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The 2008 Financial Crisis Explained Like You’re 5 — Transcript

by Fred - Money Historian · 5,383 words · 935 segments · language en · Watch on YouTube

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0:00In September of 2008, the United States
0:02government watched the largest
0:04bankruptcy in American history happen on
0:06a Monday morning and did nothing. $613
0:10billion
0:12gone before lunch. And the part they
0:14never put in the textbooks, the people
0:16who engineered the collapse walked away
0:19with their bonuses intact. That is not
0:22the beginning of this story. That is not
0:24even the worst part of this story. The
0:26worst part is that this entire
0:28catastrophe was built on something so
0:30simple, so obviously fragile, that when
0:33you understand how it actually worked,
0:36you will never look at a bank the same
0:38way again.
0:39And I mean that literally.
0:41Because this was not a failure of math.
0:44The math worked fine. This was a failure
0:46of something older and simpler.
0:49Something that has been causing
0:50civilizations to collapse since long
0:52before anyone invented a spreadsheet.
0:55Let me take you back to something that
0:56sounds completely harmless. The American
0:59dream. In the years following 2001,
1:03interest rates in the United States
1:04dropped to historic lows. The Federal
1:07Reserve, trying to prevent a recession
1:09after the dot-com bubble burst and the
1:11September 11th attacks, cut rates
1:13aggressively and repeatedly. By 2003,
1:17the federal funds rate sat at 1%. 1%.
1:21That is practically free money. And when
1:24money is practically free, people borrow
1:26it. A lot of it.
1:29And what do Americans borrow money for
1:31more than anything else? Houses.
1:34Housing prices had been climbing
1:35steadily since the early 1990s.
1:38Not dramatically, not suspiciously, just
1:42steadily.
1:43Year-over-year, home values went up. And
1:46in a country where home ownership is
1:48practically baked into the national
1:49identity, where your parents told you
1:52that buying a house is always a good
1:53investment, where the mortgage interest
1:56deduction made the government your
1:58unofficial co-signer.
1:59That steady climb felt like a law of
2:02nature. Houses go up. That is just what
2:05they do.
2:07Except it was not a law.
2:10It was a bet.
2:11And I am going to show you exactly who
2:14made it, who knew they were making it,
2:16and who got left holding the bill when
2:19it went wrong.
2:21But before I do that, I need to explain
2:23something that almost nobody explains
2:25properly because the crisis was not just
2:28about bad mortgages.
2:29It was about what happened to those
2:31mortgages after they were made.
2:33And that part, the part that turned a
2:35real estate slowdown into a global
2:38financial apocalypse,
2:40that is the part that will genuinely
2:42surprise you.
2:43I will get there. But first, here is why
2:46the foundation of this whole system was
2:48more broken than you have been told.
2:51Here's how a mortgage is supposed to
2:53work. You want to buy a house. You go to
2:56a bank. The bank looks at your income,
2:58your credit history, your savings, and
3:00decides whether you can afford the loan.
3:03If you can, they lend you the money.
3:05You pay them back over 30 years with
3:07interest. The bank makes a profit. You
3:11get a house. Everybody is reasonably
3:13happy.
3:14This model worked for decades. The bank
3:17had skin in the game. If you stopped
3:19paying, the bank lost money. So the bank
3:22was very motivated to make sure you
3:24could actually afford the loan before
3:26making it. Now, here is where it starts
3:28to get interesting.
3:30Sometime in the 1980s, and accelerating
3:32dramatically through the 1990s, banks
3:35discovered they did not have to hold on
3:37to mortgages. They could sell them.
3:40A bank could write a mortgage on Monday,
3:42bundle it up with a hundred other
3:44mortgages, sell that bundle to investors
3:46on Wall Street, and by Friday have a
3:49fresh pile of cash ready to lend out
3:51again. The investors got a steady stream
3:54of monthly payments from homeowners
3:55across the country. The bank got its
3:58money back immediately and could start
4:00the whole cycle over without waiting 30
4:03years to see a return.
4:05This process was called securitization
4:08and honestly, in theory, it is not a
4:11terrible idea.
4:13It spreads risk across the financial
4:15system. It gives more people access to
4:17credit. It gives investors a relatively
4:20safe, predictable return.
4:23In theory. The problem, and this is the
4:26first thing I want you to hold on to, is
4:28what securitization did to incentives.
4:32The moment a bank could sell a mortgage
4:34the day after it was made, the bank no
4:37longer had skin in the game. The bank's
4:39job was no longer to make sure you could
4:41repay the loan. The bank's job was just
4:45to make the loan. Originators, the
4:48people actually sitting across the desk
4:50from borrowers, got paid per mortgage
4:53they wrote, not per mortgage that got
4:55repaid, per mortgage that got written.
4:58You can see where this is going. By 2004
5:02and 2005, this incentive structure had
5:04metastasized into something genuinely
5:07dangerous.
5:08Mortgage lenders, not just the big
5:10banks, but thousands of smaller,
5:12independent brokers, were competing
5:15furiously to write as many loans as
5:17possible because Wall Street was buying
5:19them as fast as they could be produced.
5:22And to keep the volume up, the standards
5:24had to come down dramatically. This is
5:27where subprime mortgages enter the
5:29story. Subprime simply means lending to
5:32people with lower credit scores, lower
5:34incomes, or shakier financial histories.
5:37People who a traditional bank would have
5:39turned away in a previous decade.
5:42During this period, subprime lenders
5:44invented a spectacular array of mortgage
5:46products designed to get people into
5:48houses they mathematically could not
5:50afford over the long term. There were
5:52adjustable rate mortgages where the
5:54interest rate would stay artificially
5:56low for the first two or three years and
5:59then reset sharply higher.
6:02There were interest-only loans where
6:04borrowers paid nothing toward the actual
6:06principal for the first several years
6:08and there were what the industry
6:10charmingly called ninja loans. No
6:13income, no job, no assets. You could get
6:17a mortgage with no proof of income
6:19whatsoever. Banks were essentially
6:21lending money to people and hoping that
6:23rising home prices would paper over the
6:25riskiness of the loans before anyone
6:28looked too closely.
6:29Yep, you heard that right. And here is
6:32where I need to introduce someone who is
6:34going to matter a great deal in the
6:36second half of this story. Not a Wall
6:38Street banker, not a government
6:40official, just a regular person, a
6:43composite of about 6 million real
6:45Americans trying to do what they had
6:47always been told was the smart thing.
6:50Buy a house. Call her Maria. She lives
6:53in a mid-sized American city. She works
6:56two jobs. Her credit is not great. A few
6:59missed payments, a medical bill that
7:01went to collections a couple years back.
7:03But in 2005, a mortgage broker calls her
7:07and the pitch is genuinely compelling.
7:10The monthly payment for the first 2
7:11years will be lower than her current
7:13rent.
7:15At the end of 2 years, she can refinance
7:17because by then the house will be worth
7:19more and with more equity, she will
7:21qualify for better terms. The broker
7:24does not mention what happens if house
7:26prices stop going up. Nobody mentions
7:29that because in 2005, nobody can quite
7:32imagine it. Maria takes the loan. She
7:35gets the house. She paints the kitchen.
7:38She plants something in the front yard
7:40and for 2 years, everything is fine.
7:43Back to Wall Street, because we need to
7:45understand what was being built in the
7:47background while Maria was making her
7:49monthly payments.
7:51The mortgages, millions and millions of
7:54them, good ones and terrible ones,
7:57bundled together in enormous pools, were
7:59being sold to investment banks.
8:02Goldman Sachs, Lehman Brothers, Bear
8:04Stearns, Merrill Lynch.
8:07These banks took the bundles and
8:09repackaged them into what they called
8:11mortgage-backed securities.
8:13The pitch was statistical. If you take a
8:16thousand mortgages from a thousand
8:17different people in a thousand different
8:19cities, the likelihood of all of them
8:21defaulting at exactly the same time is
8:23very low.
8:25Diversification, in theory, made the
8:27whole thing safer than any single
8:29mortgage. This sounded like math. It
8:32felt like science. And in a world that
8:35had been trained to trust financial
8:36engineering the way a previous
8:38generation trusted nuclear energy, that
8:41was enough. But then someone got clever.
8:44Someone took the mortgage-backed
8:46securities, which were already a bundle
8:48of bundles, and bundled those.
8:51They sold tranches of those new bundles,
8:54where some investors got paid first if
8:56anything went wrong, and others got paid
8:58last. These were called collateralized
9:02debt obligations, CDOs.
9:05The people on trading floors had private
9:08names for these products that I cannot
9:10repeat on this channel. But the official
9:12pitch was sophistication.
9:15These were complex, mathematical, highly
9:17engineered financial instruments. So
9:20complex, in fact, that most of the
9:22investors buying them did not fully
9:24understand what was inside them. And
9:26frankly, neither did some of the people
9:28selling them. And here is where the
9:30rating agencies come in, because this is
9:33the part that still makes my jaw drop
9:35every single time I think about it.
9:37There are three major credit rating
9:39agencies in the United States, Moody's,
9:42Standard & Poor's, and Fitch. Their job,
9:45in theory, is to assess the risk of
9:47financial products and tell investors
9:49how safe they are.
9:51The ratings go from AAA, the safest
9:54thing you can buy, all the way down to
9:56D, which stands for default, and is the
9:59thing you very much do not want. United
10:02States Treasury bonds are rated AAA,
10:05solid, boring, reliable, the gold
10:08standard of safety.
10:10Here's what the rating agencies were
10:12doing with CDOs full of subprime
10:14mortgages.
10:16They were rating them AAA,
10:18the same rating as the full faith and
10:20credit of the United States government.
10:23Bundles of ninja loans, interest-only
10:25mortgages from people with no income
10:27verification, adjustable-rate products
10:29with ticking clock resets baked in.
10:32AAA, safe as houses.
10:35The phrase takes on a different flavor
10:37now.
10:38Now, why would they do that? Because the
10:40banks paid them to rate the products.
10:43The same banks that created the CDOs
10:45hired and paid the agencies to evaluate
10:48them. And if an agency rated a product
10:50too harshly, the bank simply took the
10:52product to a competing agency.
10:55The agencies were competing for the
10:56business of the very institutions whose
10:58products they were supposed to
11:00objectively assess. That is not a flaw
11:03in the system. That is a feature of the
11:05system, a feature that made everyone
11:07involved extraordinarily rich, right up
11:10until it made the entire global economy
11:12collapse. In a few minutes, I am going
11:15to show you the single moment when this
11:17entire structure fell apart, and the
11:20decision made in that moment that turned
11:22a financial crisis into a civilizational
11:25one.
11:26But first, there is another instrument
11:28layered on top of everything I just
11:30described. And when I explain it, I need
11:33you to sit with the implications for a
11:35moment. Because this is the one that
11:37turned a housing correction into a
11:40nuclear explosion.
11:42Credit default swaps. A credit default
11:45swap is essentially insurance. If I own
11:47a bond or a CDO and I am worried it
11:50might fail, I can buy a credit default
11:52swap from someone. I pay them an annual
11:55premium. If the thing fails, they pay me
11:57the full value of the bond. It is
12:00exactly like car insurance except for
12:02financial products. Except for one
12:05crucial difference that changes
12:07everything. With car insurance, you can
12:10only insure your own car. You cannot
12:12take out insurance on my car, collect
12:15money if I crash, and here is the part,
12:19secretly hope I crash so you get paid.
12:23With credit default swaps, that is
12:25exactly what could happen.
12:27Anybody could buy insurance on any CDO,
12:30even if they did not own the CDO.
12:33So hedge funds, investors who had
12:35figured out that these products were
12:37fragile and overrated, were buying
12:39credit default swaps on CDOs they did
12:42not own, betting those CDOs would fail,
12:45and collecting enormous sums when they
12:47did. This meant that as the housing
12:49market began to crack, there was an
12:51entire class of investors on the other
12:53side of the trade who were winning
12:55enormously.
12:56And the people on the losing end of
12:58those bets were the big banks and
13:00insurance companies who had written the
13:01swaps.
13:02The most famous of those was AIG,
13:05American International Group, one of the
13:08largest insurance conglomerates in the
13:10world, a company so vast and so
13:12interconnected with the global financial
13:14system that when it started hemorrhaging
13:16money on credit default swaps, the US
13:18government had to write them a check for
13:20182 billion dollars.
13:24Because the alternative, letting AIG
13:26fail, would have made everything else
13:29look like a warm-up act.
13:31$182 billion of
13:34taxpayer money to bail out an insurance
13:37company that had been collecting
13:38premiums on the world's most fragile
13:40financial products without setting aside
13:43meaningful reserves in case those
13:45products actually failed. A 17-year-old
13:48running a lemonade stand sets aside
13:49money in case it rains. AIG did not.
13:53Now, here is where I want you to feel
13:55the weight of what was happening
13:56simultaneously on both sides of this
13:59story. Because while AIG was writing
14:01credit default swaps, while the rating
14:04agencies were stamping AAA on products
14:07that deserve to be lined up and thrown
14:09into the sun,
14:11while Wall Street was engineering ever
14:13more elaborate structures to extract
14:15fees at every layer of the chain,
14:18Maria's adjustable-rate mortgage was
14:20resetting.
14:22It was 2007.
14:24The introductory period on her loan was
14:26ending. Her monthly payment was about to
14:29jump by roughly $600 per month. And
14:32here's the thing the broker had told her
14:34would happen. She would refinance. She
14:37would get better terms because the house
14:39would be worth more. Except the house
14:41was not worth more.
14:43For the first time in over a decade,
14:45housing prices had stopped going up.
14:48They were flat, and in some markets,
14:50they were going down. The foundation on
14:53which every single assumption in this
14:55system had been built, that house prices
14:57always rise, had cracked.
15:00Maria could not refinance. Her payment
15:03spiked. She fell behind. And when Maria
15:05fell behind, she was one of millions of
15:08people across the country doing the
15:10exact same thing at exactly the same
15:13time. Because adjustable-rate mortgages
15:15do not reset individually. They reset in
15:18waves tied to interest rate schedules
15:21that had been set years earlier.
15:24The system went from slowly absorbing
15:26individual defaults to confronting a
15:28simultaneous national wave of defaults
15:31at a scale nobody had modeled because
15:34the models had assumed that housing
15:36prices would never fall nationally all
15:38at once. The models were wrong. And the
15:41models were wrong because the people
15:43building the models had a financial
15:45incentive to build them that way.
15:48March of 2008. Bear Stearns, the fifth
15:51largest investment bank in the United
15:53States, runs out of cash. Not because
15:56they were a small or marginal operation.
15:59They had 300 billion dollars in assets
16:02on the books, but they had borrowed
16:04enormously. The technical term is
16:06leverage to make enormous bets on
16:09mortgage-backed securities. When those
16:11securities started losing value, their
16:14lenders asked for their money back.
16:16Bear Stearns did not have it.
16:19Over one weekend, the US government
16:21brokered a fire sale to JP Morgan Chase.
16:24The price? $2 per share.
16:28Two weeks earlier, Bear Stearns had been
16:30trading at $67 per share. The deal was
16:34eventually renegotiated to $10 a share,
16:38which was still a catastrophic loss for
16:40shareholders and a humiliation for an
16:42institution that had operated for 85
16:45years.
16:46One of the most powerful investment
16:48banks in the world ceased to exist
16:51between a Friday afternoon and a Monday
16:53morning.
16:55Wall Street assumed the government would
16:56do the same for the next bank that fell.
16:59That the Federal Reserve would step in
17:01and arrange a rescue.
17:03That there was a floor somewhere below
17:05which things would not be allowed to go.
17:08There was not.
17:10September 15th, 2008.
17:12This is the date.
17:14This is is turning point I have been
17:16building toward, and I want you to feel
17:18the specific weight of this moment.
17:21Lehman Brothers, 158
17:24years old, the fourth largest investment
17:27bank in the United States, $613
17:31billion
17:32in debt,
17:33filed for bankruptcy.
17:35The largest bankruptcy filing in
17:37American history, and the government let
17:40it happen. Treasury Secretary Hank
17:42Paulson, who had been the CEO of Goldman
17:45Sachs before taking the government role,
17:47decided that the moral hazard of bailing
17:49out Lehman, of sending the message that
17:51failure had no consequences, was too
17:54great. That markets needed to understand
17:56there was no unconditional government
17:58backstop.
17:59That someone had to feel consequences.
18:03The consequences were felt, just not
18:05primarily by Lehman's executives.
18:08The moment Lehman filed, the global
18:10financial system froze.
18:12Banks stopped lending to each other
18:13overnight.
18:15Not because they thought specific other
18:16banks were necessarily insolvent,
18:19because they had absolutely no idea
18:21which other banks were in trouble.
18:23All those CDOs, all those credit default
18:27swaps, all those interconnected
18:29obligations layered across dozens of
18:31institutions in multiple countries,
18:34nobody knew where all the risk actually
18:36lived. The opacity that had made the
18:38product so profitable to create made the
18:41system impossible to triage in a crisis.
18:45It was like trying to perform surgery in
18:47a pitch-black room, and so nobody moved.
18:51Credit markets seized. The machinery of
18:53the global economy, which runs on
18:56short-term borrowing the way a car
18:58engine runs on oil, ran dry.
19:02Companies that had absolutely nothing to
19:03do with housing or mortgages suddenly
19:06could not borrow money to meet payroll.
19:08Banks that were fundamentally sound
19:10could not access the short-term
19:11liquidity they needed to function
19:13day-to-day. Pension funds that had been
19:15parked in what were supposed to be the
19:16safest possible instruments, money
19:18market accounts, discovered those
19:20accounts had exposure to Lehman paper
19:23and were no longer worth a dollar on the
19:25dollar. The phrase breaking the buck,
19:28meaning a money market fund's value
19:30dropping below $1 per share, had not
19:33been used since the 1990s. In September
19:36of 2008, it happened to one of the
19:38largest money market funds in the
19:40country, the Reserve Primary Fund, and
19:43the panic it triggered was
19:44instantaneous.
19:46The losses that followed are staggering
19:48in a way that numbers alone cannot fully
19:50convey. So, I want to be specific about
19:52each one.
19:53The US stock market lost approximately
19:5654% of its value from peak to trough. 8
19:59million Americans lost their jobs. 6
20:02million lost their homes to foreclosure.
20:04Household wealth in the United States
20:06fell by roughly $13 trillion.
20:09The median American family lost
20:11approximately 22% of their net worth in
20:142 years. The families hit hardest,
20:17proportionally, were not wealthy
20:19investors with diversified portfolios
20:21who lost a percentage of abundant
20:23assets. They were families like Maria's,
20:26families whose primary and often only
20:29asset was a home that was now worth less
20:32than the mortgage they owed on it. They
20:34lost everything and then some. And then,
20:38they rented.
20:40The global damage spread far beyond
20:41American borders. Iceland's banking
20:44system, which had aggressively expanded
20:46into mortgage-backed securities and
20:48other structured products, collapsed so
20:50completely that the country had to be
20:51bailed out by the International Monetary
20:54Fund.
20:55Ireland, Spain, and parts of Eastern
20:57Europe experienced severe financial
20:59crises with direct roots in exposure to
21:01American mortgage products.
21:03German banks, British banks, and
21:05sovereign wealth funds across Asia had
21:07bought securities stamped AAA by
21:10American rating agencies and were now
21:13holding paper worth a fraction of the
21:15purchase price.
21:16The total estimated cost to the global
21:18economy has been calculated at somewhere
21:21around $22 trillion.
21:24$22 trillion.
21:26The government response, when it finally
21:28arrived, was enormous and fast. The
21:32Troubled Asset Relief Program,
21:34TARP,
21:36authorized $700 billion to stabilize the
21:39financial system, purchasing equity
21:41stakes in banks and other distressed
21:43institutions.
21:45The Federal Reserve cut interest rates
21:47to essentially zero and began buying
21:49trillions of dollars in assets in a
21:52program they called quantitative easing,
21:55flooding the system with liquidity to
21:57prevent a complete freeze.
21:59Fannie Mae and Freddie Mac, the two
22:02massive government-sponsored mortgage
22:04enterprises, were placed into federal
22:06conservatorship.
22:07AIG received its $182 billion lifeline.
22:12The largest banks received capital
22:14injections, debt guarantees, and access
22:16to emergency lending facilities
22:18available to no one else. And then, and
22:21this is the moment I want you to hold in
22:23your mind for the rest of this story,
22:26within 12 months of receiving those
22:27bailouts, the major banks were
22:29profitable again. Within 2 years, they
22:32were paying record bonuses. The average
22:35Wall Street bonus in 2009 was $149,000.
