Innovating Our Way to Financial Crisis

"Fraud, the "due diligence" on the part of the rating companies that rated the bundles of sub-prime mortgages was shoddy, far understating the risk of the investments."

This simply isn't true. Banks lie to rating agencies. The raters have no way of knowing that they're being lied to.

For instance, if Bank X tells S&P that its bond is backed by 1500 borrowers who meet criteria a, b and c, there is simply no way for S&P to check it out. They do not have access to the borrowers' financial details (and you'd raise hell if they did). So what happens when criterion x is "has regular employment", y is "has not previously defaulted more than three times on credit payments", and z is some other not too stringent condition, but many borrowers are seasonal workers, have missed many payments and are not within cooee of the other conditions? S&P makes its models depending on the data it is given. It is not a regulator or an investigative agency.

On top of this, the depth of the problems caused by the collapse of the housing bubble was unprecedented. That is down to Greenspan. He blew the bubble up. And Bush. He helped.

Thanks to all, especially Rich M for an informative discussion. I have followed Paul K for several years and his challenges to Friedmanism are perfectly calibrated to allowable fact based arguments in a 2 party system.He is brilliant and he does his homework.

My reservations concern his adherence to classical Liberal economic theory which fails to take into account the health of the planetary life support system, the ecologic balance, climate issues, sustainability. The new deal was built on cheap oil so the new new deal he longs for needs some serious rejiggering.

Kunstler predicted the economy would start to come apart this year.

To me, the most salient point of Krugman's article is his pointing out the problem with a 'free-market orthodoxy'. The 'market is always right' mentality of the republicans is such an ignorant, simplistic ideology - and totally amoral. There is no market force for doing what's right, unless it's just a coincidence. I just wish more economists would be a bit more sophisticated to see that an unregulated free market is no longer free - but is dominated by a select few (either people or corporations) that skim off the cream of the economy, reap billions and then call for a 'fair' flat tax...

I agree that, if anything, Paul Krugman is understating the gravity of the situation. I think we're rolling off a cliff. But if Krugman said that, his colleagues, even those who privately agree with him, would excoriate him for making rash, irresponsible remarks; you don't want to set off a stampede. But it's good that he's on the record as a harsh critic of the present financial situation.

The market is always wrong, but trying to correct.

It is quite likely that a few of the top money manipulators will indeed be prosecuted for some of their slick chicanery, but ultimately the person who will end up biting the bullet will be Joe Taxpayer.

A few people may be rescued by some much ballyhooed bailout, but ultimately the Fed will do their usual trick and just print more money, making the value of each existing dollar worth even less...

Some of us who actually understand economics have been screaming for a half dozen years about the direction the economy has been heading, but no one would listen.

Who will benefit in the end? The ultra-wealthy who have leveraged their credit wisely in things which do not depreciate in time of recession. Hence their future payback will be a fraction of their mortgaged assets.

Having seen what was coming, my wife and I parlayed about $100,000 in credit into nearly a half million in holdings since 2001.

Multi-billion bailouts are key to corporate survival, but I'm guessing that 'the powers' are doing everything possible to remember accurately all of the lessor amounts, is another way to administer our shock therapy.

While likely true for the big fish, we're just chum change for the recurring sea of loan sharks, usuary beyond limits.

Namaste … … … … … … … … … … … … … … … … … Mahatma Gandhi … … … … … … … … … …
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leobixby: I'd like to get back to your point of how do we take these greedy monsters into the bat cave with the rest of us?

The the consumer credit card debt thing has always puzzled me. I am currently debt free. But I sort of figure that if I see the shit about ready to hit the fan or at the tipping point, shouldn't I just run up the credit card for food and essentials and renig on repayment? I mean, they aren't going to be able to get blood out of a rock, right? And this rock will be well fed and helping my neighbors to survive.

Input please....

from the article, "........and that will mean a recession, possibly a nasty one."

Can't say it can you Paul, it's called a...? ....de? go ahead say it, d e p r e s s i o n.

It's interesting. I once purchased a book in a thrift store that contained a collection of columns written by Evans and Novak in the late sixties. Believe me, it was only out of curiosity. Had I been forced to pay one red cent more than the twenty-five cents I shelled out for it, I probably would have taken a pass.

In reading the book, I was struck dumb by the fact that - with the benefit of 20/20 historical hindsight (the book was over thirty years old when I read it) - they were dead wrong on so many issues. In point of fact, all these decades later they look like fools. Will people be saying the same thing about Paul Krugman a generation from today? Don't count on it.

And by the way, if you haven't read his new book, The Conscience of a Liberal, you really should.

Tom Degan
Goshen, NY.
www.tomdegan.blogspot.com

"...and that will mean a recession, possibly a nasty one." Hey, PK - you been in a grocery store lately? Trust the 90% who "own" less than you 1%ers - we're in a recession, baby, and we're well into nasty already.

Meanwhile, PK is once again pretending that the never-satiated epidemic of GSE (Greed Spongiform Encephalitis) is not the root cause of all of "our" problems. Too much is never enough as a mission statement; I got mine, screw you as a credo. "Financial innovations" as PK refers are only one of the consequences of GSE, not the cause. And when the GSE afflicted are in charge - well, it's like having a crack dealer running the DEA and then blaming "cocaine innovations" for the failure to stem the flow in spite of billions spent.

Of course, a few "legal innovations" would go a long way to curbing the GSE epidemic destroying this country. Here's one, for example: arresting and jailing the economic terrorists who continue to rape us standing up without suffering any pain, except for the pain of that golden parachute and super bonus thank you for an awful job done. What's up, PK - don't wanna see any of your "friends" perp walking and returning their stolen billions? Must be, since you don't even suggest the idea of punishing the evil doer money grubbers...

It just dawned on me that the real question we should be asking ourselves is how we - meaning the majority - can cause the wealthy elite to go down with us, if indeed things are headed that way. Many of us really are already totally broke or at least in debt up to our eyeballs. Really, what do we have to lose? More debt. That's what. What really bothers me is that people are so right when they say that it is indeed us that get screwed by the follies of the wealthy elite. How can we change that trend?

BeForKids:
Obviously, I was being a bit over the top. Yes, indeed it will always be the poor, the immigrants, the workers, and in general the disenfranchised who get nailed the worst. Notice, I used the proverbial quotations around the world "depression". I was merely making the point, albeit cryptically, that hard times for the banks is only depressing for the damn criminals who run them. That's what I should have said. Also, I guess I would say I am relatively young, at 36, but I grew up very hard. Poor, son of a Vietnam veteran, poor as hell. Like many of us, I had to work for every damn thing I have ever gotten, material and otherwise. I also spent an inordinant amount of time studying social movements and reactions to economic collapses and the like. One thing always rings true: when those hard times come, a more socially responsible version of capitalism, is usually put in place. The big example being what LaGuardia did in New York. The problem in this damn country is that we are constantly propagandized about the evilness of those who want to move us more in the direction of a society that looks out for the middle class, so when we finally get there, we lurch in the other direction.

I'm rambling. Anyway, point is: Socially, economically, environmentally, and politically, this country will never get its shit strait again - if indeed it ever has - until we relearn how to respect the little things in life. We need to get rid of all of our debt, and learn, as a society, to live within our means. And I don't mean that in any kind of libertarian way.

beforkids, thanks for the statistics. we may soon be watching for someone to organize us. then dennis kucinich's updated version of the works progress administration, which would pay decent wages to rebuild our national infrastructure, would look mighty good.

Depressions and recessions always screw the weakest and the people at the bottom the worst.

The rich might have to delay purchasing a yacht. But more often, they have the money to profit from a recession. For instance, if you have money you can be buying properties cheap as the housing market goes down. Then when it recovers you make a killing. If you are poor and are being foreclosed on your one investment which was your home, you are just screwed.

For the second time in 3 years, we have a case that points directly to the critical flaw in Republican philosophy.

The first was Katrina. Where the wealthy could flee in their SUVs, and the rest were left painting "Please Help" on the roofs they were sitting on. That plainly pointed to the flaw in the everyone is on their own style of government.

This is the second. The Republicans preach that all government and regulation is bad. Even while trying to figure out how to get out of this mess, they want to roll back the Sarbanes-Oxley reforms that were the fix to the last mess.

What this clearly points out is that in a financial market there is a role for regulators. A strong system of regulation would have stepped in and stopped this from the beginning. A strong set of regulators would have looked at these junk bonds based on mortgage loans and said that they weren't transparent enough and that no one would know where the bad loans or risk were ... therefore strong regulators of the financial markets would never have allowed this in the first place.

So, the door is once again wide open to attack the very core of the Republican philosophy. The real criminals are the people in Congress who passed the laws relaxing the Depression era controls that prevented just these abuses. Citigroupr wouldn't exist accept for the repeal of Glass-Steagal a few years ago. And the real criminals are the people in the Fed Reserve, the SEC and the Treasury Depts who failed in their responsibilities to be proper regulators.

Interesting observation, McPete. And to the point. I think just about the whole country would be repelled if they knew the truth about the Bush family, and especially if they knew what the Bushes think about the rest of us.

since1492, If Paul Krugman had the balls of gore Vidal, we wouldn't be reading him in the NYT. He's playing as close to the edge as he can, in my opinion. They have their own way of disappearing people, like Dennis Kucinich and Greg Palast.

It's ideological. The market is always right.

How can the free market, with its self correcting mechanisms, be in any way "criminal" or "fraudulent."

We're not talking about an individual, or even an individual company. This is the financial market - not only the U.S. but international banks as well. These mega banks and mega pension funds don't invest billions just because a couple of people rate an investment triple A.

The market can do no wrong, right? Quaint regulations and laws just get in the way. Free flows of capital are why we're in Iraq. Krugman is right, it's idealogical.

leobixby, I'm guessing you are relatively young from your post. I assure you, if we enter a depression, you will not be celebrating in the streets. And the poor, of whom we have many, including children, will be cold and hungry. Homeless people do freeze to death in winter.

People in this country have not known what hard times are since the 1930s. They make recessions feel like the difference between catching a cold and getting pneumonia. Recessions come and go, depressions take a long time to recover. The only ones who come through unscathed are the super rich, of whom thanks to the Bush policies, we now have many. I hear you can't make it onto the Forbes 400 list now with less than $1.3 billion. The world's billionaires own $3.5 trillion, but that's not where our biggest problem lies. There are 9.6 million millionaires worldwide, owning $33.2 trillion, about a third of the world's wealth. A disproportionate share of that imbalance is here in the US.

Funny how every time there is a banking scandal, the Bush's are around.

There are no doubt many causes of the lenders and borrowers problems and many people that can be blamed. However, I think it can be attributed mostly to greed and insane interest rates set by the Federal Reserve. When the rates passed 16% back in the 1980``s they ruined many business ventures and individual borrowers. Then a few years ago when they lowered rates to 1% that started the rush to build and buy which we are now seeing the results of. If the Fed`s could hold rates at a sensible 5 to 10% swing we would avoid much of the wild excesses that have caused so much havoc. It would be great if someone could figure out the reason for so much greed and materialism.

To add to RichM's comments, there has been other fraudulent and possibly criminal conduct all along the line: representing to buyers/borrowers that their mortgage would have one set of terms and conditions, and then giving them paperwork to sign at the closing that actually (in fine legalese) said something else; brokers telling borrowers "this is the best deal you qualify for" when in fact it wasn't, it was just the one the broker made the most money on; especially doing this to people of color or in certain neighborhoods; tacking on illegal confiscatory closing charges; deliberately mistating the APR; etc. I also anticipate some (civil not criminal) liability from trustees and money managers for public entities, non-profits, etc. who bought the sliced-and-diced securities, as if they were safer than they actually were.

The key to uncovering all this is people fighting off the foreclosures, and making the lenders go through all the hoops. Where a savvy attorney or non-profit credit counseling agency can go through all the documents, a lot of this will become clearer. In places where a foreclosure requires a judge's signature, at least one judge has ruled that the entity trying to foreclose has to PROVE that it actually owns that mortgage, which most of them can't do because of the slicing-and-dicing.

