Democrats & Liberals Archives

Wall Street's Heart Of Darkness

Anybody who knows the beginning to Apocalypse Now may hum or sing the song as appropriate. All joking aside, we have seen, at least for now, the end of the Wall Street Investment banks. What terminated their command of our economy, terminated it with extreme prejudice? Well, according to the linked article, all it took was one woman, Meredith Whitney, to start this collapse rolling.

What did she do wrong? Absolutely nothing. She was no different than the girl who told a certain monarch that the latest fashions he was modelling were nothing more than the clothes he'd been born with.

Her role in this collapse was simply to tell the truth, and the truth is what left Wall Street reeling. The Market was being run by idiots, who apparently were taking a day off from telling stories full of sound and fury that signified nothing.

To be more specific, she told investors that Citigroup had screwed things up so badly that if they didn't stop sharing so much money with their investors, they'd go bankrupt. 369 billion went away in one day. The real question, though, would be whether it was ever there in the first place.

From that moment, Whitney became E.F. Hutton: When she spoke, people listened. Her message was clear. If you want to know what these Wall Street firms are really worth, take a hard look at the crappy assets they bought with huge sums of ­borrowed money, and imagine what they’d fetch in a fire sale. The vast assemblages of highly paid people inside the firms were essentially worth nothing. For better than a year now, Whitney has responded to the claims by bankers and brokers that they had put their problems behind them with this write-down or that capital raise with a claim of her own: You’re wrong. You’re still not facing up to how badly you have mismanaged your business.


Now, obviously, Meredith Whitney didn’t sink Wall Street. She just expressed most clearly and loudly a view that was, in retrospect, far more seditious to the financial order than, say, Eliot Spitzer’s campaign against Wall Street corruption. If mere scandal could have destroyed the big Wall Street investment banks, they’d have vanished long ago. This woman wasn’t saying that Wall Street bankers were corrupt. She was saying they were stupid. These people whose job it was to allocate capital apparently didn’t even know how to manage their own.

A little background here: The author of this article also wrote Liar's Poker, a book which chronicled the fall of Solomon Brothers as a self-sufficient firm in the bond market of the eighties. He writes of his dismay as some college students took his book to be some kind of manual for getting into the business.

That wasn't the point. Let's take a bit of common knowledge: Mergers make companies better, right?

Not necessarily. One reason to encourage mergers was to encourage companies to become riskier ventures together, as they put their cash and stock into buying other companies. The point was to make their balance sheets take a hit. Now why in God's name would you do this?

It raises the interest rate on the bonds, the corporate debt. Or rather, it makes good bonds junk bonds. Junk bonds made more money when you sold them. Disrupt businesses, turn smaller, more responsive companies into larger, more bureacrating ones, increase debt holdings... You'd want some more planning before you put people into these things, right?

Worldcom was an up and coming company. But did it really have the financial strength necessary to swallow MCI? AOL certainly had the business going, but was it fit enough to swallow Time Warner?

You'd think we'd get it after one debacle after another, one collapse after another, but in our defense, I guess the boom of the nineties led us to accept the common wisdom that these people actually knew what they were doing, what their companies were worth.

The reality is that most of the people don't know what they're doing. They know selling: themselves, their businesses, the continued booms and inevitable rise in value of the market; they feed us all that pseudo-democratic stuff about how the market's wisdom overcomes all. Don't fence us in, they tell regulators. Don't take your money elsewhere, they tell investors. They sell stock in the companies who they are creditors to.

And they leveraged themselves and this country out the eyeballs. Do we honestly think these people made all those bad loans to people because they were forced to? Is that what builds a bust of this size, resigned apathy? These people weren't going broke on this before. They weren't seeing these bad loans weigh on their balance sheets. If you look at what the real problem is, the real problem is that they built their system on passing risky mortgages on, and many times on making these mortgages as risky as possible so that like those bonds, they could inflated in value with late fees, interest, and all that other wonderful stuff. Of course, if you could see the actual mortgage, that might not look good. But if you could sell the mortgages all in one big mix with the good ones, with the whole collection opaque to examination... Well then, your predatory loan could make good money, and be sold again and again. The more, the merrier, the secondary market would absorb the risk.

