USA Today has an article on how the administration is soliciting ideas on how to reform the financial markets, especially Fannie and Freddie. The article includes the following quote:
The role of Fannie and Freddie in the mortgage crisis is hotly debated in Washington. Republicans say the two companies, with the government’s encouragement, deserve most of the blame for inflating the housing bubble.
They argue that the two companies promoted homeownership to people who ultimately couldn’t afford it, and were required to do so by the Department of Housing and Urban Development, which required the companies to devote a portion of their business to affordable housing.
But Democrats say Wall Street players were the primary culprits behind shady lending practices that led to the mortgage bust. They argue that a lack of national lending standards allowed shady players to make irresponsible home loans.
I think this shows that neither party truly understand what created the financial meltdown: the simple notion in banks and investment companies that greed is good, and personal greed is better.
Yesterday on the plane, I listened to a number of podcasts. Act One of this week’s This American Life had an excellent piece on this very subject. Here’s the description: A hedge fund named Magnetar comes up with an elaborate plan to make money. It sponsors the creation of complicated and ultimately toxic financial securities… while at the same time betting against the very securities it helped create. Planet Money’s Alex Blumberg teams up with two investigative reporters from ProPublica, Jake Bernstein and Jesse Eisinger, to tell the story. Jake and Jesse pored through thousands of pages of documents and interviewed dozens of Wall Street Insiders. We bring you the result: a tale of intrigue and questionable behavior, which parallels quite closely the plot of a Mel Brooks musical.
Hint: The musical isn’t young Frankenstein. They summarized the caper in this song.
The interesting part of the story was not only what Magnatar did (basically, they encouraged the creation of CDOs that would fail, in order that the insurance (credit default swaps) would pay off), but that big banks were major investors in these securities that they knew were risky. Why did they do this? Because the bank made major fees for handling the transactions, and the fees were divided amongst the principals as bonuses. When the CDO finally failed, it wasn’t those individuals left holding the bag.
A really interesting program. You really should listen to it.
ETA: Here’s an article on a similar scheme by Goldman Sachs from the NYT… and here’s even more detail.