22:40The median American household income
22:42that same year was $49,000.
22:45The national unemployment rate was
22:47hovering around 10%. Let that ratio sit
22:50for just a moment before I continue.
22:52Nobody went to prison. One person. One
22:56person from the entire crisis was
22:58convicted and sentenced to prison time.
23:00Kareem Serageldin, a mid-level trader at
23:03Credit Suisse, convicted of hiding
23:05losses in a bond portfolio. He was not a
23:08CEO. He was not a CDO architect. He was
23:12not a rating agency executive who
23:14stamped AAA on products composed of
23:17ninja loans. He was not a mortgage
23:19broker who wrote a thousand loans to
23:22people who couldn't afford them. He was
23:24a mid-level trader who hid some losses
23:26in a portfolio. He served two and a half
23:29years.
23:30That is the complete criminal
23:32accountability for the largest financial
23:34crisis since the Great Depression, a
23:37crisis that cost the global economy $22
23:40trillion.
23:42Now, I promised you something earlier. I
23:44promised you there was a layer to this
23:46story I was saving for last because it
23:48fundamentally reframes everything else.
23:51Here it is.
23:53Many of the people who designed these
23:54instruments knew. Not all of them. Some
23:58genuinely believed in their models. Some
24:00had convinced themselves that the
24:01diversification logic was sound, but a
24:03significant and documentable subset of
24:06people in the structured finance world
24:08understood that the products they were
24:10selling were fragile, that the ratings
24:12were not credible, that the whole
24:14edifice required continuously rising
24:17home prices to hold together. And they
24:19sold them anyway.
24:21And some of them shorted them.
24:23They secretly bought credit default
24:25swaps on the very products they were
24:27selling to their own clients, betting
24:30that those products would fail,
24:32collecting when they did. Goldman Sachs
24:34in particular would later pay $5 billion
24:37to settle charges related to this
24:39practice, selling mortgage-backed
24:41securities to clients while
24:42simultaneously betting against those
24:44same securities internally using its own
24:47proprietary positions.
24:49The Department of Justice stated that
24:51Goldman had made materially false and
24:53misleading representations to investors.
24:55The settlement was $5 billion. No
24:58individual criminal charges were filed
25:01against senior executives.
25:03There is a word for selling someone a
25:05product while privately betting it will
25:07fail.
25:08The word varies depending on whether you
25:09work at a federal regulator or on a
25:11trading floor, but most people know what
25:14to call it. The Financial Crisis Inquiry
25:17Commission, the official body Congress
25:19created to investigate the crash,
25:21released its findings in 2011. Their
25:24conclusion was blunt.
25:26The crisis was avoidable,
25:28not inevitable,
25:30not an act of God or an unpredictable
25:33market event.
25:34Avoidable.
25:36They found widespread failures of
25:38financial regulation, corporate
25:40governance, and risk management. They
25:42found that the rating agencies had
25:44conflicts of interest that fatally
25:46undermined the integrity of their
25:48ratings.
25:49They found that mortgage originators had
25:51deliberately lowered underwriting
25:53standards. They found that the financial
25:55products created during this period
25:57were, and I am quoting directly here,
25:59poorly understood by investors, rating
26:02agencies, and regulators alike.
26:05That last phrase is doing a remarkable
26:07amount of work. Poorly understood.
26:10The most sophisticated financial
26:12institutions in the world, employing the
26:14most credentialed mathematicians and
26:16economists money could attract, with
26:18access to computing power that would
26:20have seemed like science fiction a
26:21generation earlier, created products
26:24that were, by official government
26:26finding, poorly understood by
26:28themselves.
