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February 05, 2009

Laura Flanders, Janeane Garofalo, and me on GRITtv

On Monday, I was a guest on the Laura Flanders Show on GRITtv along with comedian and activist Janeane Garafalo, and journalist Danny Schecter.

Our discussion was about what separates out-and-out frauds like Bernie Madoff from the architects of the subprime crisis and other Wall Street miscreants who managed to get rich by recklessly gambling away other people's money.

Morally, I'd say there's not much difference between Madoff and the folks who hyped liar loans so they could sell the debt out the back door, knowing they'd have made their quick buck before anyone realized that the people who bought the houses and the people who bought that debt were totally fucked when the former inevitably failed to pay the latter. Legally, some of these hucksters may have been on firmer ground than Madoff, but that in itself doesn't make them more ethical.

Nor is there much difference between Madoff and the credit raters who misrepresented bad securities as sound investments because they wanted the rating commission from the crooks who created the securities. Both were motivated by greed, but the corrupt credit raters ultimately ruined far more innocent people.

The irony that I was getting at in the segment was that Bernie Madoff managed to get away with the financial equivalent of a chain letter by falsely claiming to be part of the ostensibly legitimate but virtually unregulated world of hedge funds.

In reality, Madoff wasn't managing a hedge fund or investing in anything, he was running a classic Ponzi scheme. But when Madoff intimated he was making astonishing returns by trading billions of dollars worth of over-the-counter derivatives, few could contradict him because the trades he was alluding to would have been private and unregulated anyway.

We now know that Madoff's apparent financial wizardry was just a front. His methods were old fashioned Ponzi tactics: recruit new marks and divide up their money amongst your existing investors. As long as you can keep up the recruiting rate and your existing investors don't cash out en masse, you can appear to generate amazing rates of return without actually investing in anything.

I was pretty nervous being on TV with Janeane, but I guess I didn't screw up too badly because I got invited back to the Laura Flanders show.

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Lindsay,

You weer fine and how wonderful to see you as opposed to read you and see your photos. They're all impressive.

The topic makes my blood boil. These Wall Street firms are criminal operations. They steal and call it wealth creation.

We really really need to call a spade a spade here. The masters of the universe are nothing but criminals or as John Portman calls them - Economic hit men.

Great job, Lindsay. Next, the McLaughlin Group. Come on, John -- the answer is: Lindsay Beyerstein!

This is really neat, Lindsay!

Congrats, Lindsay! You came off great. (But why did they let all those other people talk? Boo!)

Well done, Lindsey! It's so refreshing to finally see an intelligent round table discussion. Chris Matthews, eat your heart out.

Yuck to Garofolo's tatts. I am so not liking bid mods.

My beef is not with the Madoffs and the Wall Street sharks. They’re just doing what comes naturally to amoral, bloodthirsty predators. Rather, my gripe is with the free market fundamentalist shitheads that thought it would be a good idea to unlock the liquor cabinet and invite the frat boys over to trash the place. We’re approaching thirty years of reaganomics / thatcherism in which the crooks sold everyone on the insane notion that if white collar thievery was completely unfettered, we could all join the mob to loot the store and everyone would get a load of swag and a free pony to haul it home with.

And here we are. The global economy is spinning down the toilet. I lost more in 2008 than I earned by a considerable margin and I’m better off than most. Income for those who are not rich has effectively stalled ever since Saint Reagan handed the till over to the voodoo economics witch doctors. Now we work for free with every prospect of toiling till we drop dead in the traces. The GOP wants more of the same, and why wouldn’t they? The scam has worked out very well for the country club set, and as long as the serfs are too busy gleaning the empty fields for fallen grain too look around, the barons will be fine.

A little quibble, Madoff actually claimed middle of the road returns much of the time. Otherwise, good show.

Wow, I would have watched or tivo'd Grit if I had know ahead of time, how about a more timely heads up next time? Maybe I missed it. Good on you.

Thanks, everyone! I'll be sure to give you guys the heads up next time I'm on the show.

A counter quibble with John, Madoff claimed extraordinary returns in the sense that he delivered strong ROIs like clockwork, year in and year out. He wasn't doubling people's money in three weeks, like some cruder Ponzi schemes. He was offering double-digit returns" year and year out.

The last year was an outlier, but otherwise he gave middle of the road returns: 11.5 percent in 2007, 13.36 percent in 2006, 10 percent in 2005, 10.52 percent in 2004, 10.37 percent in 2003, 13.9 percent in 2002, and 14 percent in 2001 (from here ).
Obviously those are good returns, but lower than many others were making in some of these years. The article notes that this is typical of cons--give very good, but not spectacular, returns so that people will think they're being a bit conservative and then they don't investigate as closely as they might with a 'riskier' group.

I'm glad to see you get it with respect to the rating agencies facilitating the mortgage meltdown scenario by grading the mortgage backed securities "AAA" so that mortgage originators could dump their mortgages and immediately profit. There is another aspect, the derivitaves, from these bogus mortgaged backed securities, which amounted to a gigantic ponzi scheme. AIG is the bottomless pit that characterizes the derivitives aspect of the financial meltdown. Madoff is just a flea in the total picture. The difference between Madoff and the credit raters is in scale. We've had 2,000,009 people newly unemployed in the last 4 months, and that is almostly attributable to the fiancial crisis. The financial crisis wouldn't have scaled to the point it did, had the mortgaged backed securities been grades the junk rating instead of the "AAA" rating that they got. Madoff is very good in one respect, because one can ask this simple question, what was the damage Madoff caused and the impact on the ecomomy, and what was the damage caused by the rating agencies rating the mortgage backed securities "AAA", and why is only Madoff being charged?

NoBuddy, the AAA rating came from a sincere belief that the mortgage bundles were safe. The reasoning was that the mortgage investments were hedged and included mortgages in multiple markets, so the only way they could default was if the entire US had a simultaneous mortgage crisis. Since it had never been observed in history - previously, all housing crashes had been local - the computational models couldn't account for it properly, making the investments seem safer than they actually were.

The hedge fund business model involves having a large pool of money spread among many different investments to minimize risk; this makes it more profitable to invest in risky and illiquid assets, as long as they don't all fail at the same time. Markets are risk-averse, so hedge funds could exploit their advantage with risky investments to make far more money than was previously possible. The problem started with investments so risky and illiquid, like mortgages, that hedge funds were the only market for them. This distorts the normal market expectation of risk aversion, and eliminates the hedge fund's advantage. In the 1990s there was a crisis with Danish mortgages that caused a lot of hedge funds with spotless records to lose a lot of money, simply because they had never before poured money into a market where there were no non-hedging investors.

At no point was there any deception. You could argue that there was an avoidable delusion, but even that is not clear. Hedge funds did work well in generating wealth, arguably more efficiently than before due to their lower level of risk aversion. And after the crisis clears out, they'll probably go back to generating more wealth, until the next time they invest in assets for which there's no other market. Even in this decade, the main activities were individually rational, just collectively irrational.

You could blame the regulators, but that opens a whole can of worms; by asking that the ratings agencies be charged, you're essentially claiming that lost growth is a criminal offense. If so, then what growth rate is normal? If the US had grown in the last 15 years at the same rate as Britain, its GDP per capita would be about 10% higher, which translates to $1.4 trillion added to the American economy every year. To put things in perspective, the pessimistic outlook about this recession is that it's going to knock about 4-5% off GDP.

Ya done did good LB. And you looked good doin it.

Bravo.

Since it had never been observed in history - previously, all housing crashes had been local - the computational models couldn't account for it properly

Surely the people who are smart enough to craft computational models could imagine that if every housing market from Anchorage to Miami is simultaneously rising, they might also collectively and simultaneously fall.


Even in this decade, the main activities were individually rational, just collectively irrational.

Which is generally probably correct, though that would indicate the problem is systemic and more intractable than a matter of busting a few crooks.


You could blame the regulators

More like the whole regulatory setup, or lack thereof, is to blame. Although Madoff was evidently in the habit of being pretty chummy with the SEC folks, which he wouldn’t have done for nothing.


To put things in perspective, the pessimistic outlook about this recession is that it's going to knock about 4-5% off GDP.

The people I know who are losing their livelihoods –and there are more all the time- will be happy to hear that.

Mortgage-backed securities aren't an intrinsically bad idea. Why not buy up little pieces of many different mortgages so that you can make some money off a rising housing market while spreading your risk around? Depends on how likely the mortgages in the pool are to get paid back. A lot of credit agencies knowingly rated bundles of very marginal mortgages as much more likely to get paid back than they actually were.

To put things in perspective, the pessimistic outlook about this recession is that it's going to knock about 4-5% off GDP

You don't hang with real pessimists, then. Try this, for example. Of course you can argue that that's a fringe viewpoint, but I'd say you're engaging in circular reasoning: effectively asserting that anyone who thinks that we're going to lose more than 4-5% from GDP is by definition not serious.

As for the idea (paraphrasing) that no one could have seen this coming and all these transactions were defensible/rational at the time, I think that's ludicrous. Some of the models used to construct derivative values assumed that real estate prices would only go up. It's also clear that, in the case of real estate, the ability to hide bad mortgages and offload them ultimately led to fraud at various levels - most transparently at the lowest level (loan origination) but likely also at higher levels. In any case, an industry that comes to taxpayers asking for an $800 billion bailout can't complain if taxpayers, in turn, expect additional oversight and regulation in return for their money.

Surely the people who are smart enough to craft computational models could imagine that if every housing market from Anchorage to Miami is simultaneously rising, they might also collectively and simultaneously fall.

In principle, you're right. In practice, they didn't. People who are more cynical about the whole issue note that quants are usually people who failed to get academic math jobs. But you don't have to be cynical: crises happen all the time, and are rarely anticipated by large numbers of people.

The people I know who are losing their livelihoods –and there are more all the time- will be happy to hear that.

It goes both ways. If the US had had that 10% extra growth, it would've created new livelihoods for many people, especially at the bottom of the ladder. Blair did a lot to reduce poverty, and if Clinton and Bush had had the same track record, the US would've had far fewer very poor people now. I know that people potentially lifted from poverty are less heart-wrenching that upper-middle class people reduced to lower-middle class status, but they're no less important.

Besides, is the situation right now really worse than it was in the 1950s, when the US had a recession every four years, or before the Depression, when it was in recession almost as often as it was in growth?

A lot of credit agencies knowingly rated bundles of very marginal mortgages as much more likely to get paid back than they actually were.

I don't know what you mean by "Knowingly." The credit agencies knew that each individual mortgage had a fairly high chance of delinquency. But based on their then-solid models, they believed that the risk of default on all mortgages in a bundle was very low. When Greenspan said the mortgage risks were fully hedged, he wasn't randomly saying something that would soothe investors; he meant something specific about the way high-risk investments could be turned into low-risk investments, which had worked well for twenty years.

The problem was something completely different. People really believed in Greenspan's wisdom, and didn't want to be the party poopers saying there was a housing bubble. Conversely, Greenspan was surrounded by a crowd of cheerleaders, so he started to believe in the hype that he was the Maestro. Of course he'd be certain everything was fine.

NoBuddy, the AAA rating came from a sincere belief that the mortgage bundles were safe.

There is plenty of anecdotal and circumstantial evidence to suggest otherwise. Even "sincerity" though doesn't exclude groupthink and rank stupidity, both of which were hugely in evidence in these firms.

