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Transcript
What went wrong with our economic system? NY Times Articles in this series explored the causes of the financial crisis and recession of 2008 -- Behind Insurer’s Crisis, Blind Eye to a Web of Risk Although America’s housing collapse is often cited as having caused the crisis, the system was vulnerable because of intricate financial contracts known as credit derivatives, which insure debt holders against default. They are fashioned privately and beyond the ken of regulators — sometimes even beyond the understanding of executives peddling them. Originally intended to diminish risk and spread prosperity, these inventions instead magnified the impact of bad mortgages like the ones that felled Bear Stearns and Lehman and now threaten the entire economy. Washington Mutual Built Empire on Shaky Loans At WaMu, getting the job done meant lending money to nearly anyone who asked for it — the force behind the bank’s meteoric rise and its precipitous collapse this year in the biggest bank failure in American history. On Wall Street, Bonuses, Not Profits, Were Real E. Stanley O’Neal, the former chief executive of Merrill Lynch, was paid $46 million in 2006, $18.5 million of it in cash. In all, Merrill handed out $5 billion to $6 billion in bonuses that year. But Merrill’s record earnings in 2006 — $7.5 billion — turned out to be a mirage. The company has since lost three times that amount, largely because the mortgage investments that supposedly had powered some of those profits plunged in value. On Wall Street, Bonuses, Not Profits, Were Real Unlike the earnings, however, the bonuses have not been reversed. As regulators and shareholders sift through the rubble of the financial crisis, questions are being asked about what role lavish bonuses played in the debacle. Scrutiny over pay is intensifying as banks like Merrill prepare to dole out bonuses even after they have had to be propped up with billions of dollars of taxpayers’ money. While bonuses are expected to be half of what they were a year ago, some bankers could still collect millions of dollars. Debt Watchdogs: Tamed or Caught Napping? Moody’s, which judges the quality of debt that corporations and banks issue to raise money, had just graded a pool of securities underwritten by Countrywide Financial, the nation’s largest mortgage lender. But Countrywide complained that the assessment was too tough. The next day, Moody’s changed its rating, even though no new and significant information had come to light. Moody’s had assigned high grades to many securities containing Countrywide mortgages. Those securities and mortgages, issued during the lending spree of recent years, later soured — leaving investors with large losses and homeowners and communities struggling with foreclosures. Debt Watchdogs: Tamed or Caught Napping? Since the subprime mortgage troubles exploded into a full-blown financial crisis last year, the three top credit-rating agencies — Moody’s, Standard & Poor’s and Fitch Ratings — have faced a firestorm of criticism about whether their rosy ratings of mortgage securities generated billions of dollars in losses to investors who relied on them. Pressured to Take More Risk, Fannie Reached Tipping Point Fannie, a government-sponsored company, had long helped Americans get cheaper home loans by serving as a powerful middleman, buying mortgages from lenders and banks and then holding or reselling them to Wall Street investors. This allowed banks to make even more loans — expanding the pool of homeowners and permitting Fannie to ring up handsome profits along the way. Pressured to Take More Risk, Fannie Reached Tipping Point Disregarding warnings from his managers that lenders were making too many loans that would never be repaid, Mudd steered Fannie into more treacherous corners of the mortgage market. For a time, that decision proved profitable. In the end, it nearly destroyed the company and threatened to drag down the housing market and the economy. the White House was forced to orchestrate a $200 billion rescue of Fannie and its corporate cousin, Freddie Mac. Greenspan Legacy ? For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” Mr. Greenspan told the Senate Banking Committee in 2003. “We think it would be a mistake” to more deeply regulate the contracts, he added. The problem is not that the contracts failed, he says. Rather, the people using them got greedy. A lack of integrity spawned the crisis, he argued in a speech a week ago at Georgetown University, intimating that those peddling derivatives were not as reliable as “the pharmacist who fills the prescription ordered by our physician.” Greenspan Legacy ? But others hold a starkly different view of how global markets unwound, and the role that Mr. Greenspan played in setting up this unrest. Warren E. Buffett presciently observed five years ago that derivatives were “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Over the years, Mr. Greenspan helped enable an ambitious American experiment in letting market forces run free. Now, the nation is confronting the consequences. Greenspan Legacy ? were created to soften — or in the argot of Wall Street, “hedge” — investment losses. For example, some of the contracts protect debt holders against losses on mortgage securities. (Their name comes from the fact that their value “derives” from underlying assets like stocks, bonds and commodities.) Many individuals own a common derivative: the insurance contract on their homes. Derivatives Greenspan Legacy ? On a grander scale, such contracts allow financial services firms and corporations to take more complex risks that they might otherwise avoid — for example, issuing more mortgages or corporate debt. And the contracts can be traded, further limiting risk but also increasing the number of parties exposed if problems occur. Throughout the 1990s, some argued that derivatives had become so vast, intertwined and inscrutable that they required federal oversight to protect the financial system. In meetings with federal officials, celebrated appearances on Capitol Hill and heavily attended speeches, Mr. Greenspan banked on the good will of Wall Street to selfregulate as he fended off restrictions.