I wrote this back at what proved to be the height of the crisis. I had occasion to find it and reread it. Interesting reading in retrospect…
January 30, 2009
I had dinner last night with a guy whose career wandered through nearly a half-dozen major brokerages. He was at ground zero of the securitization and creation of the alphabet soup of the real estate market. He ushered these new era inventions past the lawyers and regulators, launching them with the ringing endorsement “We don’t see any legal reason why you cannot do that.” He attained the level of CEO of a major banking subsidiary, until jumping ship a few years back as it became clear the game was over. He is still actively involved with the Fed trying to help sort out this mess.
I should first provide my impressions of the man. To some, this guy is Lord Voldemort. I was fully expecting to find him repugnant, arrogant, insufferable; I was prepared to either bite my lip bloody or do battle, whichever seemed more constructive. In a ping-pong-like exchange that spanned five hours, however, I found him remarkably endearing, humble, and contrite. Oddly enough, at no point did I find myself casting blame on him. Many of his actions–actions that were clearly extreme in retrospect–were shockingly understandable in context. In short, I really liked the guy. This will be hard to understand (and certainly draw scorn) based on what follows.
So what did I learn? Wall Street and the banking system is every bit as nuts as we all think. A bunch of twenty somethings with little or no adult supervision came up with ideas akin to extreme sports you see on Youtube. They did it because they could. You want leverage? Imagine a 20 billion dollar portfolio of mortgage backed securities with a capital base of $10k–literally 2 million-fold leverage. Imagine the shock of the inventor as he watches as his successors expand similar portfolios up to $900 billion. After running out of gullible Japanese bankers (and the Japanese were indeed pissed off before it was over) these young cowboys began trolling for other pools of gullible buyers: hedge funds, pension funds, and University endowments sufficed. They even found some local suckers. While sitting in a meeting listening to some guy within his own firm rant about some great tranche he just purchased for the firm, my dinner guest jumps up and blurts out, “That’s the dogshit that we sold into the open market you idiot. You don’t eat your own dogshit!” Squareds and cubes were described with the same level of astonishment that I was experiencing listening to the details.
How did we go so far off the tracks? He offered a few nuggets that seemed to explain the credit bubble. To reiterate, there really was no adult supervision. The guys putting these packages together certainly had some sense that they were crazy but nobody said stop. Government regulators being paid $100k couldn’t tell guys making $20 million to take a hike. The senior managers loved the money flows. Cubicles–millions of cubicles–were staffed with engineers, chemists, physicists, and mathematicians from the best colleges in the country with no knowledge of the history of markets, fat tails, and past human follies, only how to finanically engineer.
Several critical mutations occurred over time:
(1) The average career age in the business is something like 7 years. A twenty year veteran is a very old man. The creators of these new-fangled products understood the toxicity at some level. As they retired, however, the next generation of twenty somethings had zero sense of risk. They were simply told which button to push and which lever to pull to make money. Nobody was driving the cab at all.
(2) The money overwhelmed the system. It was like when the computers gained consciousness in Terminator. The money pushed all regulations aside. It bought deregulation, politicians, and anything else necessary to keep the money machine growing. Nobody dared yell stop because so damned much money was being made.
(3) Greenspan became a believer–he lost consciousness. (This has some bias from me; the evils of AG were not refuted.) As to whether he understood what he was doing or knowingly let the scam run remained unanswered. (I personally suspect that arrogance and incompetence mixed toxically to produce a world-class dickhead.)
So where are we now, and where are we heading? This is the bad part: I thought I was the pessimist. Sheesh. He was describing a system infected by flesh eating bacteria. Every day looks more dire than the previous day. The solutions being proposed look feeble, and the Fed looks both powerless and confused. The good bank/bad bank model that lit up the market yesterday was suggested to be flawed because the good banks would turn bad soon thereafter. When asked about seemingly stable local banks, he suggested they too would become infected. I expressed shock that JPM not only didn’t bring the system to its knees but was the last bank standing. That Jamie Dimon is quite a guy, eh? Apparently, I inferred from the answer (am nervous about explicitly attributing by quote) that JPM is on a don’t ask/don’t tell policy; the Fed simply cannot handle another mega-catastrophe while they wrestle with the fully-insolvent Citigroup and Bank of America. I suspect that JPM was told to keep everything looking peachy to buy time. (Maybe this was what caused the delayed reaction of Bank of America when it should have been gagging on its own vomit months ago.) Jack Welch got very low grades for engineering his balance sheet, moving to shorter duration debt to make GE profitable. The car industry is DOA. Germany and the UK are battling for the bottom rung of the sovereign ladder (above Iceland hopefully.) Why has the NYC housing market held up? Supposedly, it is only a matter of time: “New York may look like Detroit in ten years.” When peers claimed housing would bottom after a 40% drop, he asked “Why will it stop there?” No answer. Last but not least, the failed German bond auction was deemed catastropic: Who is gonna buy up our trillions? No answer.
In short, he sees no way out of this mess without serious pain. Despite a deflationary slant today, he sees inflation and spiking interest rates as the risk going forward. (I am short treasuries at a token level: Booyaa skidaddy!)
He finished on an upbeat note. He sermonized to my class, noting that the HR people at his last employer nicknamed the young employees the e-generation. What does the e stand for, they were asked? Entitlement! He urged the students to bust their asses, eat buckets of shit when necessary, and plan on working hard for a living. He reminded us that, by any measure, the US still has the resources and political system to dominate the globe. The healing will require retooling the workforce and educational system. The most critical part of the healing process may be a severe beating. Hard to argue with any of that if you ask me.
There you have it folks.