Captain Louis Renault (Claude Rains) in Casablanca

"I am shocked -- shocked -- to find that gambling is going on in here!"

"Your winnings, sir."

"Oh, thank you, very much. Everybody out at once!"

Robert Shiller: Crisis may run for 'years and years' -- parts 1, 2 and 3

Me on the credit crisis, standing on the shoulders of others

60 Minutes: A Look At Wall Street's Shadow Market -- Steve Kroft on How Some Arcane Wall Street Financial Instruments Magnified Economic Crisis (aired 5 Oct 2008)

(CBS) On Friday Congress finally passed - and President Bush signed into law - a financial rescue package in which the taxpayers will buy up Wall Street's bad investments.

The numbers are staggering, but they don't begin to explain the greed and incompetence that created this mess.

It began with a terrible bet that was magnified by reckless borrowing, complex securities, and a vast, unregulated shadow market worth nearly $60 trillion [$62tr?, $63tr?, $55tr?] that hid the risks until it was too late to do anything about them.

And as correspondent Steve Kroft reports, it's far from being over.

[my note: ...a somewhat hyped-up presentation in part]

COGR - Causes and Effects of the AIG Bailout (7 Oct 2008)

Especially Superintendent Eric Dinallo, New York State Insurance Department: 19:18--28:58, 38:42--41:30, 51:10--52:33, 54:10--54:50, 55:20--56:39, 59:17--1:03:28, 1:04:20--1:09:23, 1:18:08--1:19:41, 1:34:36--1:40:07, 1:40:26--1:41:36, 1:42:13--1:45:19, 1:58:15--2:04:20,

Eric Dinallo emphasises the crucial role of the Commodity Futures Modernization Act of 2000 (the CFMA) in (a) defining CDS' as being not 'securities' and thus not subject to SEC regulation, (b) exempting CDSs from gaming laws / bucket shop laws, and thereby (c) bringing about a significant problem of 'opacity' concerning CDS exposure and activity.

He would revisit (1) the CFMA and its placing of CDSs beyond regulation -- both the clearly socially useful kind, i.e. CDSs that are purchased for legitimate insurance/hedging purposes, as well as the kind of CDSs that are purchased without holding the matching credit security, (2) the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the Gramm-Leach-Bliley Act, the GLBA), which repealed in part the Glass-Steagall Act of 1933, and (3) the complete separation, made possible by securitization, between underwriting itself (e.g. of mortgages) and the bearing of the risk underwritten.

Charlie Rose: A Conversation with Nouriel Roubini (aired 14 Oct 2008)

60 Minutes: Credit Default Swaps -- Steve Kroft on The Bet That Blew Up Wall Street (aired 26 Oct 2008)

(CBS) The world's financial system teetered on the edge again last week, and anyone with more than a passing interest in their shrinking 401(k) knows it's because of a global credit crisis. It began with the collapse of the U.S. housing market and has been magnified worldwide by what Warren Buffet once called "financial weapons of mass destruction."

They are called credit derivatives or credit default swaps, and 60 Minutes did a story on the multi-trillion dollar market three weeks ago. But there's a lot more to tell.

As Steve Kroft reports, essentially they are side bets on the performance of the U.S. mortgage markets and the solvency on some of the biggest financial institutions in the world. It's a form of legalized gambling that allows you to wager on financial outcomes without ever having to actually buy the stocks and bonds and mortgages.

It would have been illegal during most of the 20th century, but eight years ago Congress gave Wall Street an exemption and it has turned out to be a very bad idea.

From the transcript:

..."If I thought certain mortgage securities were gonna fail, I could go out and buy insurance on them without actually owning them?" Kroft asks Eric Dinallo, the insurance superintendent for the state of New York.

"Yeah," Dinallo says. "The irony is, though, you're not really buying insurance at that point. You're just placing the bet."

Dinallo says credit default swaps were totally unregulated and that the big banks and investment houses that sold them didn't have to set aside any money to cover their potential losses and pay off their bets.

"As the market began to seize up and as the market for the underlying obligations began to perform poorly, everybody wanted to get paid, had a right to get paid on those credit default swaps. And there was no 'there' there. There was no money behind the commitments. And people came up short. And so that's to a large extent what happened to Bear Sterns, Lehman Brothers, and the holding company of AIG," he explains.

In other words, three of the nation's largest financial institutions had made more bad bets than they could afford to pay off. Bear Stearns was sold to J.P. Morgan for pennies on the dollar, Lehman Brothers was allowed to go belly up, and AIG, considered too big to let fail, is on life support to thanks to a $123 billion investment by U.S. taxpayers.

"It's legalized gambling. It was illegal gambling. And we made it legal gambling…with absolutely no regulatory controls. Zero, as far as I can tell," Dinallo says.

"I mean it sounds a little like a bookie operation," Kroft comments.

"Yes, and it used to be illegal. It was very illegal 100 years ago," Dinallo says.

In the early part of the 20th century, the streets of New York and other large cities were lined with gaming establishments called "bucket shops," where people could place wagers on whether the price of stocks would go up or down without actually buying them. This unfettered speculation contributed to the panic and stock market crash of 1907, and state laws all over the country were enacted to ban them.

