Thursday, May 26, 2011

"Too Big To Fail" & "The Big Short"

Last night I watched the new HBO movie "Too Big to Fail" about the financial crisis in America in 2008. The cast was led by William Hurt, playing Henry Paulson, who was trying to save the world from another Great Depression. His team managed to pull it off, but just barely. The end credits of the movie state that this could happen again.

The movie dovetailed nicely with a book I am reading called "The Big Short" by Michael Lewis, which talks about the same crisis, except from the flip side of the coin. Instead of getting destroyed and going bankrupt, there was a select group of investors who saw what was coming with the mortgage market and started betting heavily against it. These people got insanely rich as other companies were going bust. The book details how these people didn't have any supernatural skills, but were just very diligent in doing their financial research and realizing just how reckless Wall Street had become when it came to mortgage bonds.

Among my Conservative Republican social circle, it is popular to blame our economic collapse on Bill Clinton and his social engineering legislation of having the government demand that the banks loan money to uncreditworthy people. Now this legislation might have been problematic, indeed, but the true reason for the collapse was the abuse of the mortgage bond market. Banks realized that they could make money making mortgages to anyone and then re-packaging the debt into mortgage bonds. The money was so good that they couldn't write them fast enough. Eventually standards fell and those mortgages started going bad.

Unfortunately, smart traders had taken out insurance for these bad bonds and the biggest banking houses were on the hook for hundreds of billions of dollars. Part of the problem was that the big houses who wrote the insurance assumed they were writing insurance on something like car loans or credit card loans. The mortgage thing was totally different. In fact, this market in mortgage bonds was so small and so complicated, many of the banks who were making that market didn't understand it themselves.

They felt it was impossible for housing prices to fall everywhere at the same time.

But that is exactly what happens in a bad recession. And when all those mortgages started going bad, the whole world started going haywire.

One of the hidden secrets of the world economy is that a lot of it is based on fantasy. There is no such thing as money. It only exists and has value because we agree to agree that it does. It is actually just a theory. An idea.

Banking worldwide is based on trust. Rules about fractional reserves allow banks to keep only a small amount of cash, yet to loan large amounts out to anyone. The danger of this is collapses and panics and runs on banks where everyone demands their money, for fear of it disappearing.

In "Too Big To Fail", several large financial institutions are teetering on the edge of bankruptcy. Their combined collapse would have taken down banks all over the world and made Americans the scapegoats for a worldwide depression. The United States Government felt they had to do something.

The result was our government bailing out some large institutions with a large cash infusion.
Conservatives hate this. We just hate it.
But the other option was watching the world implode.

I think the moral of the story here is that banks need to get their heads out of their asses. They need to stop making financial instruments they don't understand. Government intervention is not the answer.
Government can do almost nothing competently. Look at the Post Office or Amtrak.
You don't want these people running the financial industry, or the medical field, for that matter.

The Wall Street banks got saved once, but the government needs to give them a stern warning that this will not become a habit.