I just read Chain of Blame, How Wall Street Caused the Mortgage Crisis“. Financial reporters Paul Muolo and Mathew Padilla do a laudable job of describing the mortgage mess and how it happened. Long story short: it seems that Wall Street’s best and brightest transformed a heretofore niche market for subprime and non-conventional loans into a economy-transforming beast.
The book has an interesting cast of characters, some famous, some not. Alan Greenspan makes an appearance as libertarian ideologue in chief; Angelo Mozillo the chief of Countrywide is prominent; but has anyone ever heard of Roland Arnall? Arnall was the founder of Long Beach Mortgage and one of the first practitioners of the subprime on the grand scale. His progeny are everywhere.
Arnall essentially expanded a business model originated by subprime lenders of long ago like Household Finance. Remember those guys? Operating a couple of steps above loan-sharking they had offices around the country and loaned money to folks who wanted to buy some furniture or a car and couldn’t get financing through conventional means (banks, GMAC, whatever). Of course they charged high interest, but that made sense, they were taking high risk.
Arnall and friends took this model into the residential mortgage market, but with some significant twists. One, the Household Finance guys loaned their own money, made the collection calls, and even did the repo if necessary. Not so the modern day subprimers. Divide and outsource was their plan. They were interested in the high interest rates that could be charged, but wanted to pass off the high risk to others.
Of course the desire to earn high interest and take little risk has been around since the invention of money. But the subprimers like Arnall succeeded. How did that happen?
That’s the subject of the book and the short answer is Wall Street. Major Wall Street firms like Merrill Lynch, Bear Stearns and Lehman Brothers sliced and diced the loans into various types of bonds, convinced ratings agencies that the repackaged loans were safe enough for everyone up to and including widows and orphans; then sold them to investors around the world. People just didn’t believe that companies like that would put their reputations on the line by covering huge, steaming piles of financial dogshit with a their company logo. But they did. And here we are. To paraphrase Richard Clarke’s apology to the 9/11 Commission: “America, your capital markets failed you”.
On the political side, there seems to be two general reactions to the financial meltdown. One is to observe that enterprises like Bear Stearns, Countrywide, Lehman Brothers, Merrill Lynch behave like banks, take risks like banks, and can create risk for the economy like banks. Maybe they should be regulated like banks. At one time there was a plausible argument that they would regulate themselves (this was Greenspan’s expectation). But that hasn’t worked out.
Another reaction (conservative) is to claim that government caused the problem. Banks, they say, were forced to loan to unqualified borrowers because government, in it’s zeal to help low income people, forced them to. This view is unsupported by the evidence, as this book makes clear.