This site is a Work In Progress

Site Navigation

NeoBooks In Progress

Creating a NeoBook (start here)

Admin and Help

Edit on GitHub


Snip! On the Origins of the Global Financial Crisis

Severing ties to long-term outcomes ends badly.

Early in our Pandemic, compelled by a series of ideas that clicked together in my brain (the wet, onboard, organic one),and inspired the the book and film versions of The Big Short, I created three videos to explain how we got into the Global Financial Crisis of 2008-2009, which started as the Subprime Crisis, then snowballed.

Here's the tl;dr:

Okay, not the shortest tl;dr ever 😅

When people protest that The System Is Rigged, its tktk

For the longer story, you can watch my three videos here on YouTube, or click on the player below to watch them in this page:

And of course, all of this in context, in my Brain:

This is part of a series on [[The Dark Side of Rethinking Constraints]].

— Jerry Michalski

Transcript of Video 1: Preamble

Hi, my name is Jerry Michalski and this is the first of a series of short videos I call Snip!, which are really about the financial crisis that we had back in 2007, 2008, 2009.

I call this Snip! because I have this idea that we've been cutting long-term relationships and harming society over time. Snip! is really a way of talking about the metaphor we use of the "fabric" of society, where all those little interrelationships are really the threads that hold together the fabric of society. and we've been cutting them through consumerization, through a series of things. But here I want to talk about ways that we snip long-term relationships in finance, paving the way for the global financial crisis.

I want to start in a slightly less confusing place. I'm using this tool called the Brain. I did not create this software. I've been using it for 22 years. So the mind map I'm showing you, I've been curating for 22 years and the articles I'll show you here have shown up since 2007, but some of them date back to news articles, videos, other sorts of pieces back from then. This is meant to be a demonstration of something I call Open Global Mind. And if I switch over to my browser, you'll see That here is the fledgling website for Open Global Mind, which is meant to be a container to bring together people who will help us visualize and have great discourse about difficult difficult topics. so that we might make better decisions together.

Because my own conclusion, I think we've been making really, really crappy decisions for a very long time, and I've got a whole bunch of reasons why that might have happened, but that's a a whole different set of talks. Here I'm hoping to create this as a demonstration of why we might want a platform or a convening vessel called Open Global Mind.

But of course, this demo is just me with this one brain talking and I'm an amateur. So imagine this swarmed by a whole lot of people. Now as I show you this I'm going to show you some editorials. Some it's this isn't just facts and statements about what happened when, but you there might be some points in here that you actively disagree with. The point really is to make those disagreements visible, to make them useful, so that when you and I sit down and talk, you might be able to say, you know, I was with you up until this point over here. So then we can go focus on that, open it up, unpack it, investigate what I thought the evidence was for that, and go deeper into the into that particular question.

As I said, I am no banker or lawyer. I am an informed amateur with the benefit of hindsight. It is 2020 right now. We are in the middle of lockdown from the coronavirus pandemic. And I've been curating this part of my Brain for a really long time. Nevertheless, I'm sure I've missed a whole lot of things here. And I want to say right up front, because some of the strong opinions I'm going to offer are going to sound like I'm calling this a conspiracy theory. It's not.

I have a notion of cascading failures that I've been reading up on. There's a really great paper called How Complex Systems Fail by Richard Cook, who's a resilience expert. He wrote this in 1998. Here, if you want to hit pause, you can read the many different reasons why complex systems fail.

The subprime crisis was in fact a complex system failure. However, it was informed by scripts in our heads, by basically shared principles like neoliberalism and free markets and a whole series of things that managed to slice and dice and cut the long term relationships that were there before And here I'm jumping a little too far ahead. I have a little rogues' gallery, a Hall of Shame, of the people who individually contributed to the subprime crisis in different ways, but again, it wasn't one thing that drove this. Many failures created the the subprime mistake.

So with that, I'm going to go here next to the center of this idea that of the ways that we snip long-term relationships in finance. Paving the way for the global financial crisis, but I'll do that in the next video

Transcript of Video 2: Examining the Subprime Crisis (and Cascading Failure)

Let's start. There are a whole series of sub-thoughts (screen-sharing my Brain). Every node here is called a Thought, and you'll see how they're all linked to each other, and underneath this, a couple layers down are articles, videos, editorials, whatever else.

