Academic

I'm very glad we all had an excuse to stop grading for a moment to finish All The Devils Are Here.  I very much enjoyed this very readable, but extremely fact-based, account of the years leading up to the financial crisis.  I also liked the way the authors drew a line from mortgage brokers signing up "hard money" borrowers all the way to investment banks dealing in CDOs and CDS's.  Because really, one doesn't exist without the other, and that entanglement is the important part of the story.   Finally, I think the most valuable part of the story is the Fannie Mae/Freddie Mac story, which just isn't given enough attention.  Unlike other players, these GSEs are not only still here, they played a role in the attempt to stabilize the industry and were largely ignored by Dodd-Frank.

After seeing the title, I was surprised that the book wasn't going to come out hard for criminalization of some of the actions of the players in the book.  Oh, there are plenty of sins here:  sloth, gluttony, envy, pride.  And most everyone in the book is painted some color of stupid, but few are devilishly (or criminally) evil.  And no one escapes, regardless of party or ideology:  Clinton, Bush, Obama, Summers, Rubin, Greenspan, etc.  What the book lacks are any angels.  There are Cassandras, but as in real-life, Cassandras (think Harry Markopolos) are a mixed bag.  Some see it coming, but whine only as loud as they dare before annoying others (Ned Gramlich).  Others try to warn, but their personalities get in the way (Brooksley Born).  The picture that is painted is of lobsters egging each other on into a pot of water that is slowly heating up.  A few lobsters beg off, but we really don't hear from them again (Dave Zitting, pp. 149-50).  Most are afraid of being left behind if they don't join the party.  Then they all realize the water is starting to boil.

The book is far too factually accurate to be called one-sided; however a running theme of the book is that financial innovation is bad.  Or, that financial innovation serves no useful purpose and leads to ruin.  Let me explain.  The book traces the housing market from the post-war 30-year fixed to the first mortgage-backed security to the increase in subprime lending to the securitization of subprime to the "slicing and dicing" of MBS to synthetic collateralized debt obligations to credit default swaps.  However, the book does not really analyze the utility of any of these innovations, even the home mortgage.  (p. 6, noting that the 30-year fixed "is designed to allow middle-class families to afford monthly mortgage payments" but is "standard in only one other country (Denmark)".)  We can all agree on the internal and external risks of financial innovation, but these innovations were not just innovations for innovation's sake.  I would like to see some account acknowledge that good things came from the securitization of home mortgages.  And, good things came from being able to "credit enhance" mortgages for the sake of securitization, through reinsurance or guarantees, and good things came from allowing purchasers to hedge their risk through credit default swaps, which give the market a lot more price information than the credit ratings agencies do.  The authors mention some of these assertions, but put them in the mouths of actors already deemed devils, so they aren't given as much credit as they are worth.

Because this is the problem with prescribing a low-risk diet.  We cannot go cold turkey.  We can't imagine a United States without a mortgage product.  For the capital necessary for lenders to offer mortgage products to this many people, we need some sort of securitization.  Prudent investors will want to hedge this risk with products that counteract the risk.  In a perfect world, this will decrease overall risk to as close to zero as possible.  But, in a non perfect world, the need for liquidity will necessitate professional risk-takers (speculators), and overall risk will rise.  Securities, even asset-backed securities, don't tank investors.  Investors tank themselves.  And some financial products look like tasers and some look like WMD.  How to regulate?  This is a big question, and understanding and acknowledging the tension is important.

I think one great example of this tension between positive utility and negative utility is Chapter 22, which details how the GSEs began expanding its subprime mortgage debt IN THE SUMMER OF 2007!!  Why?  Because it saw an opening, as mortgage firms were failing, and the government saw a need.  To keep the system going, the GSEs had to step in when other buyers couldn't, or there would be no new mortgages.  So all the risk in the system became concentrated in the one place that would hurt taxpayers the worst, but for the sake of allowing taxpayers to keep refinancing their mortgages.  That is not any easy knot to untangle, my friends.

The book has a lot of fodder for those who like to ponder what ifs and alternate regulatory worlds!