Saturday, January 16, 2016

The Problem with the Big Short

Michael Lewis is a friend of mine and one of my favorite writers.  That said, the message of the Big Short and some of Lewis's other writings on the 2008 financial collapse are way, way off base.

The financial collapse of 2008 had absolutely nothing to do with an untoward amount of greed on Wall Street.  Wall Street is no different than any other street in America regarding the level of greed. There is just more money there, but not more greed. Greed is ubiquitous.

Teaching in a modern university provides a first hand exposure to greed.  Having worked both on Wall Street and in academia, there is no question who the greediest folks are -- the folks in academia, without a doubt.  Wall Streeters as a group are more generous and more caring than academics.  Wall Streeters are, as a rule, honest and straight forward in their business dealings.  Academics are mainly interested, institutionally, in their compensation and benefits, as they will be happy to tell you, if you give them a chance.

People aren't greedy because they have wealth.  People are greedy when they are willing to sacrifice principle and ethics for money, advancement and job security -- something that is much more prevalent in the halls of academe than in Wall Street.  Wall Street is a place that rewards merit, while academe functions more like a religious order, where tenure holds sway over merit and petty politics is a routine part of the everyday experience.

So, back to the Big Short.

Financial collapses are not the result of bad people doing bad things.  Bad people are always doing bad things -- during the booms, during the collapses -- bad people are always around doing their thing. 

Fortunately, there are not many bad people in Wall Street, which is why the average investor over the past 110 years and has been able to capture better than 10 percent returns annually by the simple tactic of buying a diversified portfolio and letting it ride. Companies like Vanguard have made this simple to do, so that ordinary folks have been able to gain great wealth, by taking advantage of index funds, which require zero investment expertise.  Thank you, Wall Street.  Even with bad people, floating around, Joe SixPack can double his money every eight years.  Not bad.

So, what is the message of the Big Short.  The message is that bad people in Wall Street caused the 2008 financial collapse.  That is complete nonsense. 

The collapse of the housing bubble is what caused the financial collapse, not Wall Street.  The housing bubble was caused by politicians, who decided to favor home ownership over renting.  So, they inserted tax breaks (mortgage interest deductability, tax free sales of homes, etc.) in the law and created government institutions that used the taxpayer (unwittingly) to finance unsound mortgages - FNMA, FMAC come to mind. 

This lead to an absurd boom in housing after the turn of the millenium -- a boom that could only end in disaster, regardless of the ethics of anyone in Wall Street.  Barney Frank was one of the cheerleaders for this stupidity and could easily be called the father of the Great Crash, because without his championing of poor lending behavior by FNMA and FMAC, the housing boom would likely never have gotten out of control.

Canada did not do any of these things and were spared both the housing boom and collapse that followed.  There is no mortgage interest deductability in Canada; there are no tax free home sales in Canada; and, to their great credit, the citizens of Canada weren't bamboozled by their local versions of Barney Frank to create lending monsters like FNMA and FMAC to offer financing to folks who should never have received financing.  So, Canada escaped this nightmare not because their Wall Streeters are more ethical, but because their politicians, stupid though they are, cannot rival in stupidity the American politicians who created the 2008-2009 nightmare.  Thank you Barney Frank and Chris Dodd -- the champions behind FNMA and FMAC.

Of course after the crash, Dodd and Frank joined hands to shift the blame to Wall Street and managed to hammer through the most punishing anti-capitalism legislation in the history of the American republic -- the Dodd-Frank legislation.  You might say that Barney Frank and Chris Dodd are not only the fathers of the Great Crash, but also the fathers of the Great Stagnation that we have been enduring since 2009.  Thanks Barney and Chris.

Meanwhile, the very things that caused the housing boom in the first place are still enshrined in law.  Along the way, the notion that almost all financial institutions are too big to fail has been enshrined in law as well.  This means that someday there will be another housing bubble and another financial collapse.  But, what Dodd-Frank guarantees is that you the taxpayer are formally and legally on the hook for whatever happens -- whether Wall Streeters are greedy or not.  Thanks Barney and Chris.

No comments: