The Great Read-cession, