Michael Lewis has a piece in Vanity Fair that could as easily have been titled The Banality of Derivatives.
Yet the A.I.G. F.P. traders left behind, much as they despise him personally, refuse to believe Cassano was engaged in any kind of fraud. The problem is that they knew him. And they believe that his crime was not mere legal fraudulence but the deeper kind: a need for subservience in others and an unwillingness to acknowledge his own weaknesses. “When he said that he could not envision losses, that we wouldn’t lose a dime, I am positive that he believed that,” says one of the traders. The problem with Joe Cassano wasn’t that he knew he was wrong. It was that it was too important to him that he be right. More than anything, Joe Cassano wanted to be one of Wall Street’s big shots. He wound up being its perfect customer.
I often read/comment on Daily Kos, and one of the subtle surprises is the level of financial illiteracy you can find in a politically motivated, engaged population. These are the folks who vote in favor of rent control even when they do not occupy rent-controlled housing – it sounds like a decent, humane idea and they can’t understand what the consequences might be. Hell, they don’t seem incredibly able to understand how it could be that Microsoft shares trade for a lower number than Adobe shares, if it’s actually true that Microsoft is the larger company.
For these folks – and, I suspect, many others who are even less motivated to inquire of the world around them – the financial crisis of the last year is a giant conspiracy. A few men in NY got together and decided to soak the working man. It is of a piece with all conspiracy theories – the deck is stacked against us, there are a few people who know what is going on and they keep fucking us. In a way it is a very hopeful perspective. It implies that if somehow the good guys could access the levers of power, all of a sudden that tremendous, finely honed machine could be put to work for good and not evil.
The shame is that the world isn’t like this. The government is the group that brings us the Bay of Pigs and Desert One and the Department of Motor Vehicles. It’s a lot more of this:
than this:
And the private sector, well, let’s go to Lewis’ seminal work on the subject, Liar’s Poker:
[Gutfreund] would point out that Salomon Brothers carried eighty billion dollars of securities on its books overnight, every night. He would follow this observation by saying that, in asset size, Salomon Brothers was “the largest commercial bank in the world” and “one of the forty largest countries in the world.” As one (Jewish) mortgage trader said in response, “C’mon, John, you’re not talking about the Netherlands, you’re talking about a bunch of Jews who are leveraged.”
In this crisis, like the ones preceding and, no doubt, the ones that will follow, we ended up where we ended up by accident of good intentions. No one had a diabolical plan to tank the markets; in fact, people generally believed the market would work out the way they behaved. Calculated Risk discusses liar loans stated income loans here, and points out that even today there are advocates of what was a remarkably dumb idea. These folks aren’t trying to create a mountain of bad debt; they genuinely believe it’s a good idea, and it’s this good faith that makes the bad behavior so damn pernicious.
If AIG had been some garden-variety scam, some weird Bernie Madoff variant, you could be forgiven for believing that the solution is grand juries and investigations and more investigations. The reality, though, is that they were all-too-human and all-too-frail; they took massive bets they didn’t think could fail for no obvious reason other than that they had never failed in the past. I was told flatly by a derivatives originator (not at AIG) in 2006 that it was utterly impossible for there to be a nationwide house price decline, that I was describing some sort of Mad Max world that did not merit serious contemplation. And he made tons of money for having that perspective, which likely contributed to his depth of feeling about the underlying merit of his products. His firm had the liquidity to ride out the storm in a way AIG did not, and even today he is minting money doing the same thing he was always doing, now with at least one fewer competitor.
While on the subject of the distinction between negligence and criminal behavior, I have to say that I have been following the Goldman high-frequency trading story from some distance, and as best as I can tell their entire strategy is predicated on what is (or should be) a crime: front-running an open order. On a basic level, the Goldman equipment seems to interface with the NYSE clearing mechanisms such that Goldman is able to identify an order in the process of being filled, grab the allocation and resell it. A trade of 10,000 XYZ would match at $56.27, except GS – having already seen the incoming order from Buyco – puts in its own order, fills it from the delivered 10,000 XYZ shares from Sellco, and turns around to sell them to Buyco at $56.28. It’s not that different from playing blackjack with the ability to see the dealer’s hole card.
If it were true that the stolen portion of the code were such a threat to market integrity, why should Goldman be allowed to retain it? Strikes me as a bit like calling the cops to complain that your kilo of coke was stolen.
