Tag: financial crisis

COVID-19: Who Bears the Losses?

By James Kwak

Our business and household sectors are losing lots of money every day, and will continue to lose money for the foreseeable future. People no longer spend money at restaurants. Restaurant owners can no longer pay the rent or pay back their business loans. Restaurants fire their workers, who lose their paychecks and can no longer pay their rent, or their credit card bills, or their student debt. In an economic crisis like this, the overriding question is: who ultimately bears the losses?

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Photo by skeeze from Pixabay

We’ve been through this before. In the 2008 financial crisis, we applied the usual rules of capitalism—unless you were a large bank. Businesses failed and their owners (including shareholders, for corporations) were wiped out. Renters were evicted. Homeowners lost their houses. Investment funds that had bought mortgage-backed securities and collateralized debt obligations lost their money. Workers lost their pensions. Small banks were shut down by the FDIC. Big banks, however, got unlimited cheap credit from the Federal Reserve to stay afloat, thanks the the people we all know.

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And the Award for Best Financial Crisis Book …

… goes to Chain of Title, by David Dayen (with apologies to Jennifer Taub, Alyssa Katz, Michael Lewis, and many others, including my co-author, Simon Johnson).

Chain of Title isn’t primarily about the grand narrative of the financial crisis: subprime lending, mortgage-backed securities, collateralized debt obligations, credit default swaps, synthetic CDOs, the collapse of the global financial system in 2008, and the frenzied bailout that followed. Instead, it’s about foreclosure fraud: how mortgage servicers, banks, and the law firms they hired systematically broke the law to force people out of their homes. At the same time, it’s about securitization fraud: the fact that an untold number of securitizations were not properly executed, meaning that they violated the terms of their underlying agreements, meaning that their investors should have been able to force rescission of the entire deal.

The substance of the argument has been well known for years, so I’ll try to pack it into one sentence: The banks creating mortgage-backed securities failed to properly transfer notes (the documents proving a borrower’s obligation) to the trusts that issued the MBS, so not only was the securitization itself faulty, but the trust did not have legal standing to foreclose on homeowners—so the banks paid third-party companies to forge the required paper trail, and lawyers knowingly submitted fraudulent evidence to courts, who usually accepted it.

This has been common knowledge on the Internet since 2009 or 2010. But Dayen does what good writers do: he tells the story of a few real human beings figuring out the workings of this vast fraudulent system on their own, fighting against it … and ultimately, for the most part, losing. The book makes you feel the anger, disbelief, hope, and disappointment of those days over again. Even though I knew how the story ended—in a whimper of liability-eliminating settlements and self-congratulatory back-patting by politicians—it was still painful to read. Continue reading “And the Award for Best Financial Crisis Book …” →

The Value of Connections in 2008

By James Kwak

These days, some papers get more attention when they are in draft form than when they are published, in part because of the length of the review and publication cycle. Recall the Romer and Romer paper on the impact of tax changes, or the Philippon and Reshef paper on the financial sector, both of which made huge splashes years before they were finally published. My best-known paper also falls in that category. “The Value of Connections in Turbulent Times” began knocking around the Internet in 2013, and is only now being published by the Journal of Financial Economics—nine years after we began working on it, and at a time when the world seems to have completely moved on from its subject. (Note: that link will allow you to download the published version of the paper for free, but only until September 4, 2016. Thanks Elsevier, I guess.)

The paper, as you may have heard years back, shows that financial institutions with connections to Tim Geithner experienced abnormal positive market returns when his nomination to be treasury secretary was leaked and then announced in November 2008, and suffered abnormal negative returns when the news of his tax issues threatened to undermine his confirmation in January 2009. The interesting thing is that this is not ordinarily supposed to happen in the United States. Having connections to important government officials is not supposed to provide financial benefits to a company, and therefore nominations of those officials do not usually produce stock market bumps. The evidence is not completely one-sided, but in one representative example, researchers found that companies with connections to Dick Cheney did not experience abnormal returns in response to unexpected news about Cheney. This is in contrast to developing countries, where numerous studies have found that connections to important politicians are reflected in stock market valuations.

But it’s less clear why the markets (which, remember, are made up of at least some supposedly rational investors) thought that having connections to Geithner would pay off. Our main argument—after testing and discarding a bunch of other possibilities, like the effect was due to Citigroup, or to very large banks—is that, in the confusion of the time, it seemed likely that the treasury secretary would be given a large amount of discretion; and the more discretion that is available to an official, the more valuable it is simply to be able to get a meeting with him, or get him to return your phone call. You don’t have to think that Tim Geithner would consciously help out someone he served on a board with, or someone he had spent time with as president of the New York Fed; you just have to think that people are influenced by the people they spend time with, and so access matters.

This isn’t how we think our government is supposed to operate, but of course it’s how we all realize that it does operate. That’s one reason why individuals and corporations are willing to donate huge amounts of money to super PACs—so they can get access when they need it. What was unusual about the financial crisis was that, with the financial system and economy apparently falling apart, the value of those connections was much higher than usual. It also showed how, when push came to shove, the United States’ political institutions behaved more like those of a developing country than we would care to believe—the central point of Simon’s famous Atlantic article.

