty.
At this point the term “too big to fail” gained new life. Governments around the world bailed out banks and investment firms. The rest is history.
The conclusion that this crisis could have been prevented should be no surprise. The report should have said “the crisis should have been prevented”. The nature of banking and investing is well known. The fallibility of humans is equally well known, the free lunch trips most everyone.
Dishonestly filled out mortgage application forms, predatory mortgage interest terms, no (or limited) retained mortgage liability (when sold), and unregulated and non-transparent insurance-like instruments all could and should have been regulated. If already regulated, they should have been enforced.
Greed and hot money cannot be regulated. They are part of human nature. The minority report which purports the crisis could not have been prevented does everyone a disservice. Everyone that is except the banks, mortgage originators, rating agencies, and investment firms.