If the true risks involved in these subprime mortgages or default insurance had been priced into these products, they never would have been rated the way they were. Investors would have been much more wary and demanded much higher yields before buying them, which would have forced the mortgage brokers to be more careful in deciding to whom to give these mortgages and the banks to be much more careful in choosing which ones to bundle. But the money was just too good, the temptation to underprice the risk and privatize the gains just too tempting for everyone involved. And rare was the banker who could resist joining the party. As the former Citigroup CEO Charles Prince told the Financial Times on July 9, 2007, just weeks before the credit markets started nosediving: "as long as the music is playing, you've got to get up and dance." Shareholders, board members, and market analysts were all saying to these financial houses and bosses: Why are you not as aggressive as the other guy? Why are you not bundling mortgages and CDOs? Why are you not bringing in these big returns? All the incentives for CEOs pushed them to take more risk. And boy, were there incentives. In December 2007, with the credit markets already badly shaken, Goldman Sachs Group Inc.'s chief executive officer, Lloyd Blankfein, was granted a $67.9 million bonus, the biggest ever awarded to the CEO of a Wall Street firm.
And if things later went bad for a CEO's firm? No problem. Typically the CEOs' contracts, written in the seven fat years, ensured that the worst they would get were golden parachutes. On November 1, 2007, Merrill Lynch CEO Stan O'Neal quit and received a golden parachute worth $161.5 million, despite the fact that his firm's subprime investments would eventually result in over $2 billion of losses.
Some of our biggest financial firms got away from their original purpose—to fund innovation and to finance the process of "creative destruction," whereby new technologies that improve people's lives replace old ones, said the Columbia University economist Jagdish Bhagwati. Instead, he added, too many banks got involved in exotic and incomprehensible financial innovations that ended up as "destructive creation."
Only when the whole edifice cracked in September 2008 with the collapse of Lehman Brothers, which forced Congress to establish a $700 billion emergency fund for the Treasury to prevent the financial system from melting down, did people grasp what had happened: TWG—"They were gone"—the bankers who piled up these risks and privatized the gains, but WWSH—"We were still here." We had allowed Wall Street investors and executives to underprice risks and privatize their gains, but then force taxpayers to bail them out when the losses threatened a systemic breakdown.