Making Sense of the Credit Debacle
Just because there was a Big Lie doesn't mean there weren't a lot of little liars. I'm coming down on the side—which is out of favor and much dismissed—that would argue there was massive fraud in the U.S. economy. And I mean that it wasn't just intellectual fraud and it wasn't simply a matter of people wanting to believe something that was too good to be true. There was much of that, to be sure, but there was much criminality as well.
The problem is that if you chalk the credit crisis up to human nature—if you say that everyone was guilty of self-deception and therefore no one is guilty—then you resign yourself to thinking such crises are inevitable, that boom-and-bust cycles must happen. You throw up your hands. You absolve people who shouldn't be absolved. It's a failure of imagination about what our society can be. Booms and busts might be with us, but the fallout doesn't always have to be devastating. These crises don't have to be this widespread. We can envision a society where the incentives aren't skewed so much in the direction of making great wealth, which pushes people to take great risks and lie to avoid the consequences.
Barry is right that there was a series of bad decisions made at each step that weren't fraudulent that led to the great credit bubble. But these decisions weren't accidental. There were two kinds of governmental failure in the past several decades: One was active financial deregulation; the other was the purposeful malignant neglect of government's regulatory role in
overseeing the markets. Regulators were defanged.
I'll mention just two examples. The first is when Alan Greenspan, the chairman of the Fed, blocked Fed Gov. Ed Gramlich's efforts to have the chief banking regulatory arm of the country take a more active role in subprime lending. The second is the SEC's decision, which Obama's new chairman, Mary Schapiro, is repealing, to require enforcement lawyers to get the OK from commissioners before moving on cases: This was an intentional roadblock to securities enforcement erected by ideologues and cronies in the Bush administration. After all, the first SEC chairman appointed by Bush was Harvey Pitt, a lawyer who had a long career defending companies from accusations by the SEC.
I bring up Pitt's name because I attended an interesting panel last week hosted by—plug alert—Portfolio on Bernie Madoff and the financial scandal. Pitt sat on the panel with Jim Chanos, the noted short-seller, and Elie Wiesel, a Madoff victim. Chanos said that an under-covered aspect of this meltdown has been "criminality in executive suites," charging that big banks and Wall Street firms had been lying about the state of their books while raising money in the capital markets. He pointed out that Lehman's hole on its balance sheet was roughly $150 billion, more than twice that of Enron. Someone was misleading about the state of that investment bank's books. And I think his name rhymes with Schmick Schmuld.
I agreed with this line of thinking. To my surprise, so did Pitt, the erstwhile true-believer in free markets, free people. "I do believe there was criminality" at companies, he said, though he wasn't sure it reached the top ranks. He pointed out that firms often had multiple "marks" on their assets, assigning different values for different circumstances. Those might be justifiable in certain occasions, but he suspected that the marks were probably at their highest when the firms were calculating their management fees and at their lowest when using values for other purposes. "There will be criminal cases. They will be difficult, but they will be made and they have to be done."
We had a decades-long gutting of the enforcement capabilities of government and an elevation of the religious faith that markets would correct mistakes magically and therefore could police themselves. There are several areas in which this took place, where people conducted themselves by habitually misleading their customers, beholden to irreconcilable conflicts of interest:
Columbia Journalism Review's Dean Starkman and Ryan Chittum have made the point over and over again that much subprime lending was simply fraudulent. People who should have qualified for prime loans were given more expensive subprime ones instead, because it was more lucrative for the mortgage brokers, lenders, and Wall Street firms.
Accounting and balance sheet fraud
I believe it's clear now that Lehman's top management systematically and purposefully overstated the value of its assets in the weeks and months leading up to its demise. The SEC should have roped off Lehman as a crime scene the weekend it went under. Dick Fuld is being investigated. He should be. How culpable were the accountants?
Credit Rating Agencies
E-mails have surfaced that show people at the ratings agencies had serious misgivings about their systematic overrating of the toxic structured finance paper that spread throughout the system, causing more than $1 trillion in losses in the global financial system. Credit-rating agencies were paid by Wall Street firms, which designed this paper. I don't feel they have been adequately examined for their culpability in this debacle, though there are ongoing investigations.
So, start stringing people up, I say. Or at least, sending down the indictments.
Jesse Eisinger is a columnist at Portfolio.