 

Larry Summers Should Keep His Mouth Shut

By James Kwak

Larry Summers is well on his way to rehabilitating his public image as a brilliant intellectual, moving on from his checkered record as president of Harvard University and as President Obama’s chief economic adviser during the first years of the administration. Unfortunately, he can’t resist taking on his critics—and he can’t do it without letting his debating instincts take over.

I was reading his review of House of Debt by Mian and Sufi. Everything seemed reasonable until I got to this passage justifying the steps taken to bail out the financial system:

“The government got back substantially more money than it invested. All of the senior executives who created these big messes were out of their jobs within a year. And stockholders lost 90 per cent or more of their investments in all the institutions that required special treatment by the government.”

I have no doubt that every word in this passage is true in some meaninglessly narrow sense or other. But on the whole it is simply false.

Continue reading “Larry Summers Should Keep His Mouth Shut” →

The “Chicken(expletive) Club”

By James Kwak

Update: See notes in bold below.

The only “Wall Street” “executive” to go to jail for the financial crisis was Kareem Serageldin, the head of a trading desk at Credit Suisse, according to Jesse Eisinger in a recent article. Serageldin pleaded guilty to—get this—holding mortgage-backed securities at artificially high marks in order to minimize reported losses on his trading portfolio.

Now if that’s a crime, there are a lot of other people who are guilty of it. In fact, a major premise of the federal government’s crisis response strategy was exactly that: allowing banks to keep assets at inflated marks in order to pretend they were solvent when they weren’t. FASB changed its rules in April 2009 in order to make it easier for banks to inflate their marks. And the Obama administration’s “homeowner relief program” was designed to allow banks to delay realizing losses on their mortgage loans by dragging out—but generally not preventing—foreclosures. (Remember “foam the runway”?)

Combine Serageldin’s story with the story of the vigorous prosecution of Abacus Federal Savings Bank—a little Chinatown bank that, if anything, was probably allowing its borrowers to underreport their income on loan applications—which Matt Taibbi tells in the first chapter of his latest book, and the picture you get isn’t pretty. It’s a picture of the immense resources of the American criminal justice system being deployed against bit players, with no consequences for the people responsible for the financial crisis. The judge in Serageldin’s case even called his conduct “a small piece of an overall evil climate within the bank and with many other banks.”

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The Free Market’s Weak Hand

By James Kwak

“Except where market discipline is undermined by moral hazard, owing, for example, to federal guarantees of private debt, private regulation generally is far better at constraining excessive risk-taking than is government regulation.”

That was Alan Greenspan back in 2003. This is little different from another of his famous maxims, that anti-fraud regulation was unnecessary because the market would not tolerate fraudsters. It is also a key premise of the blame-the-government crowd (Wallison, Pinto, and most of the current Republican Party), which claims that the financial crisis was caused by excessive government intervention in financial markets.

Market discipline clearly failed in the lead-up to the financial crisis. This picture, for example, shows the yield on Citigroup’s subordinate debt, which is supposed to be a channel for market discipline. (The theory is that subordinated debt investors, who suffer losses relatively early, will be especially anxious to monitor their investments.) Note that yields barely budged before 2008—despite the numerous red flags that were clearly visible in 2007 (and the other red flags that were visible in 2006, like the peaking of the housing market).

 

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The Prosecution That Isn’t Happening

By James Kwak

People keep asking why no senior executive has gone to jail for the misdeeds that produced the financial crisis—and cost the United States more than $6 trillion, or $50,000 per household, in lost economic output. The usual answers are that no one did anything wrong (oh, come on) or, more realistically, that it’s too hard to convict individuals in complex financial fraud cases.

At the same time, however, the U.S. Attorney’s office for the Southern District of New York—the district that includes Wall Street—has amassed a 79-0 record in insider trading cases, including yesterday’s jury verdict against Mathew Martoma, a trader at the hedge fund firm SAC Capital Advisors. In Martoma’s case, he obtained confidential information about a clinical trial for a drug being manufactured by two pharmaceutical companies and, according to the jury, convinced his boss, Steven Cohen, to unload the firm’s positions in those two stocks.

Continue reading “The Prosecution That Isn’t Happening” →

The Wall Street Takeover, Part 2

By James Kwak

Five years later, and things seem marginally better in some areas (the CFPB exists), significantly worse in others (LIBOR, money laundering, London Whale, etc.). There has been some debate recently about whether we have a safer financial system today than before Lehman collapsed. But the fundamental issue, as Simon and I discussed in 13 Bankers, is whether our political system will put the interests of society at large ahead of the interests of large financial institutions. On that score, there is little to be encouraged about.

In 2002, Art Wilmarth wrote a mammoth (262 pages) article titled “The Transformation of the U.S. Financial Services Industry, 1975–2000.” In that article, he identified many of the key trends in the financial sector—consolidation, deregulation, breakdown of Glass-Steagall, complex products, increased risk-taking—that would not only produce a financial crisis but make it so destabilizing for the economy later in the decade. Now he has written a shorter (164 pages) article, “Turning a Blind Eye: Why Washington Keeps Giving into Wall Street,” on the key question: why our government doesn’t do anything about it, even after the financial crisis.

