Gillian Tett on the causes of the financial crisis

[nwhyte]

I took a detour from my usual intellectual pursuits at lunchtime yesterday and wandered over to my former workplace at CEPS, to hear the Financial Times journalist Gillian Tett talk about her book, Fool's Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and Unleashed a Catastrophe. I was CEPS' researcher on Balkan issues

Comments

[wwhyte]

My impression is that coming up to the crisis there was a big problem with bad information, not just between the banks and retail investors, but between the holders of bad debts (such as CDSes) and the (supposedly sophisticated) institutions that bought those bad debts. CDSes and other instruments were systematically thought to be less risky than they actually were.

In so far as there was a single point of failure, it seems to have been with the credit ratings agencies, who all the players relied on for risk assessment, and who rated these dodgy assets higher than they should have.

This was for a number of reasons, both technial and anthropological. The technical reasons include: CDSes are very complicated and hard to analyse; the entire purpose of CDSes was to disguise where the risk was going. The anthropological ones include the fact that the ratings agencies *should* have an adversarial relationship with the entities they rate, but in fact they're paid by the entities they rate, so in the interests of getting more business they will tend to provide answers closer to what their customers want to hear. Since there are only three ratings agencies, competition didn't produce better quality output (though TBH even if there were more I think the cozy relationships between agencies and vendors would still have been the main problem, and the quality of the information wouldn't have been much better).

So my first step at an answer to the question would be to have more oversight of the credit ratings agencies. Possibly this could be done by having a team of government analysts review a random sample of ratings from each agency every year. Maybe it would be a step in the right direction simply to require them to grade on a curve -- no more than 1% of your rated securites can be AAA+, for example.

In general, I focus on the agencies because they're meant to be the honest brokers -- you expect a certain amount of exaggeration elsewhere in the system and it seems likely that trying to correct that at source would just lead to creative ways of avoiding regulations rather than a significant improvement. But I don't mean this comment just to be about my brilliant ideas. Did she mention the ratings agencies as a point of failure? Was there a particular point of the system that she identified where unrestrained greed was meant to be restrained and wasn't?

[nwhyte]

As far as I followed the talk (and I'll obviously have to get the book now), she placed the crucial failure point a step farther back: the bankers themselves ought to have damn well known that CDSes couldn't reliably be applied to mortgages, as indeed was the conclusion of the banking tribe she first studied at J.P. Morgan who didn't want anything to do with such a project. Her explanation for why other bankers did not realise that extending the credit market in that way was unsustainable is simple: greed.

It's not really true that the information was not available, at least to anyone who cared to listen. George Soros was talking about the problem years ago to anyone who was in the same room (I certainly remember him talking to me about it at some point in 2005 or 2006, but heaven knows how long he had been aware of it). So was Vince Cable. Gillian Tett admits to being behind the curve but indicated that she had spotted what the problem was by early 2007. I'm not a financial services insider but the fact is that I'm on first name terms with two of those three people and reasonably well connected with the third, and none of them is without influence. So why did the information not flow to the point where the right decisions could have been made?