"A Great New Book" —Larry Kudlow, CNBCGet it on AmazonExplore the Book
“You know how when you walk into a post office you realize there is such a difference between a government employee and other people,” said Vinny. “The ratings agency people were all like government employees.”
The Big Short: Inside the Doomsday Machine (movie tie-in) (Movie Tie-in Editions) (p. 156). W. W. Norton & Company. Kindle Edition.
I wanted to blame the government.
Like millions of American conservatives, I had developed a powerful narrative of the way the world works.
- Big banks got big because they did things right.
- Investments banks made money because they hired top MBAs and lawyers and accountants (sometimes all three in one person) who worked their asses off, took intelligent risks, and kept going even after they’d earned “enough.”
- Big corporation got big by producing great products that people loved because the products made real lives better.
- The American economy grew because of ingenuity and hard work.
- And when the system didn’t work right, when big inequalities emerged, it was because of government interference. Postal workers shouldn’t interfere with Masters of the Universe, to borrow Tom Wolfe’s line.
I’ve believed and recited that narrative (in excruciating detail with reams of supporting documentation) since I was a high school freshman.
The Big Short opened in theatres today. The movie explains the poison that’s enveloped the kernel of truth. Despite many laughs, you’ll leave the theatre mad as hell.
That narrative, which I’ll call The American Design, is so powerful because it’s true.
More accurately, the narrative contains truth. There’s a kernel of truth in The American Design. And that kernel is firm enough and large enough and well-known enough that whenever a socialist challenges the narrative, we on the right slap down their heresies by hurling the kernel back at the heretic like a pea spat through a straw.
But the kernel of truth is like a healthy seed surrounded by rotting fruit. The flesh of the fruit is poisonous. And we eat from it every damn day.
The Bursting Bubble
In 2007, I was taking macro economics. My instructor was an executive at a small regional bank. (Maybe a community bank.) He went off script a few times to warn us that there was a housing bubble that would soon burst and take the whole financial system with it.
That banker worked for a bank that didn’t sell its mortgages and didn’t offer fraudulent no-doc subprime loans with teaser rates to people without jobs. They offered some subprime, but only if they were willing hold the loan themselves. They wouldn’t sell a shit loan to Goldman Sachs or Bank of America or Merrill Lynch just because the big banks begged for the shittiest paper it could buy.
None of us in class really understood what he was talking about. Like 99.999% of Americans, we trusted that the big banks got big because of smart, hardworking people. We figured this night college instructor was a Midwestern buffoon who envied his New York brethren and $50 million bonuses. Human nature.
Within a year, we all knew that the night college instructor who worked at a bank with a balance sheet smaller than Goldman Sachs’s annual catering bill knew more about banks, money, and the economy than Lloyd Blankfein, Ben Bernanke, Vikram Pandit, and the faculty of Harvard Business School combined.
If our instructor explained how shitty loans became mortgage bonds which became collateralized debt obligations which balanced out credit default swaps which inspired synthetic CDOs, I didn’t understand his story well enough to remember it. It wouldn’t be on the test.
Interest-Only Express Cruisers in Party Cove
About this time, I met up with Chris, my insurance agent, for happy hour at The Country Club in Town & Country. Chris told me that something bad was about to happen.
His agency was busy as hell in early 2007, busy writing new homeowners and boat policies for long-time customers. Longtime customers with good income and enough birthdays under their belts to know better.
“They’re refinancing for a hundred and ten, hundred and twenty percent of value on interest-only loans with options to skip four payments a year,” he told me. “They’re using the refi checks and their low mortgage payments to buy express cruisers for their second homes at the lake.”
“If you’re paying only interest and skipping four payments a year, when is the loan paid off?” I asked.
These subprime borrowers were otherwise responsible, successful, educated St. Louisans, most with kids in high school or college or beyond. They had high FICO scores but not high enough to get $450,000 for a $400,000 house with a payment of $520 a month. So they went to Countrywide and Wachovia and other criminal mortgage houses, signed no-doc variable APR notes, and pumped all their newfound (borrowed) cash into $500,000 boats to cruise Party Cove.
The Wealth Effect: Your Government at Work
From the 1990s to 2007, millions of Americans fell victim to a cruel and unusual scam operated by the United States government and Wall Street. The name of the scam: The Wealth Effect.
The wealth effect is the theory that people borrow and spend more when they believe the economy will get better in the near future. So a rising stock market, a rosy jobs report, and inflating home values will all drive people to borrow and spend—just like government.
Those otherwise upstanding St. Louisans who took out subprime loans believed Jim Cramer and Ben Bernanke and Tim Geithner and Milton Friedman and Allen Greenspan and everyone else who said real estate can only go up in value “because God ain’t making anymore land,” chuckle, chuckle.
So from 1990s to 2007 (and again since 2010) CNBC and Fox Business News paraded out analysts, economists, professors, advisors, Treasury Secretaries, former Reagan advisors, and anyone else willing to look into the camera and tell the American public “The Dow will double in the next four years, and housing prices will continue their trend of ten to twenty percent annual increases.”
Some of these pundits and experts actually believed what they were saying. People are wired to believe that the future will be a linear progression of the recent past. If it’s not a documented psychological fallacy, it should be. (Howe and Strauss explained this fallacy in The Fourth Turning. But did we listen?)
Others who spoke about the unstoppable American economy were paid to lie. Or they lied because they could make more money on the lie than they could by telling the truth.
