Taken from the top, these sentiments imply that the financial crisis was caused by fraud;
It was. The common law of business balance prohibits getting something for nothing. Absent concealment (that is, fraud) these deals don't get made on-balance.
that people who take big risks should be subject to a criminal investigation; that executives of large financial firms should be criminal suspects after a crash;
If they engaged in fraud, they should.
that public revulsion indicates likely culpability; that it is inconceivable (to Madoff, anyway) that people could lose so much money absent a conspiracy; and that Wall Street bears collective guilt for which a large part of it should be incarcerated.
Again, if you engaged in fraud, you should be.
These assumptions do violence to our system of justice and hinder our understanding of the crisis. The claim that it was "caused by financial fraud" is debatable, but the weight of the evidence is strongly against it. The financial crisis was accompanied by fraud, on the part of mortgage applicants as well as banks. It was caused, more nearly, by a speculative bubble in mortgages, in which bankers, applicants, investors, and regulators were all blind to risk. More broadly, the crash was the result of a tendency in our financial culture, especially after a period of buoyancy, to push leverage and risk-taking to the extreme.
So let's see.... it wasn't the selling of mortgages to people under false pretense - which, I remind you, was admitted to under oath during FCIC hearings - that allowed the practice to continue?
Exactly how many loans can you make without selling them to someone? Why you can only make loans until you run out of money! In order to get more money, you must sell the loans you made to someone else, clearing your balance sheet and thereby allowing you to make more loans.
But that becomes a problem when you make loans at 6% interest that have a risk-adjusted interest rate of 8%. Nobody will buy them at 6%. And therein lies the fraud: You tell people that the credit quality is better than it actually is, thereby inducing them to buy something they would otherwise not.
In the vernacular of Goldman and others, these loans were (in their own words now) "vomit", "dog ****", "crap" and other colorful adjectives.
How much would you pay for a box full of vomit?
So how do you sell a box full of vomit? Why you lie about what it is!
That would be fraud.
As this list suggests, the meltdown was multi-causal. That explanation will be unsatisfying to armchair prosecutors, but it has the virtue of answering to the complex nature of the bubble. To prosecute white-collar crime is right and proper, and a necessary aspect of deterrence. But trials are meant to deter crime—not to deter home foreclosures or economic downturns.
Actually, prosecutions are meant to punish crime. If we get a deterrent effect out of it that's so much the better.
This distinction may seem a quibble, but the yearning to pin the crisis on a handful of supposed criminals distorts the story we tell about it. The mortgage crisis was a societal breakdown—a massive failure of the private market, Wall Street in particular. It wasn't, fundamentally, rooted in fraud.
The hell it wasn't. You can't sustain a bubble without fraud. Willful and intentional concealment of material facts are necessary for a real bubble to really get cranking. Oh sure, the start of them is always a "pie in the sky" view of the word but the mathematical facts of compound functions mean that soon you have to start lying or the next sucker inevitably fails to appear.
I wasn't a fan of Goldman's slickness in letting a short-seller design a collateralized debt obligation that Goldman marketed to clients, for which it was sanctioned by the Securities and Exchange Commission. However, its unsavory dealmaking should not obscure that in betting, correctly, against the housing market,
That is not the issue. The issue is what it led clients to believe. If Goldman sold a security to someone by representing that they believed it would perform when in fact they were short the instrument that is fraud. They lied about a material fact absent which the investor would likely have not made his investment, and he suffered a loss as a direct consequence of the falsity of this presented "fact."
Mortgage securities had an element of Ponzi in that new financing was required to sustain people whose mortgages were under water. However, many companies would grind to a halt without refinancing. The reason they don't is that most have genuine income. This was also true of mortgage securities.
Ah, but that's not the problem. Many of these "loans" were made by institutions who knew that the taker of the loan could never perform as agreed. "Option ARM" loans were one such product; 2/28 and 3/27 loans were another. Therefore, there was exactly one way that loan could not blow up in their face: the house had to continually rise in value so that refinancing would be always possible.
But that's a mathematically impossibility. And therein lies the problem - representing something that's not mathematically possible to people is a fraud.
As just one example for house prices to advance by a "mere" 6% annually for 30 years results in a $100,000 house costing an astounding $574,000 at the end of that period.
Do you really believe that can happen?
More to the point, what was sold to people wasn't 6% appreciation - it was closer to 11%. That makes your $100,000 house worth $2,289,230 in 30 years.
Still think this was all "irrational exuberance" eh?
Oh, incidentally, bankers all know these ratios. In fact they have a name for the time to double - "The Rule of 72."
Even so, being negligent and even reckless with a viable business is not the same as cooking up a scheme in which revenue never existed.
Ok, I'll bite. Where was the homebuyer's revenue to support that house price going to come from? Could it ever exist as a matter of mathematics? No.
There was genuine debate over whether a bubble existed. This is not to deny the atrociously unsound, and often unethical, loan practices. It is to assert that Stan O'Neal probably did not recognize that the mortgages his firm owned were a house of cards.
Then how did people on the trading desks come to call these loans "vomit" if they didn't recognize that the mortgages were a house of cards?
Seligman says he sees "a serious enforcement effort," both civil and prosecutorial. It's hard, of course, to second-guess any specific decision not to indict. But it's worth remembering that in the American legal system, people who merely act badly or unwisely do not do time. And people who contribute to a financial collapse aren't guilty of a crime absent specific violations that make them so. We should be thankful for that.
How about those who act badly, lose money, and then demand a bailout lest the end of the world ensue?
Did we somehow excise the word "extortion" from our legal dictionary as well?
Just asking, mind you.
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