26:30The other explanation, the one the
26:32evidence supports more cleanly,
26:35is that complexity was not a bug in this
26:37system. It was a feature. Deliberate
26:41opacity made it impossible for
26:43regulators to see what was inside the
26:45products. It made it impossible for
26:47investors to independently verify the
26:49ratings. It made it possible, after the
26:51fact, for everyone in the chain to
26:53gesture at everyone else and say, "The
26:56model said it was fine." When everything
26:58is interconnected and everything is
27:00abstracted across enough layers, the
27:02person at the end of the chain can
27:04always claim they were merely following
27:06the logic of the instrument. That
27:08strategy worked, not just in escaping
27:11criminal prosecution. It worked in
27:13escaping the narrative. The dominant
27:15story told about 2008, even now, is one
27:19of complexity and collective
27:20incompetence. An honest mistake at
27:23civilizational scale. A system so
27:26sophisticated that nobody really
27:28understood it. But here is what actually
27:31happened. A system was deliberately
27:33engineered to be opaque. That opacity
27:37allowed enormous fees to be extracted at
27:39every layer, from the mortgage
27:41originator, who got paid per loan
27:43written, to the rating agency that got
27:46paid per rating issued, to the
27:48investment bank that collected
27:49structuring fees on every CDO, to the
27:52derivatives desk that collected premiums
27:54on every credit default swap. Those fees
27:58required volume. Volume required
28:00loosening standards. Loosening standards
28:03required ignoring risk. And ignoring
28:06risk was made possible by the fact that
28:08the risk was being passed down the chain
28:11to someone who did not know they were
28:13holding it until they were. The person
28:16at the end of that chain was Maria. Was
28:198 million workers who lost jobs at
28:21companies that had nothing to do with
28:23mortgages. Was every pension fund and
28:25retirement account that had bought paper
28:28nobody had properly examined.
28:30Was every country, Iceland, Ireland,
28:33Germany, and others, that had purchased
28:35American mortgage-backed securities
28:38because the ratings said they were safe
28:40and because American financial
28:41innovation was the envy of the world.
28:44There There a moment, somewhere in 2004
28:47or 2005, when warning signs were already
28:50visible to anyone willing to look.
28:53When a different choice could have been
28:55made.
28:56The Federal Reserve could have raised
28:58rates earlier and deflated the bubble
29:00gradually, rather than letting it
29:02continue to inflate.
29:04The Securities and Exchange Commission
29:06could have required meaningful
29:07disclosure about what was actually
29:09inside CDOs.
29:12The rating agencies could have been
29:13required to be paid by investors, rather
29:16than issuers, eliminating the conflict
29:18of interest at the center of the whole
29:20charade. Congress could have regulated
29:22the credit default swap market, which
29:25operated in almost complete regulatory
29:27darkness.
29:28Lenders could have been required to
29:29retain a meaningful portion of every
29:31mortgage they originated, restoring skin
29:34in the game. Any one of these
29:36interventions alone might not have been
29:38enough. All of them together would have
29:40been a very different story.
29:42None of them happened. And it was not
29:45because the people in positions of
29:46authority were uniformly unaware.
29:49Raghuram Rajan, then the chief economist
29:51of the International Monetary Fund, gave
29:53a presentation in 2005 at a prestigious
29:56gathering of central bankers, warning
29:58explicitly that financial innovation was
30:01creating systemic risks that could
30:03trigger a devastating global crisis.
30:06The assembled luminaries of global
30:08finance were not receptive. The dominant
30:10consensus of the era held that financial
30:12markets were self-correcting, that
30:14sophisticated investors priced risk
30:16accurately, and that attempts at
30:18heavy-handed regulation would only
30:20impair the efficient allocation of
30:22capital.
30:23Alan Greenspan, the chairman of the
30:25Federal Reserve from 1987 to 2006, later
30:29admitted to a congressional committee
30:31that he had found a flaw in his
30:33ideology.
30:34The flaw, he said, was that he had
30:36believed institutions would act in their
30:38own rational self-interest in ways that
30:41protected their shareholders. He had not
30:43anticipated that the incentive
30:45structures inside those institutions
30:47might point employees toward behaviors
30:49that destroyed long-term institutional
30:52value while generating short-term
30:54personal compensation. The people who
30:56saw the crisis clearly in advance were
30:59not uniformly smarter than the people in
31:01the room. They were simply willing to
31:03look at the thing directly and follow
31:04the logic to its conclusion without
31:07flinching when the conclusion was
31:08inconvenient.
31:10That is a rarer quality than a doctorate
31:12in quantitative finance.
