I'm going to go right back to the core problem that started the world careening to financial ruin... The collapse of the US sub prime market. Let's look at the players involved and what went wrong. 1) The end customer. These were people who were buying properties they could not afford with very cheap loans, either because they were stupid, or very shrewd. The stupid people were the ones that didn't really understand how their mortgage worked, ie that it would get much more expensive in 2 or 3 years. These were people who believed that the value of thier property would just keep going up forever. These kind of people took on either very low rate initial period loans, or even worse the self amortizing variable rate mortgages that actually paid the interest payments out of the mortgage loan itself, ie. to the borrower it appeared to be free, but the underlying debt got bigger and bigger. The shrewd ones where the people who owned no real collateral, so bankruptcy wasn't an issue.. someone was effectively saying you could live somewhere for free for a couple of years, after which you'd declare yourself bankrupt and leave the keys under the mat. Happy days! 2) The Mortgage broker. These people were often greedy and unscrupulous, but at the end of the day they were just doing thier job, which was to sell loans to people. They were salespeople, paid on a number and if they could get their number and make lots of money because the lenders were stupid enough to let them sell loans to people who were never going to pay them back, then really, who can blame them. 3) The mortgage lenders. Again, greedy, but just doing thier job. They were able to sell debt on and take their cut, effectively with no risk to themselves, so all good for them. 4) The banks. Greedy, reckless but just doing their job, ie. making money for their shareholders. They found a way of buying loans from the mortgage lenders, packaging them up in bonds, getting an AAA stamp, and reselling them to either gullible investors or... 5) Other banks, who then packaged the worst of the bonds, the ones that couldn't get a decent rating, into CDO's (Collateralised Debt Obligations) which could get a good rating. Why? Because the banks managed to persuade the ratings agencies that if a CDO consisted of lots of different types of bad loans it was 'diverse', which meant it was safe, bingo, AAA rating. It was basically like saying here's a pile of cat poop, here's a pile of dog poop, and here's some pidgeon poop.. If I put them in this box and shut the lid, they're now gold! And why did people buy these CDO's? Because they had good ratings, and some of them, the really dodgy ones made up of the worst bonds payed amazing yields. In fact the really dodgy ones were so popular that there weren't enough to go round, so people started making synthetic CDO's, which had no real debt, just credit default swaps at the other end.. pure gambling. So everything went a bit crazy, as people were making a lot of money due to a fundamental flaw in the system. That's just how the free market works, any gaps or flaws are always eventually discovered and exploited. And here was the flaw: The people giving the ratings on which everything was based.. prices, yields, whether a certain bond or CDO was an acceptible investment for a low risk pension fund, etc, etc, were being bought and bullied. Of course I'm referring to.. 6) The ratings agencies. And here in my opinion is the core of the problem. If there was one area I had to point my finger at and say THIS is where it all went wrong, it would be the ratings agencies. They are the most guilty, because all the above, whether stupid, or greedy, or both, were just doing their job.. the ratings agencies job was to make sure things didn't run away with themselves. They failed. Why? 2 things. Firstly, the kind of people who tend to work at ratings agencies are not as strong willed as people who tend to work on trading floors, and these were the kind of people being sent in to these meetings, so there was an element of bullying going on. Secondly, and more fundamentally, the ratings agencies are not government bodies. They are companies, and are in direct competition with each other. They are competing for fees from banks, so we have free market conditions in play in an area where they have no right to be, ie. between an industry and what is effectively part of it's regulatory system. This is where things broke down. This is the core of the whole problem. It is not in any of the ratings agencies interest to tell a bank they are wrong, as there is a threat the bank will just go to another agency. So they just did as they were told. Remember the 3 types of poop? Well, the bank would go to the agency with a box, and the ratings agency would tie a ribbon around it without opening the lid. So this is why ithink this whole mess could have been avoided if the ratings agencies had done their job, and the fact that they were, and still are, in competition with each other, means that we are at risk of the same thing happening all over again. It amazes me that hardly anything is said about this. There were a few comments when they downgraded the US in august, (ie. why does anyone listen to these jokers when they gave sub prime debt AAA), but the fact is, people as a whole still do listen to them. They need to be renationalised or at least merged into a single firm, as at the moment we have a flawed system, and it's very easy to fix. All the complex plans of ring fencing, recapitalisation, tougher regulations etc, etc won't help if at the core of the system there is still someone trying to turn sh1t into gold.
I think all of the players were guilty, not just the rating agencies: The foolish and gullible customer who took out loans that they could not afford; The unscrupulous mortgage broker who mis-represented the loan terms and scored sales to those gullible customers knowing full well that they could not afford it, and also knowing full well that they could sell them off to gullible investors, by again mis-representing the quality of those mortgages; The bankers who bundled the low quality mortgages and sold them to other investors, knowing full well that the majority of the buyers and the even the rating agencies would not be able to verify the amount of risk hidden in those bundled securities. I would say if there is a single cause to this mess, it is a failure of unfettered free market capitalism. By definition, free market capitalism assumes that there is no need for an authority to oversee and regulate the economy because ostensibly people and corporations would "self-regulate" the system. But as you can see, what happened in this instance is that people kept passing the buck to another party, i.e., people knew full well how bad these things were but they kept saying, hey, I won't be the one holding the bag, why do I care that someone else would take the fall. That's the attitude that is inherent in free market capitalism and competition: as long as you look out for yourself, everything else would take care of itself. Well, sure enough in the end everything was "taken care of" by the government, which means by you and me, the tax payer. And those who said, "why do I care" walked away with huge profits and a life of wealth and luxury. And they want to keep things that way for a good reason. And those of you who insist it's lack of transparency, that's also a red herring. These bundled mortgages were sold to investors with a full prospectus, explaining all the formulas and equations to show how they arrived at the risk assessments. Those were fully disclosed for anyone to see. So they were following the letter of the law. Of course, the quants who were writing these documents were probably holding back their laughter, thinking that who in the world would be able to follow these equations and verify the equations; and who in the world would actually find a flaw in these derivations of the risks. Perhaps math professors would have seen problems, but investors are not math professors. This was surely a guaranteed score for the sell-side.
If the brokers, lenders, banks were "just doing their job" then why did they give loans to people who were clearly unqualified? And, don't give me any crap about these people lying on their loan applications. There were far too many NINJA and no-doc loans written for me to accept that these people were doing even the bare minimum when it came to income verification and credit background checks. IMHO, you're an industry apologist if you don't think they don't have fiduciary responsibility in helping to create this mess.