Discovery Channel Magazine: The Week That Shook Wall Street
1 January, 2013Qatar: What has it done with stability?
1 January, 2013Discovery Channel Magazine, January 2013
2007: The good times end
Global capitalism up to 2007 appeared to be a magic formula of endless creation of money. Cash turned into more cash. Stock markets bounded endlessly upward. Everyone with a stake got rich, and none more so than the banks: in 2007 the financial services industry accounted for 40% of corporate profits in America. One bank, Goldman Sachs, the most venerated of all investment banks, paid its staff $20 billion in 2007; chief executive Lloyd Blankfein earned $68 million.
If anything, there was too much money around. Interest rates had been low for years, and funds were easily available. But there were huge structural problems behind this apparent bounty, and they were about to start unraveling in the USA.
One of these was what came to be known as the sub-prime crisis. One of the main engines of the banking boom was the mortgage industry – ordinary Americans repaying their home loans. But in order to expand that business, banks had asked for less and less from the people they lent to while lending then ever more: they were lending with less security, less proof, less documentation, to people with less income, for less resilient property. “At the height of the housing bubble, banks were eager to make home loans to nearly anyone capable of signing on the dotted line,” writes Andrew Ross Sorkin, author of Too Big to Fail and the main investment banking writer for the New York Times. “With no documentation, a prospective buyer could claim a six figure salary and walk out of a bank with a $500,000 mortgage, topping it off a month later with a home equity line of credit. Naturally, home prices skyrocketed, and in the hottest real estate markets ordinary people turned into speculators, flipping homes and tapping home equity lines to buy SUVs and power boats.”
At the same time, investment banks were developing ever more elaborate structures and selling them to clients who, with better advice, should never have gone near them. The most notorious were collateralized debt obligations, or CDOs, and we’re not going to try to explain them here, except to say this: they bundled together dozens of other bonds and loans, which were in turn linked to dozens more in other CDOs, making the whole thing precariously linked and exceptionally difficult to assess correctly, whether in terms of value or risk. Another, related common practice was securitization, which is best understood as slicing something up (in this case, a mortgage or some other loan) and selling all the bits of it to other investors. Worse, the credit rating agencies like Standard & Poor’s and Moody’s, who investors trust to assess risk, gave many of these odd and convoluted structures exceptionally high ratings, quite wrongly, perhaps because they didn’t really understand them. With these ratings, a huge range of people and institutions around the world assumed they must be safe and so bought them. From Australian hospital endowments to local American councils, this was to come back and bite them very hard.
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