A great deal of the rest of the article deals with Meredith Whitney's mentor, the one who taught her how to take the hard-nosed look at the finances.

“A lot of people don’t get Steve [Eisman],” Whitney says. “But the people who get him love him.” Eisman stuck to his sell rating on Lomas Financial, even after the company announced that investors needn’t worry about its financial condition, as it had hedged its market risk. “The single greatest line I ever wrote as an analyst,” says Eisman, “was after Lomas said they were hedged.” He recited the line from memory: “ ‘The Lomas Financial Corp. is a perfectly hedged financial institution: It loses money in every conceivable interest-rate environment.’ I enjoyed writing that sentence more than any sentence I ever wrote.” A few months after he’d delivered that line in his report, Lomas Financial returned to bankruptcy.

Eisman wasn’t, in short, an analyst with a sunny disposition who expected the best of his fellow financial man and the companies he created. “You have to understand,” Eisman says in his defense, “I did subprime first. I lived with the worst first. These guys lied to infinity. What I learned from that experience was that Wall Street didn’t give a s*** what it sold.”

The housing market attracted their notice pretty quickly, back in 2004. They started seeing ridiculously high ratios of median income to home prices. Though optimism was the rule of the day

In fact, it was pretty tough to find, with all this bad debt flying around, any real sign of true pessimism. Looking to short something, the stocks of these companies were too expensive. They went looking for the bonds to short, but nearly everything was rated AAA- a bit like Garrison Keilor's talk that the children in Woebegon were all above average.

So they went for our tried and true friend in this financial crisis, The Credit Default Swap. They essentially made bets against mortgages made in certain places by certain lenders. The kind of people who give migrant farmworkers the money to buy houses worth three quarters of mill, who advise Jamaican nannies to flip the refi from their mortgage into an additional house. Then another, then another, then another and one more.

In retrospect, pretty much all of the riskiest subprime-backed bonds were worth betting against; they would all one day be worth zero. But at the time Eisman began to do it, in the fall of 2006, that wasn’t clear. He and his team set out to find the smelliest pile of loans they could so that they could make side bets against them with Goldman Sachs or Deutsche Bank. What they were doing, oddly enough, was the analysis of subprime lending that should have been done before the loans were made: Which poor Americans were likely to jump which way with their finances? How much did home prices need to fall for these loans to blow up? (It turned out they didn’t have to fall; they merely needed to stay flat.) The default rate in Georgia was five times higher than that in Florida even though the two states had the same unemployment rate. Why? Indiana had a 25 percent default rate; California’s was only 5 percent. Why? [emphasis mine]

They also were concerned about how this BBB-grade stuff, high risk, was suddenly being transformed into good stuff, AAA, when they cut it up into tranches for sale. It became a theatre of the absurd, in part. Standard and Poors didn't model for a fall in home prices.

Let me repeat that for dramatic effect: Standard and Poors did not take into account in their mortgage risk ratings what would happen if the inevitable drop in home prices actually happened.

Finally, at a dinner with a man who managed CDO's (collateralized debt obligations), he was confronted with the monstrous screwed-up nature of it all.

First, you have to understand how screwed up the CDO market is to begin with:

Later, when I sit down with Eisman, the very first thing he wants to explain is the importance of the mezzanine C.D.O. [...]“You have to understand this,” he says. “This was the engine of doom.” Then he draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranche—the bonds Eisman had shorted. But Wall Street had used these BBB tranches—the worst of the worst—to build yet another tower of bonds: a “particularly egregious” C.D.O. The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities. “I cannot ****ing believe this is allowed—I must have said that a thousand times in the past two years,” Eisman says.

The man he dined with sold bonds made from the BBB tranche. Eisman expressed his sympathies to the guy, knowing through his research that those bonds were going to get wiped out, being based on the rate of defaulting mortgages. The man, happy as a clam, tells him he sold them all. He didn't mind Eisman's anger at the guy essentially leading folks down the garden path of bad investments.

Without Eisman's short-selling of his market, he'd have nothing to sell. The banks were essentially using the insurance constituted by the CDS to justify making more bonds.

As time would go on, Eisman and others would be in the very profitable, but very disheartening position of being vindicated by events. As the Mortgage crisis wore on and finally the whole house of cards collapsed. As the article puts it, rather profanely:

This was what they had been waiting for: total collapse. “The investment-banking industry is ****ed,” Eisman had told me a few weeks earlier. “These guys are only beginning to understand how ****ed they are. It’s like being a Scholastic, prior to Newton. Newton comes along, and one morning you wake up: ‘Holy ****, I’m wrong!’ ” Now Lehman Brothers had vanished, Merrill had surrendered, and Goldman Sachs and Morgan Stanley were just a week away from ceasing to be investment banks. The investment banks were not just ****ed; they were extinct.

Which is where we are now: There is no investment bank operating any longer within this country. The author of the article goes on to talk about how investment went from people investing their own money, to being publically own corporations, whose investors supplied the money that both paid salaries and paid for investments, a black box as he describes it. Why be careful when it's somebody else's money?

Here's the part where I chime in. Folks promised us a free market. What we got was and was not what we were promised. Anarchy reigned, more than ever. You got all these nice clever runarounds, pyramid schemes, outright frauds, and other schemes running, and they did their best every year to knock down whatever legal obstacles to what they wanted to do.

But was that a free market? It was a market where many people were purposefully steered wrong by those who should have been obligated to work on their behalf. It was a market which even now continues to play game like kids at recess with the money it has, instead of planning and capitalizing for the future. It was a market where clarity and quantity of good information were kept to the minimum, and the spin and hype was raised to the rafters. Bubbles were encouraged, as was speculation in excess. You might expect me to argue that it wasn't a free market, but no, that's not what I'm going to do.

I'm going to argue that this wasn't really a market. It was more a con-game, a swindle, a system set up to sell people on investments with no notion of setting people up with the right investments Whether we talk about the investments of individuals looking to get a good return on their money, or institutional investors putting money into stocks and bonds to keep pensions, mutual funds and 401K's afloat, the Wall Street Investment banks and brokerages were only interested in making their own money, not making sure their clients made theirs. They made a mockery of the market system, turning into some mutation of a free market that was one part casino, one part ponzi scheme, and one-part old boys club. And on top of it all was an economic elite using other people's money to reward themselves simply for playing the game or being an executive, not for making the right decisions or running truly successful and productive businesses.

Capitalism isn't dead, nor should it be. The Market itself is a valid, workable system. The government shouldn't bail out or stick their fingers into every business. But to be a market, there have to be people who can pay, investors who can count on some kind of return, the information to determine whether they're getting that return on investment, a reasonable system of credit, and various other structural features. One way or another, the laissez faire approach to economic management has corrupted, damaged, or destroyed those insitutions that kept our market a market, and not a law-of-the-jungle free-for-all, with money being bled in the place of blood.

We've gotten to the point where the ability to bluff, bluster, and con others, to make deals and tell lies became more important to profits than actually running businesses, banks and brokerages that work.

It's a sorry thing to see us in this shape. But the sorrier thing is that most of this was self-inflicted, not suffered in some trade war or lost in some terrorist atttack. Well, what such idiocy can do, our intelligence can undo, and must. Wisdom, humanity, responsibility must once again become part of our business culture, and where necessary, it has to be something our govenrment is willing to require of participants of the market.

Posted by Stephen Daugherty at November 16, 2008 9:13 PM
Comment #270519

Stephen D. , the word Stupid for these capitalists, is very apropos’.

They apparently never read Adam Smith, or if they did, didn’t understand a lick of what he said about ‘enlightened’ self-interest. Enlightened has the opposite meaning of stupid and ignorant.

