Remember That Financial Crisis?

Yes, we’re all supposed to be much more interested in the oil spill at the moment, but we still remember that whole huge financial crisis right?

If so, then you will want to read Jeff Madrick’s review of Michael Lewis‘ new book The Big Short: Inside The Doomsday Machine.

It’s the best kind of review–it not only gives you a sense of why you would want to read the book, it also places the book in a context, and it functions as one of the better articles on the entire mess I’ve read.

I’ll be getting Lewis’ book, and I’ll comment on it when I read it. In the mean time I suggest you read the article. (And right after I finish posting this, I’m going to go read the online excerpt from Lewis’ book.)

Here’s one bit I quite liked:

But Goldman actually transferred its obligations to naive traders at AIG, the insurance giant, by buying insurance far more cheaply from them to cover Goldman’s liability on the insurance it sold to Burry. As noted, it charged Burry 2.5 percent a year for insurance on the triple-B bonds, but it packaged most of those triple-B bonds into CDOs, turning them into triple-A securities. It then bought, according to Lewis, insurance from AIG on the supposedly less risky tranches for only 0.12 percent, or 12 cents per $100 of bond.

Yeah, there’s a way to make money–sell at $2.50/$100 what you’re buying at $0.12/$100. That’s a bit of a profit margin, for sure.

And here’s a slightly longer quotation to show you what I mean about the review putting the book in a critical context:

Had CDOs been better understood and regulated, the extent of financial collapse would have been mitigated. Had credit default swaps been traded in plain sight and the counterparties like AIG been forced to put up capital, the crisis would have been far less costly. Had the conflicts of interest of credit ratings agencies been dealt with, the tranche system would not have been so abused.

In their new book, Crisis Economics, Nouriel Roubini and Stephen Mihm would require that all derivatives, such as credit default swaps, be traded openly. They would consider prohibiting CDOs altogether on grounds that these derivatives are far too risky and complex. They would demand that investors pool funds to finance credit-rating agencies, removing the major conflicts of interest that derive from issuers paying for their ratings. They would also break up Goldman Sachs and the other big banks into relatively small pieces.

By comparison, the current finance reform legislation before Congress may well turn out to be tame. The provisions of the bill that is passed will probably provide for only a minor breakup of the banks and they may, for example, allow some derivatives not to be listed publicly. Moreover, the bill doesn’t adequately address the conflicts of interest and market-rigging that have discredited the ratings agencies.

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Creative Commons Attribution-NonCommercial-ShareAlike 2.5 Canada
This work by Chris McLaren is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 2.5 Canada.