Thoughts on the Arab-Israeli conflict
Showing posts with label history. Show all posts
Showing posts with label history. Show all posts
Why the Jews?
Turning back to the Jews, he continued, if there is a superior race, it's them. Whatever the world throws at them, they survive, and they thrive. After millennia of persecution, in whatever country they live, they are in the creme of society, among the most successful, most educated, most resourceful people. "But how can you say this, if you hate them?" - asked someone in the audience. "I'm at least honest about my reasons." - came the response.
I frankly don't remember a single thing from the book apart from this scene. It stuck with me for two reasons. One, it made complete sense. Two, only in fiction you find such compelling characters who are so clear-eyed about their moral shortcomings.
Thesis
But there are and always have been overachieving minorities. The prime example today is the Asian Americans who form the highest-income ethnic group in the US, earning well above the majority whites. The business elite in Vietnam was for a very long time dominated by ethnic Chinese. I've listened to a podcast recently that listed similar minority groups in Iran, Africa, and the Caucasus, whose names I heard for the first time, then forgotten quickly.
Why is it then that only the Jews have become the global bogeyman? I think the answer is the Catholic Church.
History - beginnings
In the early days of Christianity, the followers of Jesus were just one of the many small Jewish apocalyptic sects in historic Palestine. As small sects tend to be, they were persecuted by the religious majority of Judaism. After Christianity's improbable rise to be the state religion of the Roman Empire, the boot was on the other foot, and the "turn the other cheek"-part was put on the back burner. Unlike the pagan religions, the Christianity demanded exclusivility. The Church persecuted all other religions, but the Jews were singled out as its vilest enemies. First, it was payback time, and secondly, the believers of other faiths at least had the excuse of being ignorant. But in the Christian mind, the Jews knew the Messiah and rejected him. They were God-killers. The facts that the Old Testament is part of the Christian Holy books, and Christianity tacitly accepts that the Jews are God's Chosen People, and Jesus himself was a Jew, were conveniently put aside. There is no cognitive dissonance that cannot be suppressed.
I don't know enough about Islam to trace the roots of Muslim Antisemitism with confidence. But my guess would be that Islam and Christianity share a basis of animosity against Judaism because they both see it as their parent religion that rejected the final messenger from God - Mohamed - or God himself. To them, Judaism is much closer to heresy than being a completely different faith, like Hinduism, and heretics are always hated more than non-believers. On the other hand, the concept of God-killing was missing from Islam, and for many Muslims, both Jews and Christians were people of the Book.
History - medieval times
As mentioned above, the Christians were not so relaxed about these things, therefore in Medieval Christendom Jews lived under the constant threat of persecution, pogroms, or at least dispossession. They were not allowed to own land, to be part of the nobility, or to have a position in state administration. The paths of integration into respectable society were blocked to Jews, leaving only those professions available to them that were beneath a good Christian. Like finance, banking, or academic studies. Jews, whose culture has always valued learning and intellectual curiosity, proved to be very successful in these fields, which wasn't exactly the Christian intention.
In the Islamic Middle Ages, life for Jews was definitely better than in Western Europe for the reasons mentioned above. The Muslim religious fervor manifested itself more in conquering rather than in converting. The Muslims were much more tolerant towards other religions on the territories they controlled as long as the subjugated minorities paid their taxes and kept their heads down. But the popular concept of the golden age of Muslim tolerance is oversold. Minorities were second-class citizens without the protection of the law, at the mercy of the majority.
History - modern times
In the modern era, religiosity in the West has slowly receded. Modernity eroded the significance of ethnicity, birthright, and social status, and elevated the importance of education and intelligence. The ways of making a living Jews had been basically forced into earlier - notwithstanding that due to their traditional reverence for learning they had an affinity to -, like banking, law, and medicine, have become increasingly more important and more profitable. The old aristocracy of land was gradually pushed into irrelevance by the new one, the aristocracy of money, and it was disproportionately represented by Jewish families, like the Rothschilds. Religious animosity from the majority was increasingly replaced by material envy as the stories about baby-blood-drinking Jews were replaced by conspiracy theories of Jewish cabals secretly running the world.
From the nineteenth century, credit to these views was given by the fact that Jews were indeed overrepresented by the vanguards of ideological currents that turned the world upside down. Capitalism came first, which benefited those who held an already long tradition of being involved in finance, banking, and trading. Then Communism swept over Europe, which toppled the Christian regimes. Jews were in general disproportionally present among intellectuals, thus not surprisingly, even more so in anti-religious intellectual movements.
The Jews have been in the middle of another societal battle as well. Because of the prohibition of owning land and of their traditional professions, Jews have always converged to cities to ply their trades. The urban-rural political divide - that pitted the presumably unsullied people of the land against the decadent urbanites - always had a distinct antisemitic undertone. Furthermore, the Jews have stubbornly refused to fully assimilate.
But after the Second World War, open Antisemitism became a strong taboo in the West. Not in the Muslim world, though, where the creation and flourishing of Israel and its successive military victories over its Arab neighbors pushed them into a collective frenzy. Israel managed to defeat the combined forces of its enemies on the battlefield over and over again. Israel is a Western-style democracy, the Arab states are corrupt and incompetent. Israelis are living on Western standards (on the only land in the Middle East without oil), Arab citizens in poverty and oppression. Jewish Nobel-prize winners are a cliche, while the number of such scientists the Arab world has produced is exactly zero. The dissonance between reality and what Muslims think their rightful place in the world should be (being the receivers of the final revelation from God), is as enormous as the inferiority complex that follows it.
Matthew Effect
"For to every one who has will more be given, and he will have abundance; but from him who has not, even what he has will be taken away."
There is another factor that is so mundane that it can be easily overlooked. Every instance of publicly blaming Jews for something grows the history of Antisemitism. So the next time someone is groping for a culprit to explain away his or his tribe's failure, he can recall some antisemitic rumor more readily - this is called availability bias. He runs away with his instinct and the self-reinforcing cycle is closed. This I think is just the Network Effect, or as sometimes called, the Matthew Effect. From all the social networks available to them, people choose the ones where they can connect to the most people. From all the available conspiracy theories that explain a given state of affairs, all things being equal, we tend to choose the ones shared by the most. And conspiracy theories involving Jews have been around so long and therefore have so many followers, that they are now impossible to displace.
Summary
To summarize, Antisemitism is rooted at the foundation of Christianity. Jews have been initially persecuted for purely theological reasons, then forced into certain occupations for the same reasons, which by chance and with time have given them power that earned the envy and jealousy of the majority. They have become the perpetual culprit for any calamity or lack of success of majorities, even when the original reasons were no longer relevant. The image of scheming Jews is unerasably part of our collective psyche. As long as Jews refuse to die out or assimilate perfectly, Antisemitism will be always with us.
What makes Putin tick - The Myth of Russian Greatness
Time for another session for some armchair expertise. Coming to think of it, New Vac Times engages in this kind of punditry so often that it merits its own tag. Created.
Much has been said in the media and on public forums about what made Putin launch the war against Ukraine. The intellectual bottom comprised of arguments like "Ukraine used to be part of Russia, didn't it?", or "the USA started it!". One rung up on the sanity ladder came those who, just having left the pandemic behind transformed themselves from epidemiologists into geopolitical experts (but not historians) overnight, claiming confidently that what forced Putin's hand is "the aggressive encroachment of NATO".
But Russia invading its neighbors and playing the victim is nothing new. This is a recurrent pattern that existed before Putin, before NATO, and before even the Soviet Union.
There is a long tradition of Russian thought, according to which the Russians are a chosen people. Russia is not merely a nation-state like any other, but a civilization itself, a land with a destiny. Moscow is the Third Rome, and Russia as a whole is the successor of the Roman Empire. The bulwark against the heathen hordes of the past and the Western decadence of the present. Even without the theological/cultural charge, it is a superpower rivaled only by the United States, that deserves a place in the highest decision-making circles.
This grand delusion gives the Russians a superiority complex that immediately crashes when they look beyond their borders and get confronted by the fact that Russia is inferior to the West in everything that counts. Military might, economic clout, soft power, cultural influence.
The West dominates all major international institutions from the IMF to The Hague, American military budget and might dwarves the rest of the world combined, Western countries are the richest, most envied places on Earth. People all over the world chose English as their second language, not Russian. They watch and listen to American products, and they go for their news to the BBC, not Russia Today. Artists, scientists, and media personalities of all kinds measure their success by the extent of their breaking into the Western consciousness. The land of dreams for people from poorer countries is America and Europe, not Eurasia. Even Russians choose to school their children in Swiss or English boarding schools and send them to American universities. They park their money in London, go skiing in the Swiss Alps, and spend the summers on the French Riviera.
Russia has a GDP just below Italy's, and in the words of Barack Obama, the Russian economy "doesn't produce anything that anybody wants to buy", except oil, gas, and arms. In the even blunter words of the late John McCain, "Russia is a gas station masquerading as a country".
The gaping chasm between the grand delusions and reality yields resentment, envy, jealousy, and anger. If we are the chosen people, how come it's not us who are calling the shots here? They just start a war, and don't even bother to ask us anymore? Why do nations that used to belong to our sphere of influence choose Western alliance over us? Ukrainians, Estonians, Poles, the rest. Love us, you ungrateful scum, or else...!
When the trollish Russian Foreign Minister Sergei Lavrov publicly opined that NATO had "become a purely geopolitical project aimed at taking over territories orphaned by the collapse of the Warsaw Treaty Organization and the Soviet Union", former Polish Foreign Minister Radek Sikorski retorted, as our age demands, on Twitter: "We were not orphaned by you because you were not our daddy. More of a serial rapist. Which is why you are not missed..."
The "conversation" exposes not only the characteristic ghoulish cynicism of Russian leaders dating back to at least Stalin, but also a yearning to be seen both as a victim and great power simultaneously. A great power that has the right to "protect" its neighbors.
And like any other country with a serious inferiority complex, Russia explains away its failures by blaming them on the meddling of malign foreign powers.
When the Soviet Union, after brutalizing every land it could lock in its sphere of influence for 40 years, fell apart - due to its own incompetence, corruption, and bankrupt ideology, it wasn't invaded by its former enemy, nor by the countries it has trampled on for decades. Nor were reparations demanded. Instead, Russia received billions of dollars worth of foreign aid. Gorbachev and Boris Yeltsin were celebrated as heroes in the West. In 1994, Russia joined the Partnership for Peace program, and in 2002 the Russia-NATO council. In 1997, Russia was invited into the G8 - despite that it didn't meet the standards required for joining, and in 2012 it gained membership in the WTO. In an effort to integrate Russia into the international order, the US has made constant gestures, London (disgracefully) offered its money-laundering services, and Germany chose to unilaterally increase its own dependence on Russian energy.
Even beyond economical and political nurturing, Russian leaders have been in constant need of ego-stroking. Tony Blair's advice to George Bush in the early 2000s was to treat the Russians as a superpower. French presidents, who seemingly fancy their country as a diplomatic superpower, have been running regularly to Moscow to ask what the West should do so the Russians feel better about themselves (ironically, France is a country that also has an inflated view of its own importance and probably not accidental that in the strength of anti-American sentiment in Europe, it is second only to Russia).
And yet, in the Russian narrative, they were disrespected and mistreated. Putin is reported to engage frequently in hour-long monologues reciting his grievances to anyone who cares to listen. The West lied to us, deceived us, bullied us, and the rest, on and on.
Even when Putin disappears eventually, I don't see how this ugly side of Russian national character would go away. The only effective salve on bruised ego is success. The structure of the Russian economy and the endemic corruption prevents an economic one, and in the absence of that, Russian leaders will only measure their accomplishments in military achievements.
Firefighting - The Financial Crisis and its Lessons (2019) - Book review, part 2
The first part of this review attempted to compose a brief but coherent narrative of how the Great Recession started. The emphasis was on brevity at the expense of details. In similarly broad strokes, this part will summarize how the Recession unfolded in America from the crisis managers' point of view.
We left off at the point of the collapse of the housing market. Its implosion was already afoot in 2007, but none of the decision-makers foresaw the devastation it was about to cause in the economy. Bernanke, the chairman of the FED, expressed his belief in a testimony before Congress that the damage will be contained.
What Bernanke didn't count with was the subsequent panic that spread to the healthy part of the financial world as well, up to a point where policymakers realized that if they let the market sort the mess out itself - as libertarian-leaning purists proposed - there will be carnage. After the French investment bank BNP Paribas froze three of its investment funds in the US in August 2007, and thereby caused a liquidity crunch, intervention seemed necessary.
The first move the FED made to alleviate the situation was the classic one from the central bankers' book. It stepped up as the lender of last resort by opening a so-called discount window where banks in trouble could borrow, albeit at penalty rates. Although this infused some welcome liquidity into the system, it didn't turn out to be a great success. The transactions were confidential, but many banks feared that they would look weak if the market got wind about them. Therefore many of even those who urgently needed liquidity declined the opportunity. Despite the underwhelming results, the fears of inflation rose. Later the FED changed its strategy and organized loan auctions which were much more popular than the discount window.
Although the common narrative holds that the FED bailed out all the irresponsible actors, it silently declined such requests until much later. The first major victim of this intentional inactivity was Countrywide Financial, a $200 billion firm that financed 20% of all mortgages in the US. In January 2008, it was forced to sell itself to Bank of America for a fraction of its value in 2006.
In the meantime, the FED cut the short-term interest rates and the government introduced tax cuts to boost the economy.
The time for the next major player to buckle came in March 2008. Bear Sterns, one of the five stand-alone investment banks in the US, was twice the size of Countrywide and too interconnected not to wreak havoc if it collapsed. Although they changed their mind by this time, neither the FED nor the Treasury had the authority to help it directly. Bear Stearns was a nonbank, therefore the FED had even fewer tools at its disposal to intervene on its behalf. For a time it looked like Bear will file for bankruptcy, but almost at the last minute, Bernanke and Paulson could convince JP Morgan to buy up Bear Sterns with the help of the FED and the Treasury. Which doesn't mean Bear Sterns was bailed out. It ceased to exist and its assets were taken over by JP Morgan.
The next major event, in September 2008, was the nationalization of Fannie Mae and Freddy Mac, the strange, government-sponsored private enterprises, that underwrote half of the US residential mortgages. This was the biggest financial act since the depression. Republicans cried socialism, the liberals cried crony capitalism.
Bernanke and Paulson hoped that nationalizing Fannie Mae and Freddy Mac will send the soothing signal to the markets that the government is willing to do whatever it takes to contain the situation. But the message had the opposite effect. The markets suddenly realized how big the problem really is.
Then just a week later came the infamous collapse of Lehman Brothers. Lehman was much smaller than Fannie Mae or Freddy Mac, but somehow in the public consciousness, it became the symbol of the start of the Recession. Both the FED and the Treasury wanted to prevent its collapse, but their toolset was limited. Contrary to common belief, the authorities of both institutions were severely constrained. The FED was allowed to lend only against solid collateral and the Treasury could do little without congressional approval. No one in the private sector was willing to step up to buy it as JP Morgan did with Bear Sterns.
Lehman fell. Its demise sent shockwaves through the whole economy. Still, opinion writers of the FT and the WSJ praised the FED and the government for finally manning up and refusing to bail out irresponsible bankers. Some others, fearing the consequences of Lehman's fall, called Bernanke and Paulson idiots. Both types of reactions showed how much the pundits usually know of the things they write about.
Some saw the inactivity as a calculated political act to frighten the congress into action. It definitely played at the hand of Bernanke, because actually seeing what Lehman's fall entailed, Congress swiftly voted for expanding the powers of the FED and the Treasury and passed the TARP - Troubled Assets Program to authorize the expenditure of $700 billion to purchase toxic assets.
The next one on the verge of collapse was AIG, the insurance giant. It was deemed too big to fail and was bailed out just two days after Lehman's fall.
By then, the troubles of the financial sphere spread to the real economy. GE had problems.
The government's and the central bank's actions weren't popular, to say the least. The public was still against the bailouts. Republicans were against the prospect of runaway inflation. Professionals were against the moral hazard the saving of irresponsible market players might introduce.
There still were some negative new records in the system. The fall of 2008 saw the two largest bank failures in U.S. history: Washington Mutual and Wachovia bit the dust.
In October 2008, The FED organized the first-ever coordinated interest rate cut by major central banks around the world. At home, it organized stress testing of every bank to reassure the markets through transparency.
In November 2008, it started an aggressive monetary stimulus experiment, known as Quantitative Easing to pump even more money into the economy. The first round was followed by the second in November 2010, then by the third in September 2012.
Tapering down some of the FED's QE policies started only in 2013, by which time the Great Recession was a thing of the past.
In the end, the authors admit that their course of action was constant improvisation. The Great Recession was something no one was prepared for. Instead of following some pre-written emergency plan, their method was constant experimenting, changing tools and minds along the way. But in the end, the problem was contained. There was a real possibility of disaster. Among the "could have been" outcomes were Zimbabwe-style hyperinflation, Japanese zombie-banks, even the end of free-market capitalism. To evaluate how successful the crisis management was, we can put the events in historical perspective. The Great Depression sank the US GDP by almost 30%, which was accompanied by an unemployment rate of 20%. The Great Recession caused a GDP fall of less than 5% while the unemployment peaked at 10%.
Contrary to popular belief, the taxpayers' money didn't fall victim to saving the irresponsible Wall Street types. The FED never lost a dollar on its loans and the government, so ultimately the taxpayers, earned a substantial return on their investment in US banks. Which of course doesn't console those who lost their homes, jobs, or savings. And while the public resented the government for saving bankers instead of jailing them, the ones who were bailed out were not happy about the specifics of their rescue either. AIG actually sued the government for what they perceived as an unfairly harsh treatment.
And what about the next crisis? The authors are sure that it will come one day but less sure about how well America is prepared for that. Some things have changed for the better. Regulations have become stricter. Banks have higher capital requirements and some restrictions apply to nonbanks as well. But the emergency powers of the FED and the Treasury have been weakened.
And, very briefly and very simply, that was the story.
Firefighting - The Financial Crisis and its Lessons (2019) - Book review, part 1
I never had any education in finance or economy, but in the following decade I did some reading and I tried to come to an understanding of at least the big picture. I read about bad incentives, subprime mortgages, bubbles, inadequate regulations, and even some quasi-mathematical explanations of how the securitization of mortgages led to obfuscating financial risks instead of diluting them. But I never felt confident that I could explain the Great Recession well if I had to. In short, I lacked a coherent narrative.
This is the reason why I was so happy to put my hands on Firefighting: The Financial Crisis and Its Lessons, a book by Ben Bernanke, Timothy Geithner, and Henry Paulson, among whom the first held the office of the chairman of the FED, and the other two were the consecutive United States Secretaries of the Treasury at the time of the events. They were actually in charge of the US response to the crisis - within the limits of their offices, at least. If there was anyone who could explain what happened, I thought, these guys are the ones! Another big plus is that the book was published in 2019, more than a decade after the crisis. The future consequences of many of their actions were unknown then, but they have had the time to run their course by now.
The benefit of hindsight is a double-edged sword, of course, as the authors, who had, and at least with respect to their reputation, still have skin in the game, can present the events in lights more favorable to them. I don't have enough knowledge of the history of the Great Recession to judge that, and as a financial illiterate at worst and a curious but lazy layman at best, I really can't evaluate their decisions. In short, I just take their word for everything in the book.
And in the following, I try to summarize what I learned from a 160-pages long summary of a very tumultuous and controversial event, in chronological order. In the first part, we will look at ...
....how it all began
Crises naturally don't happen in a healthy economy, although their inevitability is only seen in hindsight. According to the current wisdom, what led to the crisis were the following: global savings glut, the common practice of overleveraged investments, a patchy system of regulations, bad incentives, rampant securitization, and a subsequent panic that turned a normal recession into the Great One.
