Download The Reckoning NY Times

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
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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?
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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 ?
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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 ?
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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.