25 April 2012

Typhoid Marys

It turns out that there is an identifiable patient zero (well, two) to The Great Recession. "Money, Power and Wall Street" is a four-part, broadcast as two two-hour segments on "Frontline" on PBS. The first two were last night, and the remaining two will be next Tuesday night. Check local listing for time, but 9 PM is standard. Also, stations typically re-broadcast the first part in the week between. Again, check local listings. It's worth watching. I've kept track of the Great Recession analyses, mostly through newspaper and magazine accounts, not by reading every book written. Can't afford the time or the money, as this endeavor is gratis. The reason I'm admonishing folks to watch because there is new, to me at least, information. The piece is constructed from interviews with participants, professional observers (other Fed members, for example), and authors. Paulson, Geithner, and Bernanke are only shown in news snippets. I doubt we'll see interviews next week. The story is told chronologically, and begins in 1994. Here's where it gets creepy, for me anyway. Regular reader may recall my telling of what it was like being an economics grad student in the early 1970s. Up to then, economics, business, and finance existed, and were taught, from the point of view policy and historical evidence. Policy A intended to elicit response B, and did so in country X at time Y. Structural requirements were M, N, and O, and were strongly in place. That sort of thing. Learn from experience, and propose policies that logically met rational expectations of greedy people. Not a whiff of algebra in sight. Then came the fruition of Samuelson, and both grad and undergrad departments wanted to make it all more rigorous. The early insurgents into these departments were, mainly, those who couldn't or wouldn't make it as mathematicians, physicists, or math stats. The insurgency was led by the dregs. In particular, these people had little to no idea of the policies or history of the fields into which they were enticed. What they could do was manipulate algebra a tad better than a (econ, business, or finance) Ph.D. from 1960. For this they got a safe teaching position and a steady paycheck. Now, run the clock forward about a generation, to 1994 in Boca Raton. This is where it all started; with two 20-something GRRLSSS from JP Morgan who invented the CDO. Their interviews are sliced up and meted out in sound bites through the two hours. Toward the end the program, they kinda, sorta admit that they hadn't any idea what they were doing. A generation of quant insurgency, when they'd taken over the fields, and they still hadn't any idea. The orphans had taken over the orphanage. The program doesn't solely blame them, and does go a bit overboard in blaming Clinton and Democrats. The facts are, even those presented in the course of the program, it was the banks and Republicans who created the legislation. Clinton was gulled and followed along. Notably, Schumer is not mentioned at all. Two points that stuck out to me. First, no one states the obvious, that housing prices are inextricably tied to median income, which was either stagnant or falling depending on which numbers you looked at during the Dubya years. Therefore, for housing prices to explode, corruption had to be at play. No mo money. How could households afford these McMansions on ditch digger wages? They couldn't, of course, so it was at least willful ignorance by banks and regulators. Also, the program focuses on banks, which makes sense from the point of view of fall 2008, but from a forensic point of view, it was mortgage companies which pushed the subprime and ARM pollution into the system. This is mentioned, but only in passing. Second, only one person, an author, states the other obvious point. The alleged reason these two quants created the CDO was to minimize risk. They state that the process had existed in other corners of finance for some time. They merely brought it into retail. Lame excuse. But, of course, financial manipulation, credit default swaps in particluar, doesn't reduce risk. It merely rearranges it, much like the deck chairs on the Titanic. While Lehman may have felt it had sold off the risky bits, when they all started to stink, the coverage didn't exist simply because it couldn't. The mortgage companies and banks had, largely, put all of their eggs in one, and the same, basket; one which had been manipulated to appear both high return and low risk. And they had done that because Greenspan sought to delay Dubya's recession by cratering interest rates. The program, last night anyway, doesn't tell us that. On the whole, watch part one, and tune into part two next Tuesday.

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