Auction 2012: Banking
January 30, 2012
Auction 2012 is a weeklong series in partnership with The Huffington Post and United Republic. Here’s Dylan’s interview with Paul Blumenthal of The Huffington Post kicking off today’s Auction 2012 series.
No money down. A sure thing. No risk loan. Free lunch. Easy money. Can’t lose.
If you’ve heard any of those expressions, a Greedy Bastard has tried to sell you something. Greedy Bastards, as I explain in my book, are the people that run our economy and politics. This week, the Huffington Post, the Dylan Ratigan Show, and United Republic are doing a series to explore corruption in our politics, looking at the various sectors of our economy to see how this impacts us. So this week, watch the Dylan Ratigan Show, read the Huffington Post, or check out CorruptionCostsYou.com to see how political corruption affects your life (for instance, why corruption leads to you paying higher ATM fees). The politicians may want us to obsess over the horse race, but we have a choice not to do so.
I use the term Greedy Bastards to describe the behavior of the corrupt elements in our culture. Greedy Bastards are spread across the economy in different industries and throughout government – in Banking, Oil, Universities, Government, Health, and Trade. While their behavior looks different depending on what industry they are in, the tactic they always use is what I call the “Very Bad Deal” hypothesis.
The essence of a Very Bad Deal is that it looks great on first glance. Someone offers us a low price on something we want or need – say housing – and we accept the deal. But there’s a catch. We have to accept a tiny chance that something terrible will happen. Even though on any given day there is only a tiny chance something very bad will happen, in the long run, that terrible thing is certain. The benefits come upfront and are obvious, while the much larger costs are deferred and hidden.
From 2003-2007, according to the St. Louis Federal Reserve, Americans took out $4.5 trillion of additional mortgage debt, which is roughly $15,000 per person. You can’t go wrong, went the sales pitch, because housing can only go up in value. And so Americans bought more homes, for higher prices, and it seemed like it was working out. And it was! Debt was up, but housing values were up more. At the peak in late 2006, American residential real estate values were worth nearly $25 trillion, up from $16 trillion just four years earlier.
The big banks were the dealers in this game, extending as much credit as they could with capital requirements. They had used their political power to lift leverage restrictions and expand the derivatives market, which when put together is the equivalent of removing all the stop signs on the road. So onward we went, faster and faster.
And then came the crash. Asset values plunged by about $7 trillion, but debt levels stayed the same. The terrible thing had come to pass. Americans today have lost everything they gained in the bubble, and then some. They effectively gave up fourteen year’s worth of savings, without counting high unemployment and high public debt levels.
The banks who orchestrated this bubble transferred what’s known in technical terms as “tail risk” to the public. Tail risk, as my friend Nassim Taleb explains, is the chance that something extreme but unlikely happens. A chance of a hurricane that causes $100 billion of damage is low, but it’s not nothing. Banks, who are in the risk trading business, think very hard about how to price “tail risk” and who pays. In the case of the housing bubble, the banks transferred their “tail risk” to the public through derivatives. When the music stopped, the banks realized that they could get the government to cover their losses by using AIG as a funnel to suck up taxpayer money. Homeowners however were on their own, and have dealt with underwater mortgages and foreclosures. So now the homeownership rate, when you back out homes in default, is probably lower than it has been since 1962.
This tactic, of transferring tail risk to the public, is conceptually no different in banking than it is in any other arena. I’ll go into other areas in depth in my book and in future blog posts. Briefly, though, when BP cost us hundreds of billions of dollars in pollution costs by dumping oil into the Gulf of Mexico, that was transferring tail risk to the public. It’s all different types of Very Bad Deals, offered to us by Greedy Bastards.
Ultimately it comes down to the expression that if it sounds too good to be true, it probably is. For decades, since the early 1980s, our big banks offered us easy credit in increasingly large amounts. Buy now, pay later. Seemed like a great deal. But a funny thing happened since the time credit became “democratized” – we stopped getting raises. And after the housing bubble collapsed in 2008, we’ve lost our homes and our wealth.
What we’re finding out, now that the terms of the Very Bad Deals are becoming clear, is that an economy based on deals that sound too good to be true is a very unstable place to live.
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