Low interest rates and overleveraged investments
What experts called the global savings glut was the phenomenon that in the early 2000s foreign investment poured like rain into America (mostly from China), as local investors sought higher yields and better investment opportunities than they could find at home. This caused a huge build-up of debt (both by private households and banks) but plenty of cash.
The sentiment of never-ending good times and low interest rates incentivized financial institutions to overleverage, that is, they financed their investments largely by borrowing. Let's enlighten the concept of leverage with an example. In this, our private citizen Optimistic Oscar decides to buy a house for investment purposes. The house costs $1 million, Oscar spends $100,000 from his own money, and takes a loan for the rest - that loan is his leverage. He duly manages to sell it a year later for $1,200,000 (a 20% extra). He pays back the $900,000 loan to the back with let's say 5% interest, which amounts to $945,000. The rest, $255,000 remains in his pocket. He turned $100,000 to $255,000 in a year, earning a spectacular 155% profit!
Had he paid half of the original price himself ($500,000), then he would have to pay back $500,000 * 1.05 = $525,000 to the bank which leaves him with $1,200,000 - $525,000 = $675,000. His profit would be $175,000 on the $500,000 investment, that is, 35%. Not bad, but far from 155%.
How would the math look like in the first case if the price of his house had dropped 20%? He would sell it for $800,000, pay the bank its $945,000, which would leave him in $145,000 debt! He started with $100,000, ended up with -$145,000, that's a loss of $245,000. -145% loss!
What if he had paid half of it himself? Then after paying back $525,000 he would end up with $275,000. He lost $225,000 of his original $500,000. -45% interest. Bad, but at least not -145%!
This whole thing is very much like what banks have been doing since the Medicis. They have realized that not all their clients will come to take out their deposits at the same time. It's enough to keep a fraction of their assets at home, the rest they can invest, and earn profit.
In short, leverage is an essential tool in finance. It multiples wins and losses equally. The markets were superbly optimistic in the early 2000s and took gambles that rewarded them immensely. When the times turned bad, it wiped them out.
Patchy regulations and the shadow banking system
Shouldn't regulations have demanded more prudence? Don't banks have capital requirements stopping them from being overleveraged? Well, there were regulations, and banks had standards. But both were inadequate.
The hodge-podge regulation framework didn't make it easy to see what's happening in the economy. There was no single regulator that could assess the big picture, and the strong anti-regulatory lobby ensured there won't be either.
The regulation net didn't even cover the whole financial infrastructure. Many financial entities - part of the so-called shadow banking system - didn't have to abide even by the low standards imposed on banks. Moreover, government institutes, like the FED or the Treasury, didn't have the authority to help them in trouble, either.
Securitization
And then there was the magic of financial engineering, especially the technique known as securitization. Let's explain that briefly and inaccurately. When Joe Average takes a loan from the bank to buy his house, the bank gives him let's say 1 million dollars on the condition that in 20 years he has to repay $2 million (the numbers are completely ad-hoc). This mortgage is an asset of the bank. Now the bank might find itself in trouble one day and in need of quick money. It can decide to sell Joe's mortgage to another bank (or any financial entity) for, let's say 1.2 million. It forgoes the stream of revenue in the next 20 years in exchange for having the cash now (not completely unlike what Joe did in the first place). So Joe's mortgage is actually a product that can be sold and bought, like a second-hand car.
A mortgage is, of course, not a riskless product (another common trait with second-hand cars...). Joe can default on it, which is a loss for the bank on him (in case the value of his home doesn't cover the mortgage). However, smart statisticians have figured out that even though Joe Average has a 1% chance to default on his debt, one thousand Joe Averages' mortgages bundled together is a very safe investment, because according to the expectations only 10 of them will default. That's the reason banks bundle products together in big numbers, so the future aggregated loss on them is both low and foreseeable.