But the people in charge of the banks and the government either knew or should have known that the wealth effect was a mirage and perpetuating people’s belief in the mirage was a crime. They perpetuated the lies, anyway.
“The impact on the broader economy and the financial markets of the problems in the subprime markets seems likely to be contained,” U.S. Federal Reserve chairman Ben Bernanke was quoted as saying in the newspapers on March 7.
We all know what happened next.
- About $5 trillion of the wealth effect was wiped out from 401(k)s, retirement funds, stock portfolios, and home values
- Eight million people lost their jobs
- Six millions homes were foreclosed on
- The labor force participation rate returned to 1976 levels and continues to fall every month
- GDP growth has never been weaker following a recession
- A malaise wraps the country
Save the Rich and Powerful–From Themselves
You and I and most of the people we will see or meet or talk to between now and the day we die took a step back in standard of living because of the subprime debacle.
The people who caused the debacle only profited. As Michael Lewis writes in The Big Short:
The CEOs of every major Wall Street firm were also on the wrong end of the gamble. All of them, without exception, either ran their public corporations into bankruptcy or were saved from bankruptcy by the United States government. They all got rich, too.
I don’t spit that kernel of truth about the American Design at heretics any longer. Not because I’ve defected to their side—I have not. But while watching the movie version of The Big Short tonight I realized that the rotting flesh surrounding the kernel of truth is so rancid, so poisonous, and so large that I risk my own life putting the kernel in my mouth. I’m pretty sure it’s impossible to defend the financial system without succumbing to its lethality. Or maybe increasing that lethality.
Back to the book:
The people in a position to resolve the financial crisis were, of course, the very same people who had failed to foresee it: Treasury Secretary Henry Paulson, future Treasury Secretary Timothy Geithner, Fed Chairman Ben Bernanke, Goldman Sachs CEO Lloyd Blankfein, Morgan Stanley CEO John Mack, Citigroup CEO Vikram Pandit, and so on. A few Wall Street CEOs had been fired for their roles in the subprime mortgage catastrophe, but most remained in their jobs, and they, of all people, became important characters operating behind the closed doors, trying to figure out what to do next. With them were a handful of government officials— the same government officials who should have known a lot more about what Wall Street firms were doing, back when they were doing it. All shared a distinction: They had proven far less capable of grasping basic truths in the heart of the U.S. financial system than a one-eyed money manager with Asperger’s syndrome.
Or, for that matter, an officer at a tiny Midwest community bank who teaches night college to make ends meet.
Sliding Down the Hanlon’s Razor of Life
Hanlon’s Razor instructs us:
Never attribute to malice that which is adequately explained by stupidity.
When Ben Bernanke gave America the “all’s clear” from the subprime meltdown before the meltdown had really started, he probably wasn’t lying. He simply didn’t understand how the system worked. (Frankly, he still doesn’t have a clue how the system works. It’s both too simple and too complex.) As Lewis wrote in The Big Short:
The big Wall Street firms, seemingly so shrewd and self-interested, had somehow become the dumb money. The people who ran them did not understand their own businesses, and their regulators obviously knew even less.
Most of the Wall Streeters depicted in The Big Short didn’t become criminals until after they realized they’d been stupid all along. That was in June 2007 when for five days all the banks refused to answer phone calls from the heroes of the movie—because of a power outage or server failure or phone failure or whatever feeble lies they told them. Lewis described this period in The Big Short, which is also depicted, frustratingly, in the movie:
On Friday, June 15, Burry’s Goldman Sachs saleswoman, Veronica Grinstein, vanished. He called and e-mailed her, but she didn’t respond until late the following Monday— to tell him that she was “out for the day.” “This is a recurrent theme whenever the market moves our way,” wrote Burry. “People get sick, people are off for unspecified reasons.” On June 20, Grinstein finally returned to tell him that Goldman Sachs had experienced “systems failure.”
That was funny, Burry replied, because Morgan Stanley had said more or less the same thing. And his salesman at Bank of America claimed they’d had a “power outage.”
“I viewed these ‘systems problems’ as excuses for buying time to sort out a mess behind the scenes,” he said. The Goldman saleswoman made a weak effort to claim that, even as the index of subprime mortgage bonds collapsed, the market for insuring them hadn’t budged. But she did it from her cell phone, rather than the office line, on which the conversations would have been recorded.
I believe that in those five days the banksters committed the greatest robbery and cover-up in history, and the Bush administration and the Fed became willing accomplices. No one could admit he’d been wrong for 20 years — wrong in every way about money, banking, economics, credit, and risk. No one in Washington or New York could stomach admitting that my macro economics instructor at Fontbonne who worked at a community bank in the Midwest understood money, banking, economics, credit, and risk better than the Masters of the Universe. And all those bankers and economists and Bush appointees were willing to risk prison or riots or lynching to avoid admitting the truth.
Of course, the banksters and their government accomplices were not prosecuted or hanged by mobs: they paid themselves billions in bonuses with taxpayers’ money.
Remember the TARP bailout that Senator Roy Blunt and Representative (now Speaker of the House) Paul Ryan championed?
Once handed the money, Paulson abandoned his promised strategy and instead essentially began giving away billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs, and a few others unnaturally selected for survival.
And nothing has changed. Not a damn thing.
But it will. And this time, the Fed and the government are out of weapons. There will be no cover-up, no QE, no TARP, because this time the government itself will be insolvent.
Before the new year, see The Big Short. If it makes you mad as hell, you get it. If it doesn’t, spit out the kernel before you die.