Blame the banks

Last week, an editorial was semi-anonymously published in The Economist by an author named M.C.K. and attacked “the real wrongdoers [who] were not those who sold risky products at inflated prices but the dupes who bought them.” This editorialist seems to think that the victims—who lost their money, their pensions and their livelihoods to the bankers, most of whom survived the crisis thanks to generous government bailouts—are those at fault. This is an example of institutionalized arrogance pervasive in the financial sector—an attitude that sorely needs changing.

In order to understand exactly how reprehensible such a claim is, it is important to understand how collateralized debt obligations (CDOs) and credit-default swaps led to a large collapse in our financial organization. Following a period of very robust growth in the early part of the decade, banks began to think that risk was overrated and overvalued certain clients’ ability to pay off large loans, which in this case were particularly related to real estate. The banks then grouped the income from these loans and sold them to investors. These are the mortgage-backed securities we all hear about. Additionally, banks also sold a credit-default swap, a sort of insurance against insolvency (i.e., if an organization went bankrupt, the selling bank would underwrite the investment loss and pay back the investor) that could be taken out on various securities. Following a normal business cycle, the economy fell into a recession in 2007. About a year later, following the so-called isolated collapse of financial giant Bear Stearns, a large number of investors realized they would not be able to pay back their loans. This led to a widespread failure of the mortgage-backed securities (the toxic assets), and the resulting obligations owed by the banks, combined with investors fearing for their own assets, led the world’s largest banks to suddenly become insolvent. Because the world’s financial system is so interconnected, with these banks lending, buying and selling various securities to one another, the insolvency spread throughout the whole financial system, necessitating a large government bailout in order to guarantee normal, everyday customers’ bank deposits.

So, who is to blame? M.C.K. seems to think that the “dupes” who bought the securities were stupid and that this sort of activity is almost entirely legitimate and perfectly moral. The facts are that the vast majority of investors do not understand what it is they are buying—no thanks to the banks, who gave their own risk assessments of these CDOs (which were said to be riskless) and provided very little information or education about precisely how these CDOs were constructed. On the other end, these same banks were engaged in so-called predatory lending to consumers who had no ability to repay the loans they were receiving. They would take these impossible loans, bundle many of them together and dump their problems on unwitting investors.

M.C.K. is also a self-admitted member of the finance world, attempting to defend the widespread deceit and questionable practices used by finance giants both before and after the financial crisis. He justifies them by saying, “It is worth stressing that none of these actions could reasonably be called criminal, or even immoral, when everyone involved understands what is going on and has accurate information.” However, due to the complexity of these investments and the lack of transparency to consumers, their sale is tantamount to fraud—certainly morally, if not legally. He counters, “No one has any business running money if they do not understand that this is how the game works. For me, the key question is why so many evidently unsophisticated investors were snookered by the banks into buying their garbage.” Perhaps the answer to his question is that the banks lied. They sold assets that even they couldn’t understand (indeed, M.C.K. even points out that “AIG sold so many credit default swaps because they thought risk was overpriced and they wanted to take advantage of it”). M.C.K. is representative of the type of institutional arrogance that allows his cohorts and him to run roughshod over the American economy. Unfortunately, due to the complexities of financial law, it is very difficult to determine that the banks that sold mortgage-backed securities and credit-default swaps did anything illegal.