Bethany McLean and Joe Nocera -- All the devils are here: the hidden history of the financial crisis
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This book covers *lots* of devils.  Many of them are the miscreants
that we've learned about in several of the books that analyze the
recent financial disaster and those who've caused it.

Another view of this book is to look at a more narrow and
specialized cause of the financial crash, specifically Fannie Mae
and the U.S. government's attempt to make everybody a home owner,
and to make their executives rich at the same time.

If you decide that everyone should own a home and you force interest
rates down and you pressure a semi-government agency (Fannie Mae) to
make it possible for everyone to get a home loan, you should expect
a disaster.  Why?  Many reasons, among them: (1) Enabling everyone
to get a loan, means that you will be loaning money to many who will
be unable to repay them.  (2) Enabling more people to buy more
houses will inflate market prices of homes, thereby causing those
who could afford more modest prices to be forced or enticed to buy
homes at higher prices, and to take out loans to do so.  And, (3) if
the money is free, then why not buy a home, whether you need one or
not.  Maybe you'll make some money during the frenzy.

So, what were some of the things that went wrong at Fannie Mae? (1)
Support by the Federal government gave Fannie Mae and other GSE's
(government sponsored enterprises) an unfair advantage against other
private companies.  (2) Because Fannie Mae had an unfair and
unnatural advantage and because it and the securities it supported
were protected from and insensitive to risk, Fannie Mae could
promote, encourage, and market securities that contained mortgages
that should never have be created.  (3) By putting that much money
in play, the Federal government and Fannie Mae attracted
unprincipled, financial players who were able to game the system to
their own benefit.  (4) The hunger for securities encourages
creative people to create evil loan types, that is loans with
adjustable rates, penalties for early payment and refinancing, and
no requirement for the loan originator to keep the loan (thus
reducing the motivation to give careful attention to loan quality).

Here is a un-virtuous, vicious cycle:  Keep interest rates low,
which enables lots of people to buy houses.  The low interest rates
encourage investors to seek securities with higher rates of return.
The demand for securities fuels the creation of more credit and more
home loans.  Repeat.

This book will also provide you with descriptions of some of the
"creative" and dangerous instruments and the dumb tricks that Wall
Street came up with in order to keep the party going.  These
included CDOs (collateralized debt obligations) and CDOs that
contain tranches of other CDO's, in other words, take the tranches
of CDO's that are so bad they can't be sold, package them into new
CDOs, and sell those.  And, if CDSs (credit default swaps) are not
risky enough for you, then create a synthetic CDO containing CDSs.
A CDS is effectively just an insurance policy, right?  There is no
collateral behind it.  So, if you create a CDO out of them, you
don't actually get a *collateralized* debt obligation; you get an
un-collateralized debt obligation, or a synthetic CDO.

Here are a few alternative views of what happened to Fannie Mae and
why:  (1) Fannie Mae was increasingly left out of the home loan
market because it could not purchase the low quality loans (sub-
prime loans) that were increasingly what the market demanded. (2)
Fannie Mae was pressured to enter the subprime loan market by the
U.S. Congress and by the desire of its executives to increase market
share.  It destroyed itself while doing this.  (3) Fannie Mae was
monitored by regulators who could have been more cautious and more
conservative but failed to do so.  That failure meant that Fannie
Mae had no protection from market pressure to compete in the
subprime and Alt-A loan market.

And, if you want to learn more about what went wrong at Fannie Mae,
take a look at "Reckless Endangerment: How Outsized Ambition, Greed,
and Corruption Led to Economic Armageddon", by Gretchen Morgenson. I
have not read it, but have listened to an interview with Mortgenson
on the radio.  It sounded perceptive to me.  A few of my notes from
the interview with Morgenson: (1) This book tells how companies and
government can work together to produce high profits for well-
positioned individuals.  (2) Money attracts people who are smart and
aggressive and willing to take risks.  If you make a system where
high risks can produce high profits (and the down-side of losing is
not especially punitive, i.e. the system is relatively risk
insensitive), you will get outrageous, reckless, and (eventually)
disastrous behavior.  (3) When you create a system that can be
manipulated for high profit, then someone *will* manipulate it for
profit.  The GSEs (Fannie Mae in particular) and the Federal
government are such a system.  This kind of system has the following
characteristics: (a) it has a private entity (Fannie Mae) that can
be supported (e.g. guaranteed, insured, subsidized) by government
action; (b) it has a mandate or product that is provided by that entity
that is viewed as popular with constituents of the government
representatives, and (c) the government has the ability to provide
support for the entity without short-term cost to the government
(for example, the Federal government can guaranttee its loans
because housing prices always go up and no one will default and ...).

There is more criticism of the bankers' (or "banksters" as we're
learning to call them) role in producing the financial disaster in
the following book review: "Cassandra among the banksters", by
Benjamin M. Friedman (The New York Review of Books, June 23, 2011,
p. 24.  It's a review of "Banker to the world: leadership lessons
from the front lines of global finance", by William R. Rhodes, and
it (the review) is quite brutal.  One lesson to take away from this
review (and from the book itself, I suspect) is that those who were
creating, packaging, and selling these mortgages were warned clearly
and in advance about the coming correction, but that they chose to
ignore those warnings in order to keep getting the outrageous
compensation that they were being paid.

Yet another book to read about how our policies and those involved
in the home mortgage industry created the recent disaster is "Our
lot: how real estate came to own us", by Alyssa Katz.  If we're
obsessed with owning our own homes, then we're likely to get a deep
hope to fall in.

Facing and accepting the likelihood of these negative consequences
of governmental support for Fannie Mae and Freddie Mac is hard for
me to accept, because I really do believe in their mission, i.e.
helping a broader section of the American public to buy homes and
encouraging behavior and outcomes that are positive for a broad
section of the public.  But, if we are going to push our government
to do that, then we have to push even harder to get our government
to regulate and monitor that effort.

Perhaps these two books (McLean's and Mortgenson's) should be taken
as evidence for and lessons in the claim that there is no free
lunch.  There are always costs.  And, if we forget this, we'll soon
have another disaster.

One of the messages that I take away from this book and the others
mentioned above is that, as much as I'd like to pin the blame on one
individual, as the words "all the devils" in the title suggests,
there are lots of evil doers here.  Creating a disaster of this
size, complexity, and destructiveness took the combined efforts of a
large number of greedy people.

06/13/2011

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