"Big headlines, huge type. This is the front page of the New York Times," Dinallo explains, holding up a headline that reads "No bucket shops for new law to hit.”

"So they'd already closed up 'cause the law was coming. Here's a picture of one of them. And they were like parlors. See," Dinallo says. "Betting parlors. It was a felony. Well, it was a felony when a law came into effect because it had brought down the market in 1907. And they said, 'We're not gonna let this happen again.' And then 100 years later in 2000, we rolled them all back."

The vehicle for doing this was an obscure but critical piece of federal legislation called the Commodity Futures Modernization Act of 2000. And the bill was a big favorite of the financial industry it would eventually help destroy.

It not only removed derivatives and credit default swaps from the purview of federal oversight, on page 262 of the legislation, Congress pre-empted the states from enforcing existing gambling and bucket shop laws against Wall Street.

"It makes it sound like they knew it was illegal," Kroft remarks.

"I would agree," Dinallo says. "They did know it was illegal. Or at least prosecutable."

In retrospect, giving Wall Street immunity from state gambling laws and legalizing activity that had been banned for most of the 20th century should have given lawmakers pause, but on the last day and the last vote of the lame duck 106th Congress, Wall Street got what it wanted when the Senate passed the bill unanimously.

"There was an awful lot of, 'Trust us. Leave it alone. We can do it better than government,' without any realistic understanding of the dangers involved," says Harvey Goldschmid, a Columbia University law professor and a former commissioner and general counsel of the Securities and Exchange Commission.

He says the bill was passed at the height of Wall Street and Washington's love affair with deregulation, an infatuation that was endorsed by President Clinton at the White House and encouraged by Federal Reserve Chairman Alan Greenspan.

PBS: Bill Moyers' JOURNAL: Joe Nocera (aired Nov 21, 2008)

NEW YORK TIMES business columnist Joe Nocera joins Deborah Amos on the JOURNAL to discuss the prospects for further bailouts of homeowners and automakers and the possible consequences of doing nothing.

PBS: Frontline: Inside the Meltdown: Brooksley Born was stopped from regulating derivatives (aired 17 Feb 2009)

Michael Greenberger (CFTC '97--'99) tells how Brooksley Born tried to regulate derivatives -- but Wall St, Chicago exchanges, Larry Summers (Deputy Secr of Treasury) and Alan Greenspan (Fed Chairman) emphatically opposed this. In 2000 Congress, Senate and Clinton enact CFMA, putting an end to attempts to regulate derivatives.

PBS: Frontline: Inside the Meltdown (aired 17 Feb 2009)

Charlie Rose -- Economic Crisis (18.02.09) -- Obama's Housing Recovery Plan -- Lawrence Summers, Nouriel Roubini, Fred Mishkin, Mark Zandi, Nina Easton

PBS: Now: Kenneth Rogoff previews the upcoming 2 April '09 G20 Summit (aired week of 13.03.09)

The world's economic superpowers are preparing to meet--will they devise a fix for the financial mess?

On March 13, financial ministers and central bankers of the world's economic superpowers will meet in London to lay the groundwork for next month's crucial meeting of their country's leaders, known as the G20. Will their work revolutionize the global economy and lift us out of this economic hole, or will politics get in the way?

David Brancaccio interviews Kenneth Rogoff, Harvard economics professor and former chief economist of the International Monetary Fund, about how high we should raise our hopes and what's at stake for America and the world.

60 Minutes: Ben Bernanke's Greatest Challenge, Part I (aired Sun 15 March 2009)

(CBS) Aside from the president he's the most powerful man working to save the economy, but you have never seen an interview with Ben Bernanke.

Bernanke is the chairman of the Board of Governors of the Federal Reserve System, better known as the Fed. The words of any Fed chairman cause fortunes to rise and fall and so, by tradition, chairmen of the Fed do not do interviews - that is until now.

The Federal Reserve controls the economy by setting interest rates. But after the crash of 2008, Bernanke invoked emergency powers, and with unprecedented aggressiveness has thrown a trillion dollars at the crisis.

Ben Bernanke may be the most important Fed chairman in history. The question is, can he help lead America out of this deep recession and when?

60 Minutes: Ben Bernanke's Greatest Challenge, Part II (aired Sun 15 March 2009)

Phantom Shares: News special on 'naked shorting' from Bloomberg News

March 14 2007 -- Bloomberg's Michael Schneider reports on the practice of naked short selling, its impact on companies such as Inc. and efforts by the Securities and Exchange Commission to combat abuses. Naked short selling involves selling stocks short without borrowing the shares first, meaning sellers theoretically can place unlimited orders to drive down a company's stock. Patrick Byrne, chief executive officer of, and others speak.

"...In all, the Depository Trust and Clearing Corporation (DTCC) says about $6 billion in trades can't be cleared every day, 1.5 percent of the total dollar value."

Challenger, Go For Launch (BBC, Jan 2001)

Shuttle Challenger left Pad 39B at Kennedy Space Flight Center. Seventy-three seconds into flight, the Orbiter Challenger exploded, killing all seven of its crew. The cause of the accident was due to the cold-related failure of the aft joint seal in the right Solid Rocket Booster. It was the worst accident in the history of the United States space program and rocked NASA to its core. This film aired in January 2001 -- coinciding with the 15th anniversary of the Challenger tragedy. It is a retrospective - an attempt to put the Challenger STS 51-L Mission into context, to understand what happened on January 28th 1986, to survey the complexity of decision-making and preparation for launch, and to finally close the book on this tragedy as NASA moves forward with its 100th Space Shuttle Mission.

This programme provides guidance and ideas as to how we may arrive at an understanding of the Credit Crisis.

Firstly, it demonstrates the approach taken in NASA / air accident investigations.

Secondly, it touches upon themes that are relevant to the Credit Crisis -- such as (i) groupthink, (ii) adverse reputational incentives, and (iii) adverse commercial incentives -- that prevented pre-emption of the ill-fated, indeed doomed, launch.

"Our [Morton Thiokol] General Manager said in a soft voice, 'We have to make a management decision.' It was obvious that they were going to change the decision, or attempt to write things down on a piece of paper, that justified changing it from a 'No Launch' to a 'Launch' decision -- to accommodate their major customer."

"...I couldn't even get them [my managers] to look at the photographs."

"The General Manager turned to his three senior managers, and asked what they wanted to do."

"Two agreed to launch, but the third was undecided."

"So he turns to him, and in no uncertain terms tells him, 'Take off your engineering hat, and put on your management hat.' And that's exactly what happenned. He changed hats, and he changed his vote. Just 30 min prior, he is the one that gave the conclusions and recommendations chart, at the main engineering meeting, to not launch below 53 degrees Farenheit."

Bay of Pigs: Declassified

JFK later called it "the worst experience of my life." BAY OF PIGS DECLASSIFIED explores how much of this legendary disaster was his own doing. Drawing extensively on documents that were kept under wraps for nearly 40 years, this documentary tells the complete story of the ill-fated invasion. Examine an extremely rare report from the CIA Inspector General, which is sharply critical of the methods and procedures employed during the invasion.

The prototypical example of GROUPTHINK.

PBS: Bill Moyers' JOURNAL: William K. Black (aired April 3, 2009)

From 09:34--10:33:

"...Here, the Justice Department, even though it very appropriately warned, in 2004, that there was an epidemic..."

"BILL MOYERS: Who did?"

"WILLIAM K. BLACK: The FBI publicly warned, in September 2004 that there was an epidemic of mortgage fraud, that if it was allowed to continue it would produce a crisis at least as large as the Savings and Loan debacle. And that they were going to make sure that they didn't let that happen. So what goes wrong? After 9/11, the attacks, the Justice Department transfers 500 white-collar specialists in the FBI to national terrorism. Well, we can all understand that. But then, the Bush administration refused to replace the missing 500 agents. So even today, again, as you say, this crisis is 1000 times worse, perhaps, certainly 100 times worse, than the Savings and Loan crisis. There are one-fifth as many FBI agents as worked the Savings and Loan crisis."

From 17:38--

"they violate the rule of law. This is being done just like Secretary Paulson did it. In violation of the law. We adopted a law after the Savings and Loan crisis, called the Prompt Corrective Action Law. And it requires them to close these institutions. And they're refusing to obey the law."

"BILL MOYERS: In other words, they could have closed these banks without nationalizing them?"

"WILLIAM K. BLACK: Well, you do a receivership. No one -- Ronald Reagan did receiverships. Nobody called it nationalization."

"BILL MOYERS: And that's a law?"

"WILLIAM K. BLACK: That's the law."

"BILL MOYERS: So, Paulson could have done this? Geithner could do this?"

"WILLIAM K. BLACK: Not could. Was mandated--"

"BILL MOYERS: By the law."

"WILLIAM K. BLACK: By the law."

"BILL MOYERS: This law, you're talking about."


"BILL MOYERS: What the reason they give for not doing it?"

"WILLIAM K. BLACK: They ignore it. And nobody calls them on it."

[n.b. This interpretation conflicts with e.g. Buiter (2009) 'The Fed's Moral Hazard Maximizing Strategy,' The Financial Times, March 6. "The error of omission was that, despite the fact that Bear Stearns had been in terminal dire straits in March 2008, there still was no Special Resolution Regime (SRR) with Prompt Corrective Action (PCA) for Investment banks in September 2008. Why was Lehman not forced to become a bank holding company (the fate of Morgan Stanley and Goldman Sachs later that year), so it could be SRR'd and PCA'd by the FDIC? With an SRR, the systemically important bits of Lehman could have been kept alive on government life support, with the shareholders and the unsecured creditors suffering the fate intended for those with exposure to insolvent institutions." Reading between the lines, Buiter is saying that it is the FDIC that can initiate an SRR mandated by the PCA requirement, but in order for the FDIC to move on an institution, it must fall within its regulatory remit.]