Some of the problem was stupidity on the part of borrowers. More of it was out and out greed by lenders and investors, plus regulators who understood their job was to take a long-acting sleeping pill, put musak on their ipods, and then as soon as they woke up, slide through the revolving door into the financial "services" industry.

barryr (1:50 pm) -- There are several levels of criminality. One (as Krugman mentioned in a recent column) is that the loan originators got the big rating agencies (Moody's and Standard & Poor's) to go along with the scam. These agencies rated the mortage-backed CDO securities as "triple A," despite the fact that they were based on high-risk loans, which everyone knew would become even less creditworthy as the initial low "teaser" rates were replaced by higher rates, a year or two into the life of the mortgages.

The rating agencies' generous ratings of these CDO's as "investment grade" predictably encouraged many pension funds around the world to pour their money into them. There's a close analogy here to Enron, which (in exchange for kickbacks, as it turned out) got the accountancy firm Arthur Andersen to review Enron's balance sheet & earnings statements, & give them a "clean bill of financial health." This favorable review led many pension funds to invest in Enron -- something they wouldn't have done if the review had pointed up serious questions about the financial statements.

Another area of criminality, also similar to Enron, is the hiding of huge liabilities in fake subsidiaries. Enron created pseudo-companies which were just paper entities, actually controlled by Enron itself. It hid losses by pretending that the assets in question belonged to these pseudo-companies. This was basically a way to shuffle around the assets to make Enron's earnings look better than they really were. // In the subprime scam, companies like Citigroup did the same thing, creating entities called "SIV's". These were used for the same purpose -- shuffling assets so as to hide losses. (Rules for disclosure of exotic entities like SIV's are a lot less demanding than rules governing Citi's official financial statements -- so there's a nice opportunity here to evade oversight.)

There's more, too. As Krugman says, Greenspan was specifically warned about this by an ex-Fed official, but he just brushed it off. // And it's not clear that the people who took out the initial mortgages to buy homes were adequately warned of the risks. There are rules against "predatory lending" -- rules which the financial industry has succeeded in weakening. But despite the weakening, it's quite likely that rules were broken in this area, too.

The whole thing was designed so that the Wall Streeters who would earn the fees by originating the loans, & by repackaging them as CDO's, would have already sold their interest to other financial institutions, by the time the sh*t hit the fan. This was part of the plan. When Krugman talks about the "financial toxic waste" being buried all throughout the system, what he's saying is that the smart guys loaned money to average Joes, many of whom (everyone knew) wouldn't be able to pay off the mortgages. But then the smart guys turned around, and sold these mortgages to others downstream in the feeding chain. The net result is that the guys who pulled this off, have long since cashed in their chips. The only people affected are those stuck holding the mortgages (which are just claims on the home-buyers -- not worth much, since many of these buyers can't make the payments).

Good point Deran.

I think Krugman is not calling out the guilty parties because in large part the Democrats have been key players in "reforming" and "innovating" the financial services sector, and financial services are the main donors to the Democratic Party and their candidates. He realizes if it comes out that the Dems are as "guilty" as the GOP, the voters will be a lot less enthusiastic abt electing any of them.

It is simply wonderful how the articles on CD are linked. There is another article on today that talks about our democracy and how the true decision makers at the corporate level never get dinged for their criminal behavior.

Just a slap on the wrist, and Milliken is close to becoming a billionaire again, albeit through the green revolution.

As long as you make your way into wall street, you will never have to worry.

no, no, Krugman. it's not a matter of 'oopsie, we let the nasties get loose.' it's a matter of the antagonism in capitalism between the productive economy and the financial system.

barryr,

Fraud, the "due diligence" on the part of the rating companies that rated the bundles of sub-prime mortgages was shoddy, far understating the risk of the investments.

Fraud, the disclosure of the sub-prime industry to the gullible home buyers wasn't stated so the borrower understood that his payments were going to be a lot higher after the interest rate adjusted.

