Tuesday, November 18, 2008

What Happened

Thank you for the birthday wishes.

My understanding is that subprime mortgages were only the largest and most concentrated asset class to go down the toilet. The same market assumptions that made mortgage lenders relax and ultimately drop their loan qualification standards for mortgage borrowers, applied to other lenders and borrowers. The most critical class of lending being short and long term lending to corporations, called 'commercial paper'.

The market would always expand, the price of the thing being sold would always go up, debts could always be refinanced, so why worry about the borrowers actual creditworthiness? The studied pretending away of actual creditworthiness went so far as to take the form of 'no documents' loans where, in return for letting you lie to them about your ability to repay they charged an additional quarter of a percent interest. Lying was formalized and priced. I am writing this in a house financed in just that way and writing this on a computer paid for with that lied-for money.

One heard during the discussion of the bailout that it wouldn't do any good because the corporations getting the money weren't going to lend it to anyone -- because no one's balance sheet was to be believed.

That is not a problem of misleading high school dropouts into thinking that Felipe's job at the carwash would still be enough to pay for the house after the mortgage reset. That is a systemic corruption of business standards.

It represents a conflict between the classes represented by the Republican party. The Eastern banking establishment had traditionally stood for old money and fiscal probity -- banking, insurance, securities -- three piece suits, gold watch chains, vested interests, old families, old money.

The Western conservatives represented people who made money in oil and in building whole cities in Arizona deserts in a year and don't look too closely at the financing or the sewage disposal. Speculators.

Regulation was a minor matter to Eastern establishment bankers. It meant that the government made sure that the correct standards were being maintained and outsiders were being kept out. An early example was junk bonds. They were called junk because by traditional standards of fiscal problity they were beneath consideration. Reputable brokers would not put their clients in them. Others would. And the ones who would (and their clients) made a lot of money on them.

For Western businessmen the loan to the wildcatter became OK after the fact when they hit oil and everybody made money. When neighborhoods, which didn't have streets or utilities let alone houses, got sold, problems with the financing would take care of themselves. To them regulation was an obstacle to be overcome. They were the outsiders the government rules were supposed to keep out.

The triumph of Ronald Reagan and deregulation mark the definitive turning of the Republican party toward the West. It also began the suffusion of Western attitudes about fiscal probity and business methods into Eastern banking, insurance, and securities.

To me there are two large symbols of the transition. One is the migration of the Bush family from Kennebunkport to Crawford. The other is the special emphasis on the rescue of AIG.

AIG sold business insurance. The assumption had been that one didn't need government regulation because there were market mechanisms that would take care of it. The specifics of the assumption was that bad practices would create risk and that risk would be carefully examined by the insurers. The insurers would either refuse to assume it or they would socialize it by raising premiums on the guilty party and that would put the bad practices on a risk-reward spectrum like everything else in the market. And the key company, at the end of all the insuring and re-insuring, was AIG.

My assumption is that the underwriting department at AIG came under greater and greater pressure from management not to look too closely at the balance sheets their clients were offering. AIG management, like every other management in the country, in the world, had to chose between controlling risk and turning away customers. Since the market would always expand and the price of the thing being sold would always go up, and everything could be refinanced, why turn away business?

The corruption of AIG and some of the Big 8 accounting firms was the abdication of business' responsibility to regulate itself. What we now know was also happening was the loss of the market's ability to regulate itself. Without the government regulating business that left..... nothing. The abyss.


  1. Yes...Happy Birthday Jackson...62 is such a good age to be, especially if you were born in 1946. Lisa and I will drink a toast to you tonight. I'll even break out the good scotch. I may even get hammered in your honor.

  2. Nick Danger5:38 PM

    Happy belated (?) birthday. Unlike AIG and the market, you no doubt still have the ability to regulate yourself on your special day.