To put things in perspective, the pessimistic outlook about this recession is that it's going to knock about 4-5% off GDP.

And for a little further perspective one can reflect on what was considered the "pessimistic outlook" a year ago, and how far removed it was from the reality we're experiencing today.

James K. Galbraith said in the NYT a few months ago that he thought "maybe ten or twelve" professional economists (out of a population, in this country, of around 15,000) had clearly seen this disaster coming. My working assumption is that no one today has any idea what the sum of these toxic assets will turn out to be, and no one has any idea how far we're all going down.

If groupthink were a chargeable offense, every blogger and blog commenter would be in prison now.

And even the "10-12 economists" who saw the crisis coming don't think the contraction will be that big. Krugman is comparing the crisis to the Great Depression only in that monetary policy has reached its limit; I haven't seen him estimate the sum total of GDP contraction, but he seems to have little problem with the official estimates of about 3%, and is more worried about a lost decade of growth, on the model of Japan and Germany in the 1990s.

Bbartlog, the article you quote is fringe for many reasons other than economics - for a start, the guy who wrote it is a Christian reconstructionist in the tradition of Rushdoony. Nor is the website where it's published a very good source for any discourse - Lew Rockwell has segregationist views.

The credit agencies knew that reality didn't match their models. For example, it was common knowledge that unscrupulous mortgage brokers were teaching applicants tricks to appear more credit-worthy than they really were. Or, the ratings agencies accepted ridiculously lax guarantees as evidence of creditworthiness--e.g., loans based on unverified assurances by the borrower about how much they make.

If the ratings agencies were compensated by the predictive value of their ratings, they would have had an incentive to investigate whether the underlying mortgages were toxic or not.

But in fact, they had an incentive to keep their clients happy--their clients being the people who were churning out these crap mortgage-backed securities and needed AAA ratings to trick institutional investors and little old ladies and gents into sinking their hard-earned money into toxic assets.

As I said, they knew that individual mortgages were risky. Nobody wanted to make NINA loans, if the more traditional mortgage loans weren't all taken. They knew there was a good chance an individual mortgage would fail, and an even better chance if housing prices came down. They just didn't think housing prices would come down nationwide.

Lindsey, you were articulate and relaxed and your points were coherent and well phrased.

But- you tend to speak, particularly toward the end of long sentences, in what linguists call "creak" or "creaky voice." Dispite the ugly name, it's not an ugly sound, and it's a way of speaking that's common in the Pacific Northwest, particularly among women, so you come by it naturally. But it's not a persuasive sound. It's a bit self-deprecating to many people's ears.

Here are a couple of discussions of creaky voice, including links to speakers who use it in a more exaggerated way than you do. You can listen to them and decide whether you want to avoid it (easy to do) or whether you think it's your natural voice and want to leave it alone.

I'm a long-time fan of yours. I'm reading the Independent now because of you, and I hope to see much more of you on TV.

http://seattlepi.nwsource.com/local/225139_nwspeak20.html

http://en.wikipedia.org/wiki/Creaky_voice

Alon, the point is that many credit rating agencies falsified their ratings relative to easily discernible objective reality. Garbage in, garbage out--even if your model works perfectly based on accurate input.

Part of the job of a ratings agency is to determine whether there's some systematic reason why the borrowers in a pool might be less creditworthy than they appear on paper.

In fact, there were several readily ascertainable systemic reasons why whole pools of borrowers were less creditworthy than they seemed on paper: Nationwide fraud.

There were also nationwide reasons why the housing market seemed to be rising everywhere--such as very public federal policies promoting home ownership with floods of cheap money after 9/11.

Corrupt ratings agencies chose ignore readily apparent discrepancies between claims and reality because a) They were on the take, b) They naively assumed that an infinitely rising housing market would wash all sins away because even the sketchiest borrowers would have bought ever-appreciating assets that could always be sold to cover their debts. They got caught out, just like Bernie Madoff did.

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