[n.b. Elsewhere on the interweb: 12 USC Section 1831 - "Prompt corrective action" is applicable to banks under the authority of the FDIC, which are commercial banks. The problem is [bank] "holding companies" owning both investment banks and commercial banks. ... "Under current law, no regulator has the authority to essentially take over a troubled bank holding company—conglomerates with a wide range of financial operations—the way the government routinely does with smaller, commercial banks." Both FDIC Chairman Sheila Bair and Fed Chairman Ben Bernanke have said that even as the government injects more taxpayer capital into two giant financial institutions, Citigroup (NYSE: C) and AIG (NYSE: AIG) it can't actually shut them down even if officials wanted to. Citigroup is a holding company.]

"BILL MOYERS: Well, where's Congress? Where's the press? Where--"

"WILLIAM K. BLACK: Well, where's the Pecora investigation?"

"BILL MOYERS: The what?"

"WILLIAM K. BLACK: The Pecora investigation. The Great Depression, we said, "Hey, we have to learn the facts. What caused this disaster, so that we can take steps, like pass the Glass-Steagall law, that will prevent future disasters?" Where's our investigation?"

"What would happen if after a plane crashes, we said, "Oh, we don't want to look in the past. We want to be forward looking. Many people might have been, you know, we don't want to pass blame. No. We have a nonpartisan, skilled inquiry. We spend lots of money on, get really bright people. And we find out, to the best of our ability, what caused every single major plane crash in America. And because of that, aviation has an extraordinarily good safety record. We ought to follow the same policies in the financial sphere. We have to find out what caused the disasters, or we will keep reliving them. And here, we've got a double tragedy. It isn't just that we are failing to learn from the mistakes of the past. We're failing to learn from the successes of the past."

Daily Show: Elizabeth Warren, Chair of the Congressional Oversight Committee on TARP, Part 1 (aired April 15, 2009)

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Total TARP committed to date: $590.4 billion. The first tranche of $350 billion, disbursed by Secretary Paulson, in return for securities (stocks, warrants) with a value, at the time, of $66 for every $100 given to the financial companies. Overall, $78 billion out of the initial £350 billion tranche was 'gifted' to the financial companies. [But, by a straightforward calculation, 100-66=34% of $350 billion is $119 billion. We may infer that the $66 on $100 was the worst extreme.] Of course, that $78 billion held by the treasury subsequently fell in value further.

Daily Show: Elizabeth Warren, Chair of the Congressional Oversight Committee on TARP, Part 2 (aired April 15, 2009)

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JS: "You had [sic]a very interesting statement. You said that... 'Capitalism without bankruptcy is like Christianity without Hell.' "

EW: "Right."

JS: "Which actually is Judaism. ...But, [that is] beside the point." ...

...EW: "We came out of the Great Depression with three regulations. FDIC insurance: it's safe to put your money into banks. Glass-Steagall: banks won't do crazy things. And some SEC regulations. We go 50 years without a financial panic, without a crisis. [JS: A couple of recessions in there. Some down times.] ...some recessions, but no financial crisis, no banks failing, you know, no big crisis like that. [JS: S&L, you know, that sort of thing.] Well now, wait a minute. I said 50 years. Because then what happens is we say, 'Regulation -- aah, it's a pain, it's expensive, we don't need it.' So we start pulling the threads out of the regulatory fabric. And what's the first thing we get? We get the S&L crisis. 700 financial institutions failed. 10 years later, what did we get? We get Long Term Capital Management -- when we learned that when something collapses in one place in the world, it collapses everywhere else. Early 2000s we get Enron, which tells us the books are dirty. And what is our repeated response? We just keep pulling the threads out of the regulatory fabric. So we have two choices. We're going to make a bid decision, probably over about the next 6 months. And the big decision we're going to make is it's going to go one way or the other. We're going to decide basically, 'Hey, we don't need regulation. You know, it's fine!' [The consequence of which is:] Boom and bust, boom and bust, boom and bust -- and good luck with your 401k. Or alternatively, we're going to say, 'You know, we're going to put in some smart regulation.' It's going to adapt to the fact that we have new products. And what we're going to have going forward, is we're going to have some stability and some real prosperity for ordinary folks."

JS: "And that's socialism." ...audience laughs, applauds...

Daily Show: Goldman's connections (aired April 15, 2009)

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From the 01:35 mark:

Is this the same GS that took $10 billion in taxpayer bailout money less than 6 months ago? Hell, that's amazing -- that now, just a few months later, turned a $1.5 billion profit! To pull that off you'd think that the Treasury Secretary who designed the bailout used to be Goldman's CEO, or something... Oh really? He... Oh really, Hank Paulson literally left GS to take the Treasury job? Wow! Well, that still doesn't explain how Goldman managed to get paid off 100 cents on the dollar in taxpayer money for risky bets they made with AIG. I mean, for that, the guy picked to run AIG would have had to have been, like, a former member of Goldman's board of... [audience laughs] Oh really, I'm literally describing Edward Liddy? ...Ho-kay, well, it's not like whoever planned the entire financial industry deregulation that enabled GS to get into this position in the first place. ...Really? Robert Rubin? Clinton's Treasury Secretary Robert Rubin preceded Paulson as Goldman's CEO? Really? And there were 14,000 other ex-Goldman guys who were in on it too? ...audience laughs, applauds...

Well, I wonder what it's like at banks that aren't as connected as GS, like Lehman Brothers? They were allowed to go bankrupt and fail. ...