Thanks for pointing me to the VF article. Here’s what I think was some key info from the story:
“A.I.G. F.P. was already insuring these big, diversified, AAA-rated piles of consumer loans; to get it to insure subprime mortgages was only a matter of pouring more and more of the things into the amorphous, unexamined piles. They went from being 2 percent subprime mortgages to being 95 percent subprime mortgages. And yet no one at A.I.G. said anything about it—not C.E.O. Martin Sullivan, not Joe Cassano, not Al Frost, the guy in A.I.G. F.P.’s Connecticut office in charge of selling his firm’s credit-default-swap services to the big Wall Street firms.”
I do not profess to expertise in derivatives.
I do not necessarily think there was a massive Wall Street conspiracy that led Wall Street to profit nicely on global misery.
However, I remain to this day astonished that none of those incredibly bright people at AIG FP – like Jake DeSantis – or any of the best and brightest people who rode the current from the Ivy MBA programs straight over to Wall Street – EVER felt that assembling the tower of toxicity was a good thing.
Sure, it was good in the short term for them – but rather miserable in the long run – especially for the AIG folks. (No downside at all, however, if you’re at GS, it seems.)
I understand that Jake worked very very hard at AIG FP – and that half his portfolio was devastated by the collapse of his company.
He’s in very good company – most investors in America lost a lot – the retirees, the families saving for college, the newly unemployed, etc. The big difference – Jake was in a position to effect change before the crash. And so was everyone else at AIG.
That an insurance company would continue to insure those things in “the amorphous, unexamined piles” is not really the business of an insurance company. It is the business of an insurance company to examine risk prior to insuring an item and to say no to insuring large amounts of extreme risk. (Health insurance companies do this all the time…)
Don’t you find it astonishing that when instruments to be insured were composed primarily of subprime mortgages (95 percent!!!), not one person at AIG FP said, “look, that the loan has no clothes!”? Or even simpler, “hey maybe we should check out what’s in the unexamined pile before we insure it.”
Negligence at this level can border on the criminal. Instead of paying a price for poor business judgment or negligence or criminal negligence, AIG execs are currently expecting to get millions in bonuses they feel they deserve. (And since Congress is owned by Wall Street, as Dick Durbin acknowledges, I’m sure they’ll get it.)
I don’t get it – I don’t understand it. Tax money should not be used to pay for bonuses at companies that exist thanks to the support of tax dollars. Extreme business failure has occurred and instead of a reward/bonus, there should be consequences.
The consequences of their business failure (and the failures of so many other financial firms) have been painfully felt by too many Americans – the idea that AIG employees should get bonuses as the unemployment rate continues to rise is absurd.
But without consequences of any kind, we’ll continue to see flagrantly risky behavior from our execs for years to come, with all the downsides that come with it.
First of all, no one thought there was anything wrong with subprime mortgages, because in a rising market there was nothing wrong with subprime mortgages, and all anyone had experienced was a rising market (look at Slide 19 here).
Secondly, even if you were the lone wolf and did think there was something wrong with subprime mortgages, Wall Street can stay irrational longer than you can stay liquid. Imagine you were a prop trader in 2002 and saw all of this coming. Unless you knew the specific date on which the market would capitulate and could wait until then, you would have been short…and you would have gotten yourself fired long before the crash. Even if you had merely sat on the sidelines, you would have been fighting for your career every step of the way. Don’t you think that during some of the fifteen hundred days before the market went your way you would have had some doubts about your thesis? Maybe you could stay confident the whole way – if so, you were born for this game – but I’m not that sure of anything. This is what I meant by “dumb shit“; the more you watch other people making money doing things that don’t make sense to you – selling pet food at a loss over the internet, loaning money to people with limited incomes, trading portfolios of loans to people with limited incomes – the more you start to wonder if the problem is with you.
Now, about the tax money. I think AIG should have been allowed to fail (search “AIG” on this blog and you’ll find dozens of posts). But it wasn’t. And there is no provision in the bankruptcy code for “almost bankrupt.” AIG could have filed and broken its contractual agreements, but it didn’t. I don’t see why Jake DeSantis or any other individual should be denied getting paid out on his contract at par when Goldman and SocGen seem to have gotten 100 cents on the dollar for their contractual claims. You can make the point that a private investor would have insisted on renegotiating the deal before investing, and the government had no business playing so loose with our money. I’d agree with you. But the way the private investor would get the objectionable contracts replaced is by saying “if you don’t renegotiate X, Y, and Z, I will let you file for bankruptcy.” It’s what the government was prepared to do (and did) with the auto companies. But the Treasury was not willing to allow AIG to fail, so it had no leverage. Absurd or not, that’s the way we treat big finance in this country.