Continue reading “The Wall Street Takeover, Part 2” →

Non-Lessons of the Financial Crisis

By James Kwak

As the fifth anniversary of the Lehman bankruptcy approaches, the Internet is filling up with reflections on the financial crisis and the ensuing years. My main feeling, as expressed in my latest Atlantic column, is amazement at how little we seem to have learned. Looking back, the period in late 2008 and early 2009, when it was obvious that the financial sector would have to change in important, structural ways, now seems like a naïve, youthful delusion. Sure, there are some new rules around the margins, but for the most part little has changed—not just in the financial sector itself, but more importantly in the political and ideological landscape that shapes regulatory policy.

Of course, this isn’t simply the product of collective amnesia. It’s the result of the fact that ideas are shaped by money and political power. And that’s where little has changed.

How The Banks Stole Medicare

By Simon Johnson

The world’s largest banks have been accused of many things in recent years, including taking excessive risk in the run-up to 2008, doing great damage to the American economy by blowing themselves up and then working hard to resist any sensible notions of financial reform.

All of this is true, but it misses what is likely to be the most profound negative impact of the banks’ behavior on most Americans. The banks’ actions led directly to an increase in government debt, which in turn has made the reduction of that debt by “cutting runaway spending” a centerpiece of the Republican presidential campaign to date.

As a result of this pressure, Medicare now stands on the brink of being eliminated as a viable form of social insurance. Yet the executives who lead these banks – and the politicians with whom they work closely – will not be held accountable this election season. Continue reading “How The Banks Stole Medicare” →

What Did the SEC Really Do in 2004?

By James Kwak

Andrew Lo’s review of twenty-one financial crisis books has been getting a fair amount of attention, including a recent mention in The Economist. Simply reading twenty-one books about the financial crisis is a demonstration of stamina that exceeds mine. I should also say at this point that I have no arguments with Lo’s description of 13 Bankers.

Lo’s main point, which he makes near the end of his article, is that it is important to get the facts straight. Too often people accept and repeat other people’s assertions—especially when they are published in reputable sources, and especially especially when those assertions back up their preexisting beliefs. This is a sentiment with which I could not agree more. One of the things I was struck by when writing 13 Bankers was learning that nonfiction books are not routinely fact-checked (Simon and I hire and pay for fact-checkers ourselves). As technology and the Internet produce a vast increase in the amount of writing on any particular subject, the base of actual facts on which all that writing rests remains the same (or even diminishes, as newspapers cut back on their staffs of journalists).

I’m not entirely convinced by Lo’s example, however. He focuses on a 2004 rule change by the SEC. According to Lo, in 2008, Lee Pickard claimed that “a rule change by the SEC in 2004 allowed broker-dealers to greatly increase their leverage, contributing to the financial crisis” (p. 33). That is Lo’s summary, not Pickard’s original. This claim was picked up by other outlets, notably The New York Times, and combined with the observation that investment bank leverage ratios increased from 2004 to 2007, leading to the belief that the SEC’s rule change was a crucial factor behind the fragility of the financial system and hence the crisis.

Continue reading “What Did the SEC Really Do in 2004?” →

How Times Change

By James Kwak

For those waiting, the paperback edition of 13 Bankers went on sale on Tuesday to little fanfare. That’s not surprising; all of the crisis books have been dribbling out in paperback, about 8-10 months after the hardcover editions, to little fanfare. It’s a commentary on how quickly times have changed, and also on the fickle nature of the publishing market. While there is still a lot of residual anger and bitterness over the financial crisis — specifically, over the fact that the big banks played a central role in triggering the crisis, then got massive amounts of bailout money, and now have returned to “health” more quickly than the economy as a whole or the typical household — most people seem resigned to a continuation of the pre-crisis status quo, and what energy remains has perversely gone into railing against the national debt.

The whole story also highlights the importance of timing in publishing. Looking back, we couldn’t have gotten any luckier, with the book going on sale during the Senate debate over financial reform and just two weeks before the SEC sued Goldman, which also happened the day that our Bill Moyers appearance aired, which drove our Amazon ranking up to #6. Today we’d be lucky to crack #600.

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We Are All “Yappers Who Don’t Know Anything”

By James Kwak

According to ex-Lehman executives interviewed by Max Abelson (hat tip Felix Salmon). To summarize, they say that using borderline-legal transactions to massage your balance sheet at the end of a quarter is completely normal, everyone does it, $50 billion is no big deal anyway, only “nonprofessionals” would even notice, and the only reason the bankruptcy examiner made so much noise about it was to justify the fee for his work. (Abelson does point out that, according to internal Lehman emails cited in the report, there were Lehman executives at the time who were worried about what they were doing and did not think it was standard practice.)

Continue reading “We Are All “Yappers Who Don’t Know Anything”” →