One of the Thoughts here is that we snipped the laws that kept banks from speculating, then suddenly everybody's money was in play. So for example, Foreclosure Phil, and this is some editorial on my part, Phil Gramm was known as Foreclosure Phil for reasons that will become evident through this whole story. He is in my rogues' gallery of people who individually contributed to the subprime crisis.

Foreclosure Phil basically helped break Glass-Steagall, the Antitrust Act, so that Travelers' Sandy Weill could buy Citicorp. Let me unpack that. Under Glass-Steagall, banks could not speculate with our deposits, which means Glass-Steagall separated commercial banks from investment banks and one couldn't do the other. This came out of the nineteen thirty three Banking Act.

Basically the Pecora Commission investigated why the the the crash of twenty nine happened and they said, hey, we need to separate these things out. And this is actually a good idea. And if you've been listening to Elizabeth Warren recently, she's been saying the same sort of thing, like we should bring this back.

So I say that Sandy Weil needed this to pass so that Travelers could eat Citicorp, and that's kind of what happened. Travelers, which was a large insurance company, the Travelers Company is founded in eighteen fifty three as Saint Paul Fire and Marine. It had become this giant enterprise that wanted to merge with Citigroup, but actually it wasn't so much a merger as a reverse merger. And in order for this to happen, they needed to be able to get rid of Glass-Steagall because Glass-Steagall would have prevented the merger of Citigroup and Travelers.

So there was this contingency. The transaction went ahead, except there was still this annoying bill in the way, Glass-Steagall. So they managed to pass and I'm not saying Sandy Weil did this personally, but through a whole series of legislation and a bunch of help from Phil Gramm, they passed the Financial Services Modernization Act of 1999, or GLB, the Gramm-Leach-Bliley Act. This in fact took apart the provisions that were in there from Glass-Steagall.

And here's a Wall Street Journal article from much later titled Sandy Regrets Breaking Glass. Ah, too bad. It's one of the causes of the global financial crisis.

So if I go back to my nexus of reasons, we snip the laws that kept banks from speculating with everybody's money. Forcing everybody to invest in a particular security makes that pool of money really, really huge. This is one of the later insights.

It used to be that your bank deposits were pretty safe. They had to be invested conservatively. They couldn't be invested in all these high-risk instruments. Getting rid of Glass-Steagall snipped that particular kind of responsibility over time. I have to say that a lot of people talk about volatility in finance, the beta factor.

Canny investors need volatility. Canny investors hate a predictable stock that just goes up slowly, slowly, slowly, and always does exactly what it's promising to do. No, they want a high beta. They want a lot of volatility in the markets, because if they have some control over that volatility they can in fact make a lot of money. Making everybody invest in a particular security created a gigantic pool of money around these derivatives.

Another way that that happened is that the investment ratings houses — Moody's, Fitch, and Standard and Poor's — were basically giving all these derivatives Triple-A ratings. AAA is the highest rating they can possibly give a security.

I kind of "got this" when I read the article, It's the Economy, Dummkopf! by Michael Lewis, the same fellow who wrote The Big Short. Here's The Big Short, the book, Inside the Doomsday Machine (showing it in my Brain). He published this in 2010. And here's the film The Big Short, which has in it Brad Pitt, Christian Bale, Ryan Gosling, and Steve Carell, whom I normally can't stand who was just brilliant in this particular movie.

So Michael Lewis writes this article, It's the Economy, Dummkopf! in Vanity Fair. He goes to this little German retirement fund investment bank called IKB Deutsche Industriebank. It turns out that they were, you know, buying these things up. They were gobbling everything up.

I was stunned to discover that they went under because they had been buying CDOs, CDSs, and all of the derivatives that people had been conjuring up during this entire incident. It suddenly dawned on me: At at the end of this article there's a quote from one of the bankers at IKB, who says, We were doing all the math and all that, and we thought we were okay, but these instruments were all rated triple A, which means no risk, right?

We severed the logic of risk and so the connection between risk because all these ratings houses were transaction mills. Basically, they never said no, because then the next guy would get the business and they'd make the fees and they were being paid by the banks per transaction for certifying that these derivatives were in fact triple A.

At the beginning, they were probably mostly triple A, because at the beginning these derivatives were pretty reasonable. But over time, one of the things that happened is that John Paulson — J. P. Paulson — another person who is very individually involved in all of this, he convinced Goldman and Deutsche Bank to go fill CDOs with junk mortgages.

