EXCERPT: 'Hot, Flat, and Crowded,' by Thomas L. Friedman

Why not? These different piles of loans all seemed so diversified that nothing really big could go wrong. And so AIG gorged on them, but without noticing that these piles of consumer loans it was insuring were changing, said Lewis. After 2005, subprime mortgages went from 2 percent to 95 percent of the consumer loan packages that AIGFP was guaranteeing, without maintaining anywhere near the capital required to cover them if there were widespread defaults. No problem. AIGFP officials were confident that housing prices, even if they fell, could never fall everywhere at once and thereby trigger massive defaults requiring the insurance giant to fork over cash to all the holders of subprime bonds at once. Lewis quotes Joe Cassano, who headed AIGFP at the time, on an investor conference call in the summer of 2007, as the subprime crisis was just starting to unfold: "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 on any of those transactions."

A few months later, housing prices across the land started falling like dominoes and AIGFP's bets were on their way to bankrupting the entire company. That, ladies and gentlemen, is what you call massively underpricing risk.


It is a lot easier to underprice risk when you can take your percentage quickly and then pass off the bad loan to someone else. All that global capital that flowed into Wall Street in search of higher returns in the early 2000s arrived not only at a time of a loosening of credit and a loosening of traditional regulatory constraints in America, but also at a time of a loosening of ethics. Actually, it was worse than that. The Great Recession was caused in part by a broad-based breakdown in ethics by key players—bankers, rating agencies, investment houses, mortgage brokers, and consumers. You can have all the regulations in the world, but when greed tempts large numbers of people to lose sight of any kind of longterm thinking and sense of accountability, regulations won't help you. It was not the illicit behavior that caused the Great Recession. It was all the stuff going on in plain sight by people who should have known better but suspended their beliefs and values and norms and skepticism to get in on the party. Yes, they had "principles." Unfortunately, the whole credit bubble that destabilized the global economy was built on the "principles" known in the banking world as IBG/ YBG—"I'll be gone" or "You'll be gone" when things go bad.

Join the Discussion
blog comments powered by Disqus
You Might Also Like...