It was barely nine months ago, on December 11, 2008, that Bernard Madoff was arrested for fraud. The dust has not settled yet on the causes of the financial crisis nor has the extent of the Madoff fraud been determined. Even so, a quick look at bookstores reveals a growing collection of books on the subject—just recently, I counted no less than six volumes on Madoff alone. If history has taught us a lesson, it is safe to assume that we will never understand the causes if we look for a simple, straightforward answer. However, we already have a good number of fascinating articles, focused on different events and aspects of the crisis that provide plenty of material for reflection. Here, I link to the ones I have found most interesting.
- First, some timelines of the crisis. Both the New York Fed (hat tip to Jonathan Parker in the Everything Finance blog) and the St. Louis Fed are maintaining timelines.
Roots of the crisis
- Triple-A Failure by Roger Lowenstein (New York Times, April 27, 2008) sheds light on how Moody’s ratings of mortgage backed collateralized default obligations (CDOs) come about—a mechanical and uninformed process based on historical data. This article is discussed in a blog entry by Bob McDonald in Finance and the Public Interest. NPR’s This American Life revisited this topic in The Watchmen—Act Two. Investigation Report # 2 by Alex Blumberg (June 5, 2009; segment starts 32:20 into the podcast).
- The Giant Pool of Money, by Alex Blumberg and Adam Davidson (This American Life, May 9, 2008)—This report on the subprime mortgage meltdown received a Peabody and duPont awards. They trace the subprime mess through each of the steps in the chain, from borrowers to Wall Street.
- Enforcers—Act Two. Now You SEC Me, Now You Don’t by Alex Blumberg (This American Life, September 12, 2008; segment starts 35:38 into the podcast). Remember “naked shorting”? Recognize the name of the SEC’s chairman, Christopher Cox? This American Life‘s series on the economy is worth listening to. Also read Bob McDonald’s blog entry “Naked Shorting: Do Clothes Make the Trade?“.
- Tracking Loans through a Firm that Holds Millions, by Mike McIntire (New York Times, April 23, 2009)—Have you heard about MERS or wondered how mortgage loans could change hands so quickly? This informative piece helps fill in many blanks.
- Cocksure. Banks, Battles and the Psychology of Overconfidence, by Malcolm Gladwell (The New Yorker, July 2009) discusses the Bear Stearns collapse.
- The Final Days of Merril Lynch, by William Cohan (The Atlantic, September 2009)
- Vanity Fair has an excellent series of articles about Madoff’s Ponzi scheme, published between January and September 2009, and collected under “The Madoff Chronicles“.
- The Man Who Crashed the World by Michael Lewis (Vanity Fair, August 2009; hat tip to Vefa Tarhan): This article discusses the role of Joe Cassano in AIG. It’s a “familiar” story: one man’s power is unchecked and not challenged by anyone else in the company, which is anesthetized by the profits his division brings. Similar stories have been told about Nick Leeson, in Barings Bank’s Singapore office back in 1995 (see Helga Drummond, 2002, “Living in a Fool’s Paradise: The Collapse of Barings Bank,” Management Decision, 40(3): 232-238; the link is gated), or Jérôme Kerviel in Société Générale in early 2008 (see “A Trader’s Secrets, a Bank’s Missteps,” by Nelson D. Schwartz and Katrin Bennhold, New York Times, February 5th, 2008).
- Reading My Personal Credit Crisis, by Edmund L. Andrews (New York Times, May 14, 2009) is very much like watching an accident in slow motion. Andrews is caught in the throes of his own financial hurricane. He paints the picture of an informed consumer caught up making the wrong choices and serves as a good reminder that this crisis was not just about evil bankers tricking uneducated customers.
- Henry Paulson’s Longest Night, by Todd S. Purdum (Vanity Fair, October 2009). A sympathetic profile.
As we seek to understand the events and people that led to the crisis, we try to find what institution failed, where there might have been insufficient regulation or supervision; we try to pinpoint who was negligent or incompetent, blinded by power and surrounded by complacent colleagues, all impaired by groupthink. Who was responsible for the crisis?
I cannot help but to think of Charles Perrow’s volume on Normal Accidents. Living with High Risk Technologies (Princeton University Press, 1999). Perrow, a noted Yale organizational sociologist, analyzed the social side of catastrophes or near catastrophes in different high risk industries, from nuclear plants (the 1979 Three Mile Island accident) to aviation. Normal accidents or system accidents are those in which more than one component fails, with multiple and unanticipated interactions between failures. He concludes that we design systems so complex that we cannot anticipate all the interactions caused by failures. Attempts to fix the systems can lead to the creation of additional, unintentional pathways which themselves may fail. While this book (which is a fascinating read) is about industrial accidents, I believe there are parallels to the financial system and the current crisis. For example, think how banks have been required to reserve capital against risky assets (under Basel II) and how AIG, not required to keep those reserves, was able to “bury” those risks in its balance sheets.
Yes, there were greedy crooks, there was lax or even incompetent supervision, there was groupthink and complacency. Most of all, there were individuals, relying on the institutional framework without an idea or concern about how their individual actions impacted the system. There were multiple points of failure. In the next couple of years, there will be more financial innovations (e.g., securitization of life settlements is being touted as the next Wall Street fad), and regulators will put in place new safeguards that will lay the ground for a future crisis. There is one more book worth reading if you haven’t done so already—Charles Kindleberger’s Manias, Panics, and Crashes: A History of Financial Crises (Wiley, 5th ed., 2005).
Please share links to other interesting reporting on this crisis you may have encountered and your reflections on it.