Then he went out and bought CDSs, which I haven't explained yet, as insurance against these CDOs that he now knew were going to fail because most of the mortgages at the time had balloon payments that would come due kind of around the same time, sometime later. These weren't obviously mortgages that were going to fail up front, but everybody in the system thought they were going to flip their houses and make a lot of money going forward.

So all of a sudden we start getting all these horrible loans in the system all over the place. And these instruments, these derivatives, these mortgage-backed securities... which goes back to Lew Ranieri, who invents the mortgage-backed security at Solomon. He's another person who individually contributed this. It's a couple layers out.

Michael Lewis wrote the book Liar's Poker about his time, in that same environment. Lew Ranieri basically helps invent the mortgage-backed security, which for a while is probably an okay thing because it allows risk to be spread across pools of mortgages. Actually, it allows very large institutions with a whole lot of money in hand to buy clusters of mortgages all at once rather than having to go create transactions to buy them all. So nice that you can do that. Partly, this series of videos is trying to explain the complexities that come out of that.

These securities just got ever harder to understand and they kept coming out with them. The ratings agencies couldn't rate them quickly enough, they couldn't do the analysis. Everybody was just kind of jamming, because returns were high and doubters were getting slammed.

In fact, if you go back and read The Big Short, you'll see that the six or seven people who figured out that this system was broken and was about to implode hated the whole experience. There was probably a thrill of discovery and the thrill of pursuit and trying to figure out how it happened, but not a one of them wanted to repeat this episode ever again in their lives. They were hated by everybody in their circles. All of their peers, all of their clients were calling to demand their money back because they were betting against a market that was rising and rising and rising like crazy

In the meantime, we snipped away our ability to see what was going on. Derivatives are not standardized or recorded. In fact, there was an attempt in 1998 for the Commodity Futures Trading Commission to get oversight of derivatives. Brooksley Born actually went and tried to get control, but Larry Summers, Robert Rubin, and Alan Greenspan all blocked Born from regulating derivatives.

That's another part of our snipping away our ability to see what was going on. We also snipped the financial system's brake lines. Brakes are the ability to stop what's going on.

For example, a lot of executives were doing the revolving door: They were basically going in and out. They'd go to some one of these big banks and then they'd become regulators and change the regulations, severing more of the of the brakes in the system.

A lot of these companies became transaction mills. They were being paid regardless what the outcome would be, long run, of the mortgage. They were happy because they made money and just jumped off. They were they were paid, they they could go home and regardless what happened later, they had no reason to worry.

Another big puddle here is that we snip the moral reasons to raise red flags and intervene. Many different ways here.

Antitrust got completely changed. Robert Bork, of the famous Bork hearings — who didn't get confirmed (to the Supreme Court) because of Anita Hill — wrote a book in 1978 called The Antitrust Paradox, in which he basically said that, you know, monopolies are just fine as long as they deliver everyday low prices. Anything else they can do. He was arguing that most antitrust is antiquated and unnecessary. The Reaganites basically went with this and started weakening antitrust. The Clintonites helped.

One of my deductions here is that Bill Clinton was a really good Republican president. He, along with other Progressives all around the world, bought the Neoliberal agenda and bought the need to weaken antitrust, all those kinds of things.

So we end up with people trying to put the brakes on and that not actually working. We we couldn't see what was happening, we were kind of blind to the events, because derivatives were not publicly listed in any way, they were not registered securities.

In the middle of all this, something I should have shown you a little earlier: Lenders start approving no-doc, stated income, also known as "liar's loans" and "ninja loans." A NINJA loan is No Income, No Job, no Assets.

I remember the day I heard about ninja loans and I'm like, wait, that sounds like a recipe for disaster. That sounds absolutely horrible.

In the meantime, politicians and regulators were busy selling the Ownership Society. They were busy saying everybody gets to own their own home. This is part of the American Dream.

Here are elements of the American dream: Anybody can make it. Rags-to-riches stories, successful humble origins. This is a land of unlimited opportunity. Progress is our measure of economic growth. Everybody should own their own home. Everybody should go to college. We are the melting pot. A detached single-family home is the ideal. So go buy your home, right?

This was all part of the narrative that everybody was pumping so that we could, I guess, become prosperous.

Along the way, we also snipped bankers' and investors' responsibility for long-term outcomes in a whole bunch of different ways.