Nassim Taleb and Daniel Kahneman: Reflection on a Crisis (January 27, 2009)

Author Nassim Taleb and Nobel Laureate Daniel Kahneman discuss the intricacies of the financial crisis and its far-reaching influence.

Looking forward, they offer proposals to remedy the situation and prevent it from ever recurring.

Robert Shiller: How Animal Spirits Drive the Economy (February 18, 2009)

Professor Robert Shiller presents the annual Irene and Bernard L. Schwartz lecture titled Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism.

The lecture will be based on Professor Shiller's upcoming book of the same title, which is co-authored with George Akerlof, Koshland Professor of Economics at University of California, Berkeley and Nobel Laureate.

A panel discussion and question and answer session follows the lecture and features: Brad DeLong, professor of Economics at the University of California, Berkeley; Teresa Ghilarducci, Irene and Bernard L. Schwartz Professor of Economic Policy Analysis at The New School for Social Research; and Jeff Madrick, senior fellow, SCEPA, The New School for Social Research.

[Talking about Miami] "But then, all off a sudden, in the early 2000s, there was this huge boom and sudden collapse. Now it's partly due to the subprime lending revolution, and I think that's why the low [price] tier homes went up the most, as you can see, and came down the most. But I think that I wouldn't blame it on the subprime revolution because the subprime revolution only affects -- primarily affects low price homes -- and you can see the high-priced homes in the same boom. Moreover, I think the subprime revolution was in some sense a consequence of the housing bubble. People got so excited about housing, the lenders believed it too, and thought that they were doing these low income borrowers a great favour by getting them into a mortgage, because they all believed that home prices were just going to go up and up. I know they believed this because Carl Case and I have been doing questionnaire surveys of home buyers - and they've had really extravagant expectations. The mean expectation for Los Angeles at the peak of the market was 23% a year for the next 10 years. That's what people told us. The median was only something like 12%, because about a third of the people are just 'waco' about this. They think it's going to be 50% a year. No, it just can't be right. If home prices went up just 10% a year, do you know what compound interest does? This boom was driven not by a sense that we're in a temporary boom that you want to get out of, it was driven by a sense of a 'new reality' that home prices will just always go up at 10% a year. …[about new book with George Akerlof, Animal Spirits] Our theory is that 'animal spirits' is what substantially drives economies, and this is totally contrary to contemporary macro theory…

…Bubbles start because of some precipitating factor, but the real thing that drives them is an amplification mechanism -- something that reinforces the bubble. …And that is feedback. …The media has a big role in this.

US Stock Market Data Used in "Irrational Exuberance" Princeton University Press, 2000, 2005, updated:

Richard Herring: Mortgage-backed Securities (released June 20, 2008)

Susan Wachter: Securitizations and Deregulation (released June 20, 2008)

Franklin Allen: Lessons from the Subprime Crisis (released Sept 17, 2008)

Todd Sinai: Home Values (released June 20, 2008)

Marshall Blume on the Evolving Marketplace (released June 20, 2008)

Mark Zandi: the Risky Loans Behind the Meltdown (released October 15, 2008)

Franklin Allen: Past Crises (released June 20, 2008)

Richard Marston: Risk (released June 20, 2008)

The Economist, Special Report: Executive pay

Median pay for executives is around $7m per year. That's a lot of money, but not that much when you compare it with people in similar professions--lawyers, traders, hedge fund managers.

Edward Carr, The Economist Business Affairs Editor, is interviewed on the topic of Executive pay.

CNBC: Marc Faber: Time to Jump Ship? (aired October 22 2007)

Called a "global credit bubble" in February 2007.

Robert Shiller: Real Estate Finance and its Vulnerability to Crisis

Real Estate is the biggest asset class and of great importance for both individuals and institutional investors. An array of economic and psychological factors impact real estate investment decisions and the public has changing ideas of real estate as a profitable investment. People's demand to buy a home by taking on long-term debt, called a mortgage, is often tied with the overall health of the economy and financial markets. In recessions, home buying tends to fall and the opposite holds in a strong economy. Commercial real estate, held indirectly by the public through partnerships and real estate investment trusts (REITs), is vulnerable to similar speculative activity. The most recent real estate boom illustrates the speculative nature of real estate, and its relation to financial and economic crises.

Alan Blinder: Origins of the Financial Mess (November 11, 2008)

Alan Blinder, a Professor of Economics and Public Affairs at the Woodrow Wilson School and co-director of Princeton's Center for Economic Policy Studies, discusses the financial crisis.

"Errors must have been massive and multiple. And, the safeguards must also have failed."