Of course, the mortgage is just one example of financial products that generate steady streams of revenue for some limited time. Jane's student loan is another example. Joe's mortgage can be bundled with Jane's debt and a hundred similar products and then sold and resold, and split into smaller products and merged into other bundles made of products originated from other banks. Products can be sliced even "horizontally". To explain it with an example, let's assume a bank has a package of 1000 debts, which it splits into 3 tiers or "tranches", each of which generates the same revenue to its holder. It sells the lowest, Tier 1, for 10 million dollars. When some of the 1000 debtors start to default, this will be the tier whose revenues will be affected by those losses. Tier 2 is sold for a bit more, 12 million dollars. The holder of that will be affected only in the unlikely event of more than 10 debtors defaulting. Tier 3 is the priciest, it's sold for 14 million dollars because its revenue is guaranteed. The owner of this has bought peace of mind for the extra 2 million bucks. The numbers might be unrealistic here, but the concept holds.
So at the end of the day, a Norwegian city council can invest into a product to enjoy a steady stream of revenue for the next 20 years that consists of a fraction of Joe's mortgage monthly payment from Texas, a fraction of Jane's payment on her student loan in California, and bits and pieces from a thousand different origins. Of course, by the time the first cent reaches Norway, these products went through so many hands and slicing and dicing that no one can trace them in either direction anymore.
The core idea behind this whole complicated business is to reduce risk. The products are made of diverse and often geographically distributed components. Some of them will default, but the overwhelming majority won't because they are independent. They need different reasons to fail (Joe's financial situation in Texas correlates very little with Jane's in California), and the failure of one product doesn't affect the other. With the vertical splitting, even the probabilities can be controlled, so risky products will be bought by those who can bear the risk.
At least, such was the consensus before 2008. What happened?
A housing bubble happened...
... that exposed the flaws in the theory brutally. From the early 2000s, the American government actively promoted house ownership. With the help of government subsidies (tax breaks and such) and the historically low interest rates, a huge number of people could afford (and were actively encouraged) to buy their own houses. They did it mostly by taking loans, sometimes with no capital at all (see overleveraged). House prices shot up all across America. This didn't stop the buyers, because the rise seemed to be inexorable. Joe thought that he could buy his house on a loan only. The interest rates were low (at least in the first couple of years, in the "teasing period") and he figured that the price of his home will continue to rise. Even if he ends up being unable to pay the monthly installments, he can sell the house for more than he bought it for, thus even earning some money on the whole thing.
Bad incentives
The buyers weren't alone to blame. Banks and brokers gave loans to people about whom a basic background check would have revealed that they will never be able to repay their mortgages (these were the so-called NINJA loans - for borrowers with No Income, No Job or Assets). Why? Because they had no incentives to do so, just the opposite. The practice of securitization made them indifferent to whether the buyers will be able to meet their obligations or not. The originators of the loans immediately repackaged and sold them, and thus they no longer bore the risk. Brokers even received hefty commissions after each mortgage they negotiated, making them financially interested in not making those background checks.
What about the financial entities who bought the securities? Shouldn't they have demanded more checks? They actually did, that is what credit rating agencies, like Moody's and Standard & Poor's, are for. However, these agencies were funded by fees paid by issuers or sellers of securities. This is called a conflict of interest. It's like you were paid by Adam Sandler to write a review of one of his movies.
And the panic
Eventually, more and more homeowners defaulted on their mortgages. They put the houses on the market which started to push the prices down. Once the trend turned, there was no stop to it.
The bubble burst and so did the theory of risk-defeating securities. House prices started to fall everywhere, which eliminated the supposed safety of the geographic diversity of the securities. Banks and other financial institutions that stored their wealth in mortgage-based securities saw them evaporate. The byproduct of the financial engineering of spreading out and diluting the risk was obfuscation. No one knew exactly which financial products were affected. So instead of cauterizing the rotten part of the system - and rid it of the bad actors and practices with some collateral damage -, the fire spread. The market players started to distrust those who dealt with any kind of securities. Then those who made business with them. And then those who had links to those. And so on. Everyone was reluctant to lend to anyone else, and the system started to come to a grinding halt.
In the second part, I will sum up how the events unfolded in the following 2-3 years, and what role the FED and the Treasury played in the story.
Subscribe to:
Posts (Atom)