First of all, collateralizing mortgages disconnected the lenders from the borrowers. In fact, you now had mortgage originators, basically separate companies that would create the mortgage and then instantaneously sell it off. So they were getting paid for originating a mortgage. They're very happy. They just ignored a lot of the risks afterward, especially once they were given permission to not worry so much about tracking down whether the income the person had declared on the application actually was real.

Another thing that comes out from Michael Lewis's investigations is that the major investment banks stopped being partnerships, not all in the same way. The one that he talks about, he has an interview where he sits down with John Gutfreund from Solomon Brothers (Gutfreund afterward told him, your interview destroyed my career and made your career). Gutfreund basically took Solomon public and other investment banks kind of had to follow.

Shearson buys Lehman and you get Shearson-Lehman in 1984. Goldman goes public in 1999. Suddenly, the investment banks which traditionally had been all about the bankers' reputation and about their assets on the line, holding these these assets and that's how they actually made money, to suddenly these were public corporations with completely different ideas about their responsibilities and their role in transactions.

That was a problem, because they no longer had any any real skin in the game long term, other than their longer-term reputation as institutions, but they were gonna do okay in the long run anyway, as you'll see.

Then a really big one here is that everybody started realizing that too big to fail really was too big to fail. I discovered something called the government put. To know what a put is, you have to understand a put option, which means I can I can buy an option that allows me to force you to buy my stock down the road. That's called a put.

The government put says, "We're going to do something so big that if you let us go under, the whole economy goes under. So you can't let us go under." This is basically an enforced obligation to bail us out, so these financial institutions got too big to be allowed to fail. So too big to fail was actually a very literal thing.

Here's a piece from an article called Corporate Socialism: The Government's Bailing Out Investors and Managers, Not You: "They have no honest risk mitigation strategy other than a trained, naive reliance on bailouts, or what's called in the industry, the government put."

Then in the background are these incredible over-the-top executive comp packages where not just in banking, but everywhere, US executive compensation has gone completely overboard, and is contributing heavily to income inequality in the United States. It's known as C-Suite Capitalism. I've got a whole bunch of information on that.

What it meant was that senior executives were busy trying to maximize their short-term comp packages because as we see from trends, tenure for senior executives in most corporations in the US keeps getting shorter and shorter and shorter. When you sign, you get yourself a nice golden parachute, and then you try to maximize that in the near term.

All of this was about rampant short-termism. Everything I've described is I think pretty crappy. I mean, we're sort of running blind. Everybody's been forced to play on this merry-go-round, and the first few who jumped off, like Goldman, did pretty well in the end.

I'll have a final video about the lessons learned from what what happened and what we might have done or what we could still probably do.

But I haven't talked about CDSs or credit default swaps, which are basically insurance you can buy on somebody else's CDOs. AIG and other companies, but mostly AIG, sold insurance against assets, and you didn't have to hold the asset to bet against it. If you've watched the movie The Big Short, when they're in the casino and everybody's betting on everybody's betting on everybody's betting on everybody else's instruments. That's what happens. So the pile of money that's in these things gets gigantic.

My question is: I'm sorry, how did any risk officer ever sign off on CDSs? How was this permitted? How is this not illegal? How isn't this crazy? And the guy who was on deck at the time, the chief risk officer at AIG, was Bob Lewis. How is he not in jail? How did he walk out on this whole thing? These are questions that have to come up once you start kind of looking at this.

AIG Financial Products is the group that insured CDSs and basically brought AIG down. There are a few more twists and turns to this story, but I think I've I've taken you through this this territory enough and I will put a link to this spot in my Brain in the comments below so you can jump in in here and browse around all you want.

I am interested in all your comments. I'm sure I got a lot of things wrong. There are a bunch of other theories for what caused uh the entire debacle, including that Fannie Mae and Freddie Mack were pushing really hard. I don't buy that theory and I've got some logics in here for why I don't buy that theory.

Remember that long ago, George Bailey from It's a Wonderful Life, played by Jimmy Stewart, that lenders used to know their clients personally and banks used to hold the loans to maturity. That was typically what happened. That now looks like a quaint and antiquated little world.

We've come very, very far from that world. And I don't know that we've left that world to our benefit. I think that if we re-established some of the linkages, some of those responsibilities over time that existed, we might actually be able to heal some of the problems in our financial system that persist to this day. I'll get into those problems in the next video.

Transcript of Video 3: Lessons from the Subprime Crisis (plus what we might do)

Now for the home stretch. What lessons might we have learned from the global financial crisis? Again, this is just my perspective. I'm an informed amateur. I have the benefit of hindsight, but what might we have learned?