Unlike banks most sub-prime lenders had very few real assets, they borrowed vast sums from hedge funds or retirement funds then lent that money to home buyers. Once the hedge fund lenders lost confidence in the sub-prime industry there was very little to act as a buffer. Since the economic policies of the NeoCons and free trade democrats are designed to destroy America's Middle Class it was inevitable that residential real estate values would collapse from the absurdly inflated peak they reached at the end of the housing bubble.

Liquidity crises can always be relieved. Just print more money. Then everyone will have lots of money and we'll all be rich!

The time has come for "we the people" to effectively slap the criminal bankers accross their collective faces and laugh while we do it. I, for one, just paid off one of the smaller college loans I had, and when I called them to make the final payment I gave them a piece of my mind. For more than three years I paid nearly $100 per month to that bank on a miserable salary, for a loan that originally was just below $9000. Guess what my payoff amount was? Are you ready? $10,800!!

As if that was not enough, all my life, I have noticed that whenever we, the consumer, screw up and make a late payment, or something happens that has us in the position of being behind on our payments, we are IMMEDIATELY penalized. In my case, even though I have not defaulted on any loans, paid one of them off in full, make regular double payments on all my credit cards, and have NEVER missed a car payment, my credit was recently tacked down a notch because I was late by a week on one payment - the first time in three years!

However, I honestly cannot count how many times the credit cards, banks (same difference of course), loan guarantours, etc. have mysteriously levied some kind of miscellaneous charge upon my account, or penalized me because I used the damn Internet to pay my bill instead of sending a check, etc. Do I have any recourse in those situations? The answer is not.

I don't believe these criminal bastards should receive any help whatsoever from the government, nor private investors. As a matter of fact, I think the best damn thing for this country, in the long run, would be if there was a giant run on the banks. Hell, the vast majority of the population lives paycheck to paycheck anyway, and if the banks all went down in flames, so would our loans.

I will be celebrating in the streets when we enter the new so-called "depression".

RichM, could you please clarify what laws specifically have been broken in the subprime lending crisis?

Very true RichM. Paul himself is innovating his way at telling the truth. He knows who he is writing for and what they don't want to read. His readership may be varied but the only critics he worries about are the Wall Street bosses. He can't piss them off by saying that their people and policies are not only criminal but also immoral. The New York Times, and soon the Wall Street Journal, is a part of the empire we know as The United States of Everything. I wish he had the balls of Gore Vidal.
Hoa binh

The language Krugman chooses is interesting. If you read between the lines, you can tell that Krugman knows full well that this subprime fiasco is deeply criminal. Lots of people on Wall Street should be going to jail, for their roles in this scam. What has really happened is far, far worse than Enron. In fact, it's the Enron scheme writ large -- applied to the entire US financial system, & beyond.

Yet Krugman (who has more integrity than almost any of the MSM columnists) is careful to avoid "inflammatory language." On the one hand, he sees the fiasco for what it is; on the other hand, he recognizes that if he described it in terms which fully fit the crime, he'd be calling almost every ruling US financial institution (the Fed, the Treasury, Wall St, all the big banks) "criminals." Needless to say, we can't have the NY Times using language like that!! So Krugman arrives at a clever compromise -- which is to deliver an assessment that's conceptually accurate, yet at the same time avoids frontal attacks on the perps.

The article's last sentence is made to sound as though the fiasco might have been an "innocent mistake," or the result of unforeseen consequences of financial innovation. There's a hint there that Krugman himself knows that's not so. But he's willing to soften the language, to keep his piece within the limits of political acceptability.

Banking is not the only crime that the chimp family specializes in...google kennedy assasination and read the expose by kangas or go to cbc/fifth estate/conspiracy theories and read how the arab shieks brought in millions of dollars without going thru customs and having a cia escort to fund these loosers campaign funds. then we get to hitlers buddy, prescott. The whole family should be in prison. our entire economy is fucked up because the chimpy family is using it to pay back the arabs for all of the money that they have loaned the assholes since nixon put them in place to make the oil deals.

"This time, market players seem truly horrified - because they've suddenly realized that they don't understand the complex financial system they created."

Well, when they lose their shirts they'll understand what it's like to walk through a dark, shit-filled bat cave in their bare feet.