31:15In the years following 2008, significant
31:17regulatory reforms were enacted. The
31:20Dodd-Frank Wall Street Reform and
31:22Consumer Protection Act, passed in 2010,
31:25was the most sweeping overhaul of
31:27financial regulation since the Great
31:29Depression. It created new oversight
31:31bodies, imposed stricter capital
31:33requirements on banks, attempted to
31:36regulate derivatives markets, and
31:37established the Consumer Financial
31:39Protection Bureau specifically to
31:41protect individuals from predatory
31:43financial products. The banks fought
31:45many of these reforms energetically.
31:48Several provisions were subsequently
31:49weakened or rolled back in later years.
31:52The revolving door between financial
31:54regulators and the firms they regulate
31:56continued to spin. The rating agencies
31:59continued to be paid by the issuers of
32:00the products they rate.
32:02The structure of incentives, in other
32:04words, was adjusted at the margins.
32:07It was not fundamentally redesigned.
32:10Maria, our composite 6 million
32:12Americans, eventually rebuilt
32:14slowly,
32:16painfully.
32:17Some never fully did.
32:19The median black American family, which
32:21had a higher proportion of its wealth in
32:23home equity than the median white
32:25family, and which had been
32:26disproportionately targeted by subprime
32:29lenders in the years before the crash,
32:31lost wealth at a rate that set back
32:33decades of hard-won progress in the
32:35racial wealth gap.
32:37That is not a footnote to the story of
32:392008. That is a structural consequence
32:42of how the crisis was distributed. The
32:44communities most aggressively targeted
32:46by the predatory lending that inflated
32:48the bubble were the communities that
32:50suffered most catastrophically when the
32:52bubble collapsed. The instrument of
32:54inclusion became the mechanism of
32:57dispossession.
32:58The banks that created the products that
33:00devastated those communities paid fines.
33:03Large ones. Bank of America $16.65
33:06billion in 2014 to settle charges
33:09related to its mortgage practices and
33:11those of Countrywide Financial, which it
33:13had acquired. JP Morgan paid $13
33:15billion. Citigroup paid $7 billion. The
33:19fine sound enormous because they are
33:21enormous. They were also, in most cases,
33:24partially tax-deductible business
33:26expenses, and in every case, they were
33:28paid by the corporations, meaning
33:30ultimately by shareholders, rather than
33:33by the individual human beings who made
33:35the specific decisions that caused the
33:38specific harms.
33:40I started this story by telling you that
33:42the biggest surprise of 2008 is not how
33:45it happened. It is what happened
33:47afterward.
33:49And I meant that because the response to
33:51the largest financial crisis since the
33:53Great Depression, a crisis that cost $22
33:56trillion globally, wiped out $13
33:59trillion in American household wealth,
34:01destroyed 8 million jobs, and eliminated
34:046 million families' homes, was not a
34:07fundamental restructuring of the system
34:09that produced it.
34:10The response was flood the system with
34:13enough liquidity to stabilize it, enact
34:16some regulatory adjustments at the
34:17margins, pay the fines, and move
34:20forward.
34:21The bonuses resumed. The banks returned
34:24to profitability.
34:25The revolving door kept spinning. The
34:28rating agencies kept rating. And Maria
34:31rented.
34:32The last question this story has been
34:34circling, the one I have deliberately
34:36not answered directly, is not whether it
34:39could happen again.
34:41It is simpler than that. It is to whom
34:44does the financial system actually
34:46belong?
34:48Because in a democracy, the institutions
34:50that channel money through the economy
34:52are supposed to serve everyone.
34:54The homeowner saving for retirement, the
34:57worker whose pension fund needs a safe
34:59place to park its reserves, the taxpayer
35:02whose money forms the ultimate backstop
35:04when everything else fails.
35:07The system is supposed to belong to all
35:09of them.
35:10What 2008 demonstrated in the plainest
35:13possible language is that when the
35:15interests of that system conflict with
35:18the interests of the people who profit
35:20from running it, the people who profit
35:22from running it win.
35:25They win because they are organized and
35:27the rest of us are not.
35:29They win because they have access to
35:31regulators and the rest of us do not.
35:35They win because the products they
35:36create are complex enough that
35:39accountability cannot be cleanly
35:40assigned, and because the alternative to
35:43rescuing them, letting the whole thing
35:45come down, is genuinely catastrophic for
35:48the very people they just finished
35:50taking advantage of.
35:52$613
35:55billion dollars one Monday morning
35:58bonuses paid within the year.
36:02Maria is still renting.

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