Culprit #1: Bond Market. Fed brought interest rates down to 1% from 2003. Bond market 'masters of the universe' weren't content with 1%, and searched for alternative investment targets: e.g. Bulgarian Bonds. As this diversion into alternative investments continued, the prices of those instruments rose, depressing their yields. Low risk premia. Based on the short series 2003--2005, lending risk appeared very low (myopia; inference from a very short series). 35 basis points was levered up in order to generate returns needed for serious bonus payouts. -> The "fixed income bubble." Waay beyond sub-prime mortgage securitization. This bubble burst, triggered by events in the subprime mortgage holdings of BNP Paribas on Aug 9, 2007. It was predictable that this was going to burst, but not where or when. LESSONS: Self-delusion is a powerful [pervasive] force. Those who forget history are bound to repeat the errors of history. Risk models need longer data periods [or else Garbage In, Garbage Out]. Excess levergage can be hazardous to your financial health. Culprit #2: Us -- ordinary Americans [and Brits] -- we all participated in the great housing mania. Took on mortgages irresponsibly [esp. subprime, ARMs...] -- that could only be paid off if housing prices kept on rising. A ponzi scheme. Some were duped. LESSONS: Sometimes people need to be protected from themselves. We need to install much better consumer protection. ...But we can't expect to eliminate real estate bubbles with this. Culprit #3: Mortgage Lenders (both banks and non-banks). Some of the worst behaviour committed by unregulated mortgage brokers [who have since disappeared, becoming defunct -- con artists?]. Others, legitimate, nevertheless used 'disgraceful' underwriting standards [liar loans, no-doc loans NINJA loans], because they intended from the very beginning to sell the loans on to a securitizer. LESSONS: We need a federal regulator for all mortgage lenders. [The federal govt hand no (authority) regulatory means of putting a lid on mortgage lending, aside from the FBI, that was indeed active raising cases against mortgage fraud] We need a "suitability standard" [equivalent to the 'sophisticated investor' requirement for, e.g. hedge funds, etc.] for mortgage products. We should require originators to hold a fraction of the mortgages they originate. Culprit #4: Bank Regulators failed both their safety & soundness and consumer protection roles (Fed). These horrible subprime lending practices were plainly visible years before the bust -- Ned Gramlich, who famously went to Alan Greenspan's office warning about practices in the subprime market, saying 'We gotta do something about this.', and Greenspan said something like, 'The market will take care of it.' Warnings were not heeded -- essentially because of deregulatory ideology. Or a factor at least. The worst loans and the largest volumes occurred late in the bubble. [When the bubble burst, sub-prime mortgages constituted 25% of new mortgages.] LESSONS: Regulators need to get serious. (They already have the authority.) Culprit #5: Private-label Securitizers (i.e. Wall St., not Fannie-Mae, Freddie-Mac or Ginne-Mae) -- packaged mortgages into MBS. Churn-em and burn-em? No, the masters of the universe held a lot of this 'junk' -- part of the self-delusion. Godman Sach's got out, but the rest were holding a lot of this junk when the music stopped. Risk management practices were horrific (embarrassing). They held a lot of this stuff, extremely large percentages (80%?), relative to their total capital. Enormous risk concentrations were allowed (by 'risk management'). Chuck Prince (Citi): "While the music plays, ya gotta dance." LESSONS: Risk management practices need huge improvement (e.g. empower risk managers). Do exotic OTC derivatives [e.g. CDOs] serve any useful [social] purpose? They make comparison shopping impossible. They serve to enrich the investment professionals making/packaging/selling them? Culprit #6: Rating Agencies were supposed to be an important -- reliable! -- safeguard. Failed miserably (threw AAA ratings around like confetti). Had (still have) massive conflicts of interest. Customers 'negotiated' ratings on these structured products (and played one agency off against the other). LESSONS: The conflict of interest problem needs to be solved. (It's a hard one.) Investors should do their own risk assessments, not just rely on agencies. Culprit #7: Securities Firms (and some of the banks) built a mountain of complex derivatives on top of the mortgages. The derivatives markets were (and remain) essentially unregulated. OTC derivatives were a source of huge fees. These markets get to be very large. CDS market has a notional total value of $66tr. These firms operate with excessive leverage -- sometimes > 30-to-1. (Bear Stears had 33-to-1 when it was folded up.) If you're leveraged 33-to-1, if your assets decline in value 3.1%, you have negative net worth. As if that weren't precarious enough, they were also funded precariously -- much overnight [repos], most short-term [3 months]. LESSONS: Well, they're gone! Less leverage; also liquidity requirements. Even if you're solvent nominally, if you can't roll over your debt, you can be forced out of business. Push toward standardized, exchange-traded derivatives (even though less profitable, they'll be more transparent). Culprit #8: The SEC was asleep at the wheel, possibly because of ideological reasons. Such extreme leverage and tenuous liquidity should never have been allowed. A mistake was made in 2000 regarding regulating derivatives (CFMA). The CFTA wanted to bring regulation to derivatives -- incidentally not to Brooksley Born's own agency -- but she was trampled by the more powerful regulators, all of whom thought she was crazy to even have a thought like that. Regulate the derivatives market. How? Culprit #9: The Leadership Vacuum ("Who's in charge here?") A disengaged president. A passive Treasury (the market will take care of this -- or, why don't you take care of this, not us). To this day, no-one has explained [really attempted to explain] all this to the people. So, was there ever a plan? It's more like "Whack a mole." LESSONS: Leadership is important in a crisis. And: "Explain your work!" Culprit #10: Whoever decided to let Lehman Brothers fail. "We had a serious crisis on Sept 14 2008. On Sept 15 2008, we had a catastrophe. The thing that changed, was the failure of Lehman Brothers." Not too big to fail? n.b. Bear Stearns was half Lehman Brothers' size. Not too entangled to fail? Somebody wanted us to believe this didn't apply to Lehman Brothers. Destroyed any belief in any intelligible rules of the game. What happenned to the 'too big to fail doctrine'? We learned, within hours, that Lehman Bros was in fact entangled to have been allowed to fail. Was this another ideologically-based decision? LESSONS: There are not supposed to be any atheists or ideologues in a foxhole. Where are we now? (as of Nov 11 2008) Still in a financial crisis, which got much worse after 'Lehman Day'. In the early stages of what looks like a long and deep recession. Recessions create more bad loans (turn good loans into bad loans -- a self-reinforcing spiral). The Fed and the Treasury are now back-stopping the entire financial system. In a political transition [incoming Obama administration.] The TARP is just getting off the ground -- and not too well. Brief summary: Mistakes were made. First the credit crisis damaged the economy; now the ailing economy will damage the credit system. The economy is still in the EMS (Emergency Measures Stage -- roadside emergency measures to tie the patient over until transport to the hospital can be completed). There is much to be done once the patient is in hospital.

Robert Shiller: Human Foibles, Fraud, Manipulation, and Regulation

Regulation of financial and securities markets is intended to protect investors while still enabling them to make personal investment decisions. Psychological phenomena, such as 1. wishful thinking -- you feel that your team has a higher probability of winning than it really does, 2. attention anomalies -- mostly 'inattention' anomalies; also, there is a social basis for attention, 3. anchoring, 4. representativeness heuristic -- a similarity heuristic that ignores base rates, 5. gambling behavior -- present in all human cultures; but a small fraction of the population are pathological gamblers, 6. magical thinking -- in investment strategies, 7. quasi-magical thinking -- people get the impression/illusion they can 'control' randomness, and 8. overconfidence can cause deviations from rational behavior and distort financial decision-making. However, regulation and regulatory bodies, such as the SEC, FDIC, and SIPC, most of which were created just after the Great Depression, are intended to help prevent the manipulation of investors' psychological foibles and maintain trust in the markets so that a broad spectrum of investors will continue to participate.

Temptations of the market: 1. Oversell; 2. Hide information; 3. Loyalty to friends; 4. Churning (for commissions).

US regulation came in during the progressive era at the beginning of the 20th century, culminating in the Great Depression. Then deregulation came in, starting in the 1970s. And what we're seeing in the financial markets now is the result of both the regulation and the deregulation.

1920s, the telephone, lead to 'boiler rooms'. In 1934, to respond, the Securities and Exchange Commission was established. SEC enforces difference between 'public' and 'private' securities. Public securities have been vetted as being suitable for the public. ...

Elizabeth Warren, TARP Oversight Commission Chair on "Real Time with Bill Maher" (aired May 15, 2009)

Elizabeth Warren gets more time to explain herself, elaborating on the themes she introduced on John Stewart's show April 15, 2009.

From 6:01 mark -- EW: "You know, it really is important to note, our history -- colonial America, thoughout our history -- we had strong usury laws in place until 1979, and we just very quietly changed a law -- interpretation by the US Supreme Court on an ambiguous statute -- and the whole game came unravelled from that point. "

She says we have shifted over to a "tricks and traps model" for the whole lending industry (credit cards, payday loans, mortgage loans).

PIRSA: Nouriel Roubini: Interpreting the failure to predict financial crises and recession (aired May 1, 2009)

A very insightful video from the Perimeter Institute in which Nouriel lectures on his interpretation of the lack of vision of bubble participants, as well as the implicit bubble-creation facilitation by regulators and economists.

Robert C. Merton: Observations on the Science of Finance in the Practice of Finance (aired March 5, 2009)

MIT's Robert A. Muh Alumni Award Lecture 2009.

There will be a time “beyond crisis,” asserts Robert C. Merton, who delves into the dense science of derivatives -- a field he has fundamentally shaped -- to explain how the vast global economic collapse has come about, and how financial innovations at the heart of the collapse could also be tools for reconstruction.

Merton uses deceptively simple graphs to show how risk propagated rapidly across financial networks, bringing down financial institutions. While he admits the crisis “is very big and complicated,” Merton boils a piece of it down to the use of put options, a derivative contract that’s been around since the 17th century. This asset-value insurance contract, a guarantee of debt, is the basis for the credit default swaps widely adopted by financial giants in the last few years -- now widely regarded as a primary cause of the meltdown. It turns out, says Merton, that the put “makes risky debt very complicated, and treacherous…”

including: ...mathematical models are incomplete. ...when everybody is doing the mathematics correctly -- ethically & the same way -- and the model is incomplete (as it will be), then the resulting errors (inconsistencies with the unfolding of reality) will be *systematic*

including: ...was the problem actually 'complexity'? turns out, the complexity of plain-vanilla corporate securities (equity, debt) is actually *greater* than the complexity of the CDOs issued by SPVs. Is the govt using 'complexity' as a reason for not valuing the CDOs? ...But, how do you undertake a govt intervention/rescue without valuing the assets? ...perhaps we should have a National Transportation Safety Board for finance?

Brett Sherman: The Wall Street Law Blog: The subprime story -- How it worked, the short version

"Subprime mortgages, of course, are home loans extended to individuals with poor credit. People with credit problems usually have a history of late payments and/or defaults on obligations to creditors. One of the most common reasons that people don't pay their bills on time is insufficient income. In other words, people with bad credit frequently got that way because they couldn't afford to pay bills. These were the people - the ones that couldn't pay their bills in the past - that Bear Stearns, Lehman Brothers, Citigroup, and others needed to be placed in adjustable rate subprime home mortgages in a never-ending supply. To call this concept unethical and ridiculous does not come close to providing an adequate description. Anyone unable to see that the subprime machine had to fail, resulting in both a securities crisis and a housing crisis, any extended sampling of time should immediately cease thinking. This tragedy was more than reasonably foreseeable (a legal standard), it was a stone cold guarantee (not a legal term)."

Michael Lewis: The End of Wall Street (at The Hudson Union Society June 1 2009)

38:47 Ch. 13 The End of Wall Street article

46:26 Ch. 14 Why didn't it get more attention?

49:40 Ch. 15 Media responsibility for Financial Crisis

CSPAN Q&A with Janet Tavakoli, CDO expert and author of "Dear Mr. Buffett" (aired April 19, 2009)

Can Elements of the Danish Mortgage System Fix Mortgage Securitization? (March 26, 2009)

Panelists will review the characteristics of the Danish system that have helped Denmark survive financial crises for over two hundred years and consider whether any of the elements of the Danish system can be useful in the United States.

The originate-to-distribute mortgage securitization system that is in use in the United States has been blamed, in part, for the current financial crisis. The conventional analysis is that it does not require mortgage originators or distributors to share any of the underwriting risk, and thus creates moral hazard as bad mortgages are passed along to subsequent purchasers in the distribution chain. In seeking alternatives to the current system, the Treasury Department and the FDIC have both praised a covered bond system--in which banks continue to hold mortgages in a segregated account on their own balance sheets--that has been used widely in Europe. Although that system has not fared well in the financial crisis, a somewhat different covered bond system used in Denmark over several centuries has not been significantly impaired, despite the fact that the housing bubble in Denmark--which was proportionately larger than the one in the United States--also deflated. In this conference, we will review the characteristics of the Danish system that have helped Denmark survive financial crises for over two hundred years, and consider whether any of the elements of the Danish system can be useful in the United States.

Jamie Dimon, CEO JPM, on the banking crisis: Part 1 (March 11, 2009)

Jamie Dimon, CEO JPM, on the banking crisis: Part 2 (March 11, 2009)

Elizabeth Warren: Toxic assets still in America's banks" (Aug. 12, 2009)

House of Commons Treasury Committee: Banking Crisis -- Executive remuneration (Nov. 19, 2009)


    • Carol Arrowsmith, Deloitte,
    • Ronnie Fox, Principal, Fox Law Firm
    • Peter Hahn, Sir John Cass Business School
    • Charles Cotton, Chartered Institute for Personnel and Development
    • Brendan Barber, Secretary-General, TUC
    • Peter Montagnon, ABI
    • Jonathon Taylor, LIBA
    • Miles Templeman, Director-General, Institute of Directors

Didier Sornette: Financial Bubbles, Real Estate Bubbles, Derivative Bubbles, and the Financial and Economic Crisis (June 2009)

The financial crisis of 2008, which started with an initially well-defined epicenter focused on mortgage backed securities (MBS), has been cascading into a global economic recession, whose increasing severity and uncertain duration had led and is continuing to lead to massive losses and damage for billions of people. Heavy central bank interventions and government spending programs have been launched worldwide and especially in the USA and Europe, in the hope to unfreeze credit and boltster consumption. Here, I present evidence and articulate a general framework that allows one to diagnose the fundamental cause of the unfolding financial and economic crisis: the accumulation of several bubbles and their interplay and mutual reinforcement has led to an illusion of a perpetual money machine allowing financial institutions to extract wealth from an unsustainable artificial process. Taking stock of this diagnostic, I conclude that many of the intervention to address the so-called liquidity crisis and to encouragemore consumption are ill-advised and even dangerous, given the lack of precautionary reserves that have been unaccumulated in the good times and the huge liabilities. The most interesting presents times constitute unique opportunities but also great challenges, for which I offer a few recommendations.

Anatomy of the Mortgage Crisis (Hyun Song Shin (Chair), Mark Zandi, Erica Groshen, David Wilcox) (Nov 7, 2008)

Robert Shiller on the future of outlook for house prices (May 19, 2009)

Peter Schiff Mortgage Bankers Speech (Nov 13, 2006)

William Black: "The Great American Bank Robbery" at the Hammer Forum (Jun 11, 2010)

Quants: The Alchemists of Wall Street (Marije Meerman, VPRO Backlight 2010)

Libor Rate-Fixing Scandal (Matt Taibbi, July 19, 2012)

Dr. Michael J. Burry at UCLA Economics Commencement Speech (2012)

"when the entitled elect themselves, the party accelerates, and the brutal hangover is inevitable"