Several things. First, none of the Snip!s I've talked about got mended afterward. Pretty much all the problems I talked about got worse. In fact, Wall Street funds have been snapping up foreclosed properties on the cheap: the Blackstone Group and a bunch of others. Here's an article from the New York Times, A $60 Billion Housing Grab by Wall Street. Here's another article.

Basically, a few people benefited from the foreclosures. Again, canny investors want volatility. So that happened.

The global financial crisis led to very few structural changes The too-big-to-fail banks in fact got even bigger, because they bought the failed banks. Washington Mutual got sold to Chase, JP Morgan bought Bear at seven percent of its market value, three dollars a share. Now we have four US mega banks after 2008, and a couple years later Wells Fargo got into a whole bunch of hot water because it was trying to inflate its earnings by pushing accounts on people. This did not really solve any kinds of problem here, but other structural changes that didn't happen.

I really don't understand why none of the so-called banksters did the perp walk. In Iceland, they let the banks fail and save the citizens, and a bunch of people went to jail. Ireland did the opposite: Ireland saved the banks and saddled citizens with a whole bunch of debt. I don't understand how in the US we didn't do anything better.

One of my beliefs here is that um Barack Obama, when he took office, had to make two Faustian bargains. A Faustian bargain is basically a deal with the Devil.

Obama knew that two things couldn't happen during his presidency. One is that there couldn't be any more major attacks on America, so he doubled down on W's privacy-invasion programs

The other is, he knew that the economy had to go up, and he also knew that nobody across the aisle wanted him to succeed or was going to be helpful in any way whatsoever. So he handed the economy back to the people who broke the system and said, here, you fix it. I know you're gonna get wealthy doing it. And he was right, because we're just now at the end of the longest bull market in US history. He knew that they that it would keep going up. So that's disappointing.

Derivatives still plague the financial system, where they're not as visible, because we've sort of seen this.

The ratings agencies are still alive. How is that even possible that that Fitch, Moody's, and Standard Poor's exist in their same way? When when Enron went under, you all remember the Enron fiasco in 2002. Their accounting firm was Andersen. There is no more Andersen, because their 55,000 people went under when Enron failed. The accounting firm that had signed off on their books also went under. Awesome. There appears to be no good legal recourse for this in this kind of situation. So we did what we did.

Generally, when these things happen, we protect the wealthy and hurt the vulnerable. A general rule of thumb might be that capitalism privatizes gains and socializes the losses. It doesn't pay to not have a lot of power in these sorts of situations.

Because so little changed after the global financial crisis, people became more and more convinced that the system is rigged. Gotta say, from you watching me do this, you probably know I think they're really right. Bernie and Trump were the only people saying that during the last American electoral cycle. Couple that with austerity measures that came in after the global financial crisis precipitated all these economies to go South, And all of a sudden we start seeing populism and authoritarianism come in after the whole crisis.

There's a contributing factor here that uh led to uh I think Trump's election. Finally (and I'm again no banker or anything like that), what might we have done after the global financial crisis? Well, Elizabeth Warren, John McCain and others were trying to reinstate Glass-Steagall in 2013, and failed to do that. That would have been really useful.

We might require all derivatives to be registered, visible securities, so that we could see what's going on and see where the toxic assets are.

We might have shut down the ratings houses and tried to reinvent investment ratings in some credible way.

There's probably other things, I'd love to hear what you would do, what you would add to this list. But there's plenty of things we might have done, none of which happened, including sending some of the people who caused this thing to spend a little time behind bars, thinking about what they did, so that they don't wind up being folk heroes who made off like bandits.

Those are the lessons from Snip! and Finance. These are all ways we Snip!ed long-term relationships in finance, paving the way for the global financial crisis, which is my first big Snip! essay.

I actually think that those interdependencies are the very fabric of society. The idea that we're responsible for things, whether it's my retirement account or my mortgage or whether it's the land that we sit on and the aquifer under it and the clean air above it. Those ideas are the things that make up the fabric of society. And society is actually really important.

We're busy at this point weaving a whole new fabric, which is another set of videos that I'll do at some other point later on. But for now, thank you very much for listening. I would love to hear your comments. Please add them below or tweet at me or whatever else. And happy hunting.

This article is cross-posted on Substack here, Medium here and LinkedIn here. It's also here in my Brain.

Pages that link to this page