Inside Job: Part I (Notes)

[SydTheSkeptic]

My new love is economics.  It's one of my weakest areas when it comes to teaching Humanities so I learn when and where I can in order to have a decent-enough depth of knowledge around it.

 

As it so happens, the Academy Award winner for best documentary, Inside Job, is about the U.S.'s current global economic screw-up.

 

It has so much information and it's not hard to follow so I'm definitely planning on using it next year (if not this one).

 

Undoubtedly, my students will still be grappling with the fallout by the time they graduate (as will their children, most likely), and I want to be real with them enough so that they're prepared to face the current state of the so-called "American Dream".   I think it's an excellent lesson in hubris, too. 

Anyhow, I started taking notes and figured I'd drop 'em here in the chance that others may benefit.  I'd be shocked if anyone actually reads through the whole thing, but there it is.     Cheers!

___________________________________________________________________________________________

 

The global economic crisis of 2008 cost 10,000,000 people their homes, their jobs, or their savings.     This is how it happened.

 

PRELUDE

 

Year 2000, Iceland

A great place to live and raise a family.

Robust economy.

Then comes deregulation.

Banks are privatized.

 

2008

Three banks bring Iceland’s economy to its knees.  

Regulators do nothing. 

A third of them are put on the bank’s payrolls.

 

PART ONE: HOW WE GOT HERE

 

After the Depression, 40 years of economic growth.

Not a single financial crisis. 

Industry’s tightly regulated.

Most banks are small local businesses, prohibited from speculating with depositors’ savings.

Investment banks handle stocks and are small investment partnerships.

Partners front money so they shy away from big risks and watch the market carefully.

 

1980’s

financial industry explodes

Banks go public giving them huge amounts of money to invest.

Partnerships become obsolete. 

People on Wall St start getting rich.

 

From 1978 to 2008

a banker’s average salary goes from 47 to 100K.

For everyone else, it starts at 45 and goes up 3K during that same span of time.

 

1981

Reagan chooses Don Regan as Treasury Secretary (Merrill Lynch CEO) 

With support of his party, economists, & financial lobbyists, Reagan begins push for deregulation. 

 

George Soros uses the metaphor of an oil tanker to describe the financial sector at this point.

It’s enormous.  Compartments (regulation) that kept the oil from sloshin’ around and capsizing the tanker have been taken away.

The tanker now has a much greater probability of sinking, taking with it its precious cargo.

 

1982

Savings & Loan companies are successfully deregulated.

Without oversight, they begin making risky investments 

Example: Charles Keating is one S&L financier (now the most well-known).

He hires Alan Greenspan as his advisor.

Greenspan praises his “no-risk business sense”

 

1986

the first financial crisis

S & L’s begin losing depositors’ savings.

100’s of S & L companies fail.

 Taxpayers pay the cost- 124 billion (and for some, their life’s savings)

1000’s of S & L execs go to jail, including Keating.

 

Greenspan goes on to become chairman of US central bank, The Federal Reserve,

and is reappointed by Clinton and Bush Jr.

 

Under Clinton, deregulation continues.

Treasury Sec. Robert Rubin (Goldman Sachs CEO) and Larry Summers (Harvard economics professor) are key players

 

By late 1990’s

financial sector is consolidated into a few gigantic firms that are so large, their failure could threaten the whole system.

Clinton Administration helps them grow even larger.

 

1998

CitiCorp and Travelers merge to form CitiGroup, largest financial services company in the world

Merger violates the Glass-Steegal Act, passed in 1934, after the Great Depression

The Act, up to this point, has prevented banks from engaging in risky investment activities with consumer deposits.

 

Federal Reserve (Greenspan) says nothing, gives them an exemption for a year.

 

1999

Summers and Rubin urge Congress to pass the Gramm-Leach-Bliley Act (some called it the “CityGroup Relief Act”)

It overturns Glass-Steegal and clears the way for future marketers.

 

Rubin later makes $126 million as Vice Chairman of Citigroup (hence, the Act’s nickname)

 

Late 1990’s

The second crisis

Investment banks fuel a massive bubble in Internet stocks followed by a crash in 2001.

5 trillion in investments are lost in a short amount of time.

The Securities and Exchange Commission (federal agency created during the Depression to regulate investment banking) does nothing.

 

Eliot Spitzer (NY Attorney General) investigates.

He finds that investment firms promoted Internet companies they knew would fail.

Stock analysts were being paid for how much business they brought in.

What they said publicly was different from what they said privately.

Companies with high ratings had no value.

Investment banks didn’t deny it.

Their defense: Everyone was doing it.  In-house analysts should not have been taken seriously by investors.

 

2002

Ten investment firms settle for a total of 1.4 billion (for conflicts in their firm’s stock research) and promise to change their ways.

 

• Bear Sterns                    80 million
• Credit Suisse                 200 million
• Deutsche Bank              80 million
• JP Morgan                     80 million
• Lehman Brothers          80 million
• Merrll Lynch                  200 million
• Morgan Stanley            125 million
• UBS                                 80 million
• Goldman Sachs             110 million
• Citigroup                        400 million

 

Since deregulation began, the biggest firms are caught laundering money, defrauding customers, and cooking their books.

 

• JP Morgan bribes government officials
• Riggs Bank launders money for Chilean dictator Augusto Pinochet
• Credit Suisse launders money for Iran’s nuclear & missile program in violation of US sanctions (fined $536 million)
• Citibank helps funnel $100 million worth of drug money out of Mexico
• Freddie Mac commits accounting fraud (fined $125 milion)
• Fannie Mae commits accounting fraud, overstates their worth by $40 billion (fined $400 million)
• (Clinton’s  former budge director, Franklin Reins, receives over $52 mil in bonuses  from Fannie Mae leading up to 2006)
• UBS is caught helping wealthy Americans evade taxes (fined $780 mil)  and pleads the Fifth
• AIG commits fraud, cooks their books and rigs bids ($1.6 billion settlement)
• Citibank, JP Morgan, and Merrill Lynch help Enron to conceal fraud (fined $385 million) 
• (All are fined but without having to admit wrong-doing).

 

Beginning in the 1990’s

Deregulation and advances in technology lead to an explosion of complex financial products called “derivatives”

Economists and bankers claim they make markets safer, but in reality, they cause instability.

 

The Cold War ends, high tech turns to financial markets to work with investment firms (weapons of mass financial destruction)

Regulators, politicians, and business people poo poo the threat financial innovation poses to the industry.

 

Using derivatives, bankers start gambling on virtually anything.

• -the rise and fall of oil prices
• -the bankruptcy of a company
• -even the weather

 

By the late 1990’s

derivatives are a $50 trillion dollar, unregulated market.

 

1998

The CFTC attempts to regulate.

Brooksley Born, former derivatives manager,

appointed by Clinton to chair Commodities Futures Trading Commission (the CFTC), which oversaw the derivatives market

and her Deputy Director, Michael Greenberger, issue a proposal to regulate derivatives.

Clinton’s Treasury Department (Larry Summers) responds by strong-arming them to stop.

Afterwards, Greenspan, Rubin, and FCC Chairman Arthur Levitt issue a statement condemning Born, saying it’s out of the CFTC’s jurisdiction.

They recommend legislation to keep derivatives unregulated on the basis they’re privately negotiated by professionals so it’s unnecessary.

Born and Greenberger are overruled by Clinton Admin, then by Congress.

 

Sen. Gramm (R-TX) ultimately pushes legislation through to exempt derivatives from regulation on the basis they unify the market.

After leaving the Senate, Phil Gramm becomes Vice-Chairman of UBS.  His wife serves on the board at Enron.

Larry Summers later makes $20 million as a consultant to a hedge fund that relies heavily on derivatives

 

2000

Congress passes Commodity Futures Modernization Act (written with the help of financial industry lobbyists), which bans regulation of derivatives.

Use of derivatives and financial innovation explodes

 

2001

Bush Jr takes office.

Financial sector is now vastly more powerful, profitable, and concentrated than ever before.

 

THERE ARE FIVE INVESTMENT BANKS

• Goldman Sachs
• Morgan Stanley
• Lehman Brothers
• Merrill Lynch
• Bear Stearns

 

TWO FINANCIAL CONGLOMERATES

• CitiGroup
• JP Morgan

 

THREE SECURITIES INSURANCE COMPANIES

• AIG
• MBIA
• AMBAC

 

AND THREE RATINGS AGENCIES

• Moody’s
• Standard & Poor’s
• Fitch

 

Linking them all together is the “Securitization Food Chain”.

Securitization is a new system which connects trillions of dollars in mortgages and other loans with investors all over the world

 

It used to be you got a loan from an investor who expected you to pay back. 

It took decades to repay so lenders were careful.

Old system:

HOME BUYERS-->    LOCAL LENDERS

 

Now there’s “securitization” whereby the people who make the loan are no longer at risk if there’s a failure to repay.

New system:

HOME BUYERS       LENDERS       INVESTMENT BANKS       INVESTORS

Loan Payments   -->  -->  -->  -->  -->  -->  -->  -->  -->  -->

 

In the new system, LENDERS sell the mortgages to INVESTMENT BANKS.

INVESTMENT BANKS sell the home mortgages along with other stuff to create “complex derivatives”. 

• Other stuff= corporate buy-out debt, commercial mortgages, car loans, student loans, and credit card debt

They bundle them all together and call them “CDO’s” (Collateralized Debt Obligations). 

 

INVESTMENT BANKS pay RATINGS AGENCIES to rate the CDO’s based on their profitability and then sell them to INVESTORS.

HOME BUYERS who were previously paying a monthly mortgage to a lender are now paying out to investors from all over the world.

Most are unaware.

 

The ratings for these CDO bundles go like this:

Best-->       AAA

Mid-->       BBB

Junk -->      BB

 

High ratings make CDO’s popular with retirement funds because they only purchase triple A-rated securities

 

The system’s now a ticking time bomb.

• LENDERS don’t care anymore whether BORROWERS can repay so they make riskier loans.
• INVESTMENT BANKS go mostly for subprime loans because they carry the highest interest rates promising the most returns.
• And the more CDO’s they sell, the higher their profits.
• RATING AGENCIES (paid by the INVESTMENT BANKS) have no liability or incentive for accurately evaluating CDO ratings.
• They give thousands of subprime CDO’s a triple A rating because it pays to do so .

 

No regulation, no one seemingly on the hook.

A green light to pump out more and more loans.

Feeding frenzy in the securitization food chain!

 

2000-2003

Each year, mortgages quadruple.

 

2002-2006

Each year, there’s a huge increase in the riskiest loans (subprime).

 

This leads to a massive increase in predatory lending.

All incentives for mortgage brokers are based on selling predatory loans (now the most profitable).

Borrowers are needlessly placed in expensive subprime loans (because the banker makes more),

and many loans are knowingly given to people who won’t be able to repay them.

 

Next…

PART II: THE BUBBLE



[photo2010]

When my Mom was almost 80 years old, a banker at Chase Bank convinced her to take a large part of her savings and invest it in a risky annuity. This was done without my knowing and without the banker telling my Mother of the risks. It was unethical, and IMO, criminal behavior of the bank to be selling such a product to an 80 year old woman who, while still sharp at the time, did not know what the risks were or what questions to ask. At that age, her savings should have only been in federally insured products, and this was not. Almost immediately she lost $2000 of her investment in taxes. When I learned this I was furious! I went to the bank and literally blasted the manager about what they had done to my Mother. He sheepishly agreed it was wrong, but basically shrugged his shoulders. The annuity made money for the bank and lost thousands for my Mother.

[Marie]

Thanks for the notes! It's on my 'to watch' list! I think that you can go back even further to the '70s when free market and deregulation became the darlings of economic theory.

[NatureJunkie]

Good notes, Syd. This is all so staggering. I've heard a lot about Inside Job and I will definitely see it. Not that it makes any difference at all in financial catastrophes involving trillions of dollars or in how the international financial industry is regulated, but I've conducted all my finances at small community banks or credit unions since I was 18. I've never understood the thinking of my friends who insisted on conducting their finances with national corporations, beieving that "bigger" means "safer."

[SydTheSkeptic]

Kevin, very sorry to hear that. 

As I learn about the mechanisms of the financial sector, it's becoming all too clear how it's in the interests of Wall St. for the common citizen to be overly-confused by these matters, even at a personal banking level.  

 

Marie- indeed.  

 

NJ- I switched awhile ago from a big bank and there were SO many obstacles!  It's not as easy as some people might think to change.   Also, when I looked around for a local bank or credit union, many of them required initial deposit and credit checks.   They make sense in the large scheme of things, but it effectively cuts off a large segment of the population.  The choice is there for some, but not for most.

[NatureJunkie]

"...when I looked around for a local bank or credit union, many of them required initial deposit and credit checks."

 

But Syd, those are exactly the kind of safeguards a responsible institution would insist on! Checking to make sure that a potential customer is credit worthy, especially at a credit union, is what makes those smaller outfits the secure lenders they are. For sure it's an inconvenience to change banks (I've done it five times in my adult life), but not more so than, say, buying a car or purchasing insurance.

[SydTheSkeptic]

You're right NJ- those weren't what were in my way (it was more the big bank making it hard to change all the direct deposit stuff), but what I'm saying is that poorer people who are having a tough time of it do NOT have that option.

 

It's kind of like processed food.  It's not good for ya, but it's cheaper and more available than locally-grown, organic whole foods. Same for banks for some.  Easier, but not good for ya.

[photo2010]

Syd, thank you. Regarding the S&L debacle, wasn't one of the Bush family largely involved in that scam? It seems to me that his involvement dipped below the radar and I don't recall any legal repercussions to

him.

[SydTheSkeptic]

Both Neil and Jeb were directly involved.   Neil was on the board of Silverado, whose collapse cost taxpayers $1.3 billion dollars alone.