Friday, March 18, 2011

All the Devils Are Here by McLean & Nocera - Book Review


When we think about the captains of industry, the people who manage and direct our economic life, we like to believe these people are hugely competent managers who direct their companies and firms toward serving the customer and providing services we all want and need.  Many of us, through our direct investments or through the pension funds, 401K's and mutual funds that control our retirement futures, have placed our trust in these managers to invest and manage our money in ways that will conservatively lead to sufficient income to make our retirements comfortable and enjoyable.  All The Devils Are Here: The Hidden History of the Financial Crisis by Bethany McClean and Joe Nocera does an excellent and highly readable job of disabusing us of these misconceptions and beliefs. The book examines the financial crisis, which still bounces around our economy in all its virulent forms, in detail. Sometimes the proliferation of acronyms and financial jargon requires re-reading, but a convenient glossary and carefully explained examples in layman's language make the dimensions and elements of the problem and it's inevitable results clear and readable.

Bethany McLean

Joe Nocera is an award winning business writer for the New York Times with extensive experience in business journalism.  Bethany McLean is a contributing editor for Vanity Fair Magazine and has written extensively about business matters including a book on the collapse of Enron.
  
Joe Nocera
 

All the big names are here. AIG-FP, Countrywide Financial, Bear Sterns, Fanny Mae, Freddie Mac, and, of course, Goldman Sachs. As the title says, All the Devils Are Here except that they're not merely the names of companies and agencies, they're real people behaving like real people. We don't meet here the high-minded leaders of institutions that control our financial future.  Rather, we encounter the ego driven motives of (mostly) men who are limited by their own needs, perspectives, understandings, and ego. These people are much like those Tom Wolfe describes as "Masters of the Universe" in his excellent novel The Bonfire of the Vanities.  And that's where the important learnings this book has to offer occur.  Alan Greenspan emerges not as the data-based savior of our economic system three presidents appointed, but as a vain political suck-up too influenced by Ayn Rand's rantings to be able to recognize the need for careful and powerful regulation of the system.  One of the important principles emerging from this book is an understanding that government regulators were too easily influenced by political pressure from the legislative and executive branches and too much in awe of the supposed brains and money of the financial elites to do their jobs.

Alan Greenspan

In case after case, people like Angelo Mozillo, founder of Countrywide, and Stan O'Neal, CEO of Merrill Lynch, were so blinded by their ambition and hubris they were unable to perceive the problems their policies were creating and unwilling to hear the bad news subordinates brought to them. In fact, people who tried to alert the top executives of the corporations involved in our financial disaster were almost uniformly relegated to positions where they had no influence and the ear of no one in a position to effect change or improve policy. Thus, the top men created environments where ambitious traders, happy to take home annual bonuses in the tens of millions of dollars, created huge risks only a few people in the back rooms recognized.  The testosterone of the trading floor always trumped the conservative bankers' urge to assess risk carefully. This led voracious loan officers to sell mortgage products to potential home owners who  could never understand them and whose obligations they could never meet.  The loans were then cut up into financial instruments repeatedly and sold to investors around the world, building risk on risk that no one wanted recognize as dangerous.  Complicit in all this were almost all those involved in placing mortgages and turning them into negotiable instruments that divorced the homes and homeowners from those who held the paper.  The continual effort by some to blame the purchasers of no down payment mortgages they could never afford to pay off places the blame in exactly the wrong part of society. The homeowners were merely pawns in a game they could never understand.

Angelo Mozillo - Founder and CEO
Countrywide

As I read through this horror story, there are some principles which arose for me.(1) Markets don't work as the process takes place.  The ceaseless effort to increase yield in order to increase sales and burnish companies' bottom lines became a race to the bottom as the only way to bring in money was to sell mortgage products to people who couldn't afford them.  (2) Regulators often regulate in favor of the entity they're supposed to keep under control.  As individuals moved from corporations to government they brought with them the culture and values of the organizations in which they were nurtured. They bought the rhetoric of their training.  The language of increasing home ownership by providing sub-prime mortgages and then creating instruments like Credit Default Swaps and Collateralized Debt Obligations  to hedge them never increased home ownership. A vast majority of the bad loans were made to people refinancing their homes on the theory that they could refinance and then take equity out, thus having more to spend on other luxuries.  Many homes bought under these conditions were never even occupied.  (3) Risk Management disappeared. Risk managers in financial institutions are like internal regulators. When they get pushed aside at a bank or brokerage house, it's a clear sign that the testosterone of the trading floor has taken over and problems are likely to arise sooner rather than later.  While loan originators were busy providing no down payment loans, risk managers were sidelined and high pressure traders took over.  One banker said that bankers ignore the four C's (credit, collateral, capacity, and character) at their risk. (pg. 149).

Irony!
Rubin, Greenspan, Summers

As we look at the chaos the banks left behind and come to understand the culpability at the top, we cannot avoid anger, and perhaps despair, at the continued granting of huge bonuses to executives and sales personnel who are rewarded for creating no economic engine or tool that benefits anyone but them.  There appear to be precious few good guys and no real rewards for them.  It's sad to consider the ego and ambition of bankers, brokers, and politicians are more the driving forces as they have large and powerful toys to feather their own nests while damaging the rest of us. All The Devils Are Here by Bethany McLean and Joe Nocera is a worthwhile read for anyone wishing to come to a better understanding of the complexities that led to the financial collapse. It doesn't, however, suggest that we're any nearer a cure for the next bubble to come along.
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