(including, at that time, me), but the Clinton government did nothing about it. For the first time, investment bankers were given clear signals that they could behave as they wished.
Equally dangerous, however, were several other developments in the US financial sector during the 1990s. The first was far-reaching deregulation, in both law and practice, championed by the
Clinton government, Congress, and the Federal Reserve. The second was the structural concentration of the industry, much of which would have been illegal without the deregulatory measures. With
astonishing speed, the financial sector’s major components—commercial banking, investment banking, brokerage, trading, rating, securities insurance, derivatives—consolidated
sharply into tight oligopolies of gigantic firms, which often cooperated with each other, particularly in lobbying and politics.
The third change in the industry was the rise of the “securitization food chain”, an elaborate industrywide supply chain for generating mortgages, selling them to investment banks,
and packaging them into “structured” investments for sale to pension funds, hedge funds, and other institutional investors. The result was an extremely complex, opaque process that
integrated nearly every segment of the financial system.
The fourth change in financial services was growth in unregulated, “innovative” financial instruments. Once again enabled by continued deregulation, the industry invented clever new
things like credit default swaps, collateralized debt obligations, and “synthetic” mortgage securities.
In principle, these changes created major efficiencies; but they also made the entire system more fragile, interdependent, and extremely vulnerable to both fraud and systemic crises.
But the final change in the financial sector was the most fatal. Bythe end of the 1990s, at every level of the system and at every step in the securitization food chain,
all of the players—from lenders to investment banks to rating agencies to pension funds, from mortgage brokers to traders to fund managers to CEOs to boards of directors—were
compensated heavily in cash, based on short-term gains (often as short as the last transaction), with built-in conflicts of interest, and with no penalties for causing losses. Almost nobody was
risking their own money. In short, nobody had an incentive to behave ethically and prudently. By the time George W. Bush took office, the explosives had been planted; all it took was for someone to
light the fuse.
Taming Mortgages but Creating a Monster
IT ALL BEGAN with a clever, sane idea: the mortgage-backed security. In order to allow S&Ls to lend more money, banks could buy mortgages from
S&Ls—which would give the S&Ls immediate cash—and then the bank would package the mortgages into securities, which it would sell to investors.
In 1983 Larry Fink and his investment banking team at First Boston invented the CMO, or collateralized mortgage obligation. (Fink is now CEO of BlackRock, the big investment manager.)
Fink’s innovation was that his CMOs were sliced into several distinct classes, or “tranches”, with different credit ratings and yields. The top tranche had first claim on cash
flows from the mortgages, while the bottom tranche absorbed the brunt of prepayment and default risk.
Demand was high. These new products started to change the whole structure of housing finance. Now, mortgage brokers sourced deals for a new group of “mortgage banks”. The mortgage
banks bought loans from brokers, and held them only until they had enough for Wall Street to securitize. By the mid-1990s, this model dominated the market.
But even in the first several years of their existence, collateralized mortgage obligations produced an interlude of craziness ending in a mini-crisis, in the early 1990s. Though tiny by current
standards, withestimated losses of $55 billion, it was a warning of the damage that could be inflicted by
Equally dangerous, however, were several other developments in the US financial sector during the 1990s. The first was far-reaching deregulation, in both law and practice, championed by the
Clinton government, Congress, and the Federal Reserve. The second was the structural concentration of the industry, much of which would have been illegal without the deregulatory measures. With
astonishing speed, the financial sector’s major components—commercial banking, investment banking, brokerage, trading, rating, securities insurance, derivatives—consolidated
sharply into tight oligopolies of gigantic firms, which often cooperated with each other, particularly in lobbying and politics.
The third change in the industry was the rise of the “securitization food chain”, an elaborate industrywide supply chain for generating mortgages, selling them to investment banks,
and packaging them into “structured” investments for sale to pension funds, hedge funds, and other institutional investors. The result was an extremely complex, opaque process that
integrated nearly every segment of the financial system.
The fourth change in financial services was growth in unregulated, “innovative” financial instruments. Once again enabled by continued deregulation, the industry invented clever new
things like credit default swaps, collateralized debt obligations, and “synthetic” mortgage securities.
In principle, these changes created major efficiencies; but they also made the entire system more fragile, interdependent, and extremely vulnerable to both fraud and systemic crises.
But the final change in the financial sector was the most fatal. Bythe end of the 1990s, at every level of the system and at every step in the securitization food chain,
all of the players—from lenders to investment banks to rating agencies to pension funds, from mortgage brokers to traders to fund managers to CEOs to boards of directors—were
compensated heavily in cash, based on short-term gains (often as short as the last transaction), with built-in conflicts of interest, and with no penalties for causing losses. Almost nobody was
risking their own money. In short, nobody had an incentive to behave ethically and prudently. By the time George W. Bush took office, the explosives had been planted; all it took was for someone to
light the fuse.
Taming Mortgages but Creating a Monster
IT ALL BEGAN with a clever, sane idea: the mortgage-backed security. In order to allow S&Ls to lend more money, banks could buy mortgages from
S&Ls—which would give the S&Ls immediate cash—and then the bank would package the mortgages into securities, which it would sell to investors.
In 1983 Larry Fink and his investment banking team at First Boston invented the CMO, or collateralized mortgage obligation. (Fink is now CEO of BlackRock, the big investment manager.)
Fink’s innovation was that his CMOs were sliced into several distinct classes, or “tranches”, with different credit ratings and yields. The top tranche had first claim on cash
flows from the mortgages, while the bottom tranche absorbed the brunt of prepayment and default risk.
Demand was high. These new products started to change the whole structure of housing finance. Now, mortgage brokers sourced deals for a new group of “mortgage banks”. The mortgage
banks bought loans from brokers, and held them only until they had enough for Wall Street to securitize. By the mid-1990s, this model dominated the market.
But even in the first several years of their existence, collateralized mortgage obligations produced an interlude of craziness ending in a mini-crisis, in the early 1990s. Though tiny by current
standards, withestimated losses of $55 billion, it was a warning of the damage that could be inflicted by
Similar Books
![Tracie Peterson - [Land of the Lone Star 03]](https://fs.collectorofbookboyfriends.com/604163/thumbs/152x264/tracie-peterson-land-of-the-lone-star-03.jpg)