In Adam Smith’s time, if a stupid person’s business failed, at most a few thousand people were affected. Today, the right stupid person in the right place at the right time can wreak havoc on billions of people.

Hence the absolute need for oversight and regulation of capitalists in every corner of this global economy. But, most especially in the U.S., Europe, and Asia.

As Adam Smith pointed out in Theory of Moral Sentiment, greed is an ultimately self-defeating motive, most hurriedly when lacking an ‘enlightened’ awareness of the effects of greed upon those whom one shares one’s world with. Those around one will resist and oppose unenlightened greed in their midst.

The difference, in Adam Smith’s view, between a capitalist and a statesman, was motive, enlightened or not. From that I take the meaning that to posit the two roles in the same person is the height of folly, for it marries greed and power potentially in the same person and role.

Posted by: David R. Remer at November 18, 2008 6:14 AM
Comment #270521

Stupid? Maybe.

Criminal? More likely.

The smart ones took the money and ran from the open vault. The dumb ones kept taking it, until someone finally noticed.

Posted by: snert at November 18, 2008 7:57 AM
Comment #270537

the market is over inflated. has been for a very long time. bush’s people have made their money, and will leave everyone high and dry. the market is and will be at about 5000 - 6000. it will continue to fall until it stablizes at that point. you are right, they have swindled america. and they will not be done until it falls another 3000 points. this is no secret. just like gas prices. it was all fake. you put an oil man in the office, and you will see record profits for the oil companies - which we did. now they are lowering the prices so congress will not investigate. you will continue to see lower prices. it is a game that a certain amount of americans voted into office. problem being most of them were unaware of this game. and that is where the ignorance kicks in.

side note: aig - are they still going to sponsor f1 (formula one)? are they still going to sponsor a 2 car field for about 100 million dollars/year? why are these questions not being asked? sorry to stray, but this bothers me.

Posted by: bluebuss at November 18, 2008 1:10 PM
Comment #270539

I think the low OIL prices are a result of the bear market and worldwide Demand destruction Caused by some degree by our own government’s Bumbling, something OPEC and The OIL companies never counted on ,We/ve seen OPEC cut Millions with virtually no effect to stabilize or increase. believe me OPEC wants and claims they need $100 oil. BTW japan announced this week there in a recession so enjoy the low OIL prices for now.

Posted by: Rodney Brown at November 18, 2008 1:48 PM
Comment #270540

Rodney Brown-
Another element is that people aren’t buying up and bidding up the oil commodities, ever since the financial institutions playing these games went under. I think we’re seeing the kind of premium speculation was putting on the market.

Posted by: Stephen Daugherty at November 18, 2008 2:45 PM
Comment #270546


To balance out your article, you need to bring Congress, Clinton and Bush into the act.

The S&P 500 has fallen 20% since Obama took a nice lead in the polls in late September. There is little confidence in the new government going forward.

Posted by: Craig Holmes at November 18, 2008 4:49 PM
Comment #270548

That was crap, Craig, when your like-minded buds posted it weeks ago….and it’s crap now.

Posted by: janedoe at November 18, 2008 5:40 PM
Comment #270549

Craig Holmes-
I learned long ago that if you sneak up behind a stock broker and shout, they’ll hit the ceiling and dig their fingernails in like the cat in the Looney Tunes cartoon.

All joking aside, the capacity for the market to bounce around like a kid overloaded with sugar long ago lost me whatever faith I had in the short term meaning of the DJIA or the other numbers.

If you’re looking for causes in terms of that fall in value, though, the cratering of the investment banks and the ripple effects from that strike me as the more proximate causes of those events. We got to take a less superficial appreciation of the markets than just the index numbers.

Posted by: Stephen Daugherty at November 18, 2008 5:49 PM
Comment #270554

A protracted 2009 recession whose direction began in the Fall quarter of 2007, is what the Stock Market is reacting to, and all that insures a dismal 2009, including credit problems at the consumer level, global recession and diminished US exports, and of course, the increasing job losses and consequent losses in consumer activity.

Craig knows all this. He is just pulling ya’ll’s chain. He knows too that it was Republican policies and abdication of responsibilities that have brought us to this. Which is why Democrats were elected to take over by a majority of the population and the states. A change is what the people wanted - a change from Republican rule. Obviously.

Posted by: David R. Remer at November 18, 2008 8:02 PM
Comment #270558

Stevens loses Alaska Senate race
By MICHAEL R. BLOOD, Associated Press Associated Press Writer – 6 mins ago

Posted by: Rodney Brown at November 18, 2008 10:00 PM
Comment #270559

Thanks for the news Rodney!

Posted by: janedoe at November 18, 2008 10:15 PM
Comment #270561

you’re welcome, he was the “King of Pork”

Posted by: Rodney Brown at November 18, 2008 10:25 PM
Comment #270566

It’s fine to play the blame game, but what can be done to prevent such problems in the future?

It would be one thing if all this went down during the Republican watch and Democrats saw it all coming and were screaming “Stop!” the whole time. You want more regulation, but did Alan Greenspan see it coming? Why do you assume that giving the feds more power will give them more knowledge?

Posted by: Liam at November 19, 2008 12:10 AM
Comment #270578

“It’s fine to play the blame game, but what can be done to prevent such problems in the future?”

1. Never let the fox guard the chickens.
2. Many of the new deal regulations were put into place to correct the defects of the late ‘20’s. The economic plan adopted by the Reagans and later the conservatives/repubs mirrored the ‘20’s model that lead us to the great depression of the ‘30’s. Modernize? OK, remove these regulations. Not.
3. By constitutional amendment make it clear the corporations are not people and do not have the rights of a natural born person.
4. Listen to our elders.
“If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them (around the banks), will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.” Thomas Jefferson

“I hope we shall crush in its birth the aristocracy of our moneyed corporations, which dare already to challenge our government to a trial of strength and bid defiance to the laws of our country.” Thomas Jefferson, 1812 Source:Liberty Quotes

5. Stop bailing them out. We have been doing this since the days of the Reagans, both Ron and Don, and still haven’t learned. However we now are saddled with a terrific debt and mismanagement of the bailouts. Has credit gotten easier for people to obtain? Why are these very same banks we just bailed not lending money to the big three?

“It would be one thing if all this went down during the Republican watch and Democrats saw it all coming and were screaming “Stop!” the whole time.”

For the same reason we were led into the Iraq debacle. I think of it as the “figures lie and liars figure” approach. Momentum on the side of the greedy, a good sales job and the fear of being on the wrong side should it work. Couple that with the fact that the dems are only slightly less owned by the corporate lobbyist, who rocks the boat when they want to be reelected?

“Why do you assume that giving the feds more power will give them more knowledge?”

It is our only chance. To leave the federal government to the capitalist doesn’t work as we have seen. Much like we need a separation of church and state we also need a separation of cappitalism from our representative democracy lest we slide into some type of corporate fascism.
Of course this is just my humble opinion.

Posted by: j2t2 at November 19, 2008 10:54 AM
Comment #270580

There are some people who just don’t want to learn, no matter how many lessons the market gives them. One thing you can do is to outlaw their practices, so its no longer a matter of individuals learning a lesson, but society as a whole.

Democrats like myself were warning that if we didn’t get our act together with regulating Wall Stree, that if we kept on letting them essentially peddle BS to investors, that sooner or later, we would reap the consequences. Hell, the author of the article that forms the basis for my blog entry knew that this problem would come to a head twenty years ago.

We’ve known for a long time what to do: Stop encouraging a culture which deceives investors to make money. It’s not a market until the legal environment makes such deceptions and cheating difficult enough that most people just do the right thing to avoid trouble.

Posted by: Stephen Daugherty at November 19, 2008 11:20 AM
Comment #270601

Liam, there are many steps to be taken. First and foremost is radically improving our education system so that high school graduates have ample facility with math, can invest intelligently according to basic and common sense rules of investing, and providing high school graduates with a firm grasp on opportunity costs, and the fact that if it sounds too good to be true, in all probability, it is.

Second, self-regulation in the financial markets is a bust. End it, or at least, put in place independent oversight and regulatory agents as a backstop to transactions which are clearly starting to get out of prudent balance, constituting a threat to the entire market down the road.

Third, STOP accepting globalization as a universal truth! This international dependence needs the same kinds of stop loss measures as a car’s brakes have, such that, if one fails, the other three are isolated enough to continue functioning. Globalization NEED NOT mean total dependence and helplessness at the mercy of other’s markets or dealings. That is pure fiction.

America can and should grow its own food supplies. The higher prices would be compensated by the drop in costs coming for import inspections and terrorist contamination of imported food stocks, seeds, fertilizers, and other contaminants including biological diseases.

America can and should provide the bulk of its own energy needs. America can and should provide its own national security technologies and infrastructure.

We can’t eliminate global interdependence, but, we also don’t have to let it turn us all in to helpless whiners unable to maintain at least survival level independence should the rest of the world sink into chaos and ruin.

Posted by: David R. Remer at November 19, 2008 5:02 PM
Comment #270648

My point is that even if you gave the federal goverment every single power they could dream up and total authority to regulate and approve every single transaction in the economy I don’t see how it would have guaranteed avoiding something like just what happened. And of course that would raise its own problems.

Liberals seem to “get this” in other areas so I don’t understand why they don’t get it with the economy. Can we prevent violent crime and drug use for example by having an all-powerful government that ignores individual liberty and polices everything and that allows the cops to search us without cause, listen to all our phone calls, read all our emails and open our mail? It’s funny when the same people who are against stuff like the Patriot Act think the feds should put their noses as far into our economic decisions as possible.

Its weird to me that lots of the folks who don’t want the government to know who we’re talking to and associating with overseas want the goverment to put us under a microscope and micromanage to the hilt what we buy, sell and borrow.

Posted by: Liam at November 19, 2008 11:52 PM
Comment #270652

“Its weird to me that lots of the folks who don’t want the government to know who we’re talking to and associating with overseas want the goverment to put us under a microscope and micromanage to the hilt what we buy, sell and borrow.”

Exactly where has this been said? Seems your statement in indicative of a “any regulation is a lot of regulation” mentality. No one has asked for government micromanagement from what I have read Liam.

Posted by: j2t2 at November 20, 2008 12:28 AM
Comment #270671

Liam, avoiding what just happened was easy. Texas avoided it by having a long standing state law preventing loans on property in excess of 80% of the market value of the property. In other words, Texans understood what what sound collateralization principles were and INSTALLED those principles in regulation of the lending industry.

That is how we could have avoided this particular melt-down. Though others would have followed in the Credit card and commercial property industry (that bubble is just now bursting and for the same reasons as the housing market).

Now, Credit default swaps and hedge funds regulation would not be as simple, but, very doable in terms of assessing potential market wide risk based on monitoring data, had the Federal Reserve been doing that monitoring as it should, but didn’t, partly because it didn’t think it had legislated authority to.

Going forward, the Fed will have that oversight and regulatory authority. Which will have a prophylactic effect.

The fundamental principle we have to observe going forward is not new. “Follow the Money, and monitor and analyze the transactions that get the money from point A to point B.” There is a word for this principle. It is called ‘Accounting’. And if accounting is performed by accountants who themselves are not invested in money moving from Point A to Point B, then prudent and objective accounting can work, and our regulatory bodies can respond to those accounting reports if they have the necessary investigatory authority review the bookkeeping of entities involved in massive transactions, either in dollar amount or volume.

This all very doable. But, it requires the political will to get it done. I think that political will has been arrived at, and we will see what’s necessary put in place.

Posted by: David R. Remer at November 20, 2008 11:28 AM
Comment #270794

David, Stephen, all. A good section on our infrastructure.

Posted by: Rodney Brown at November 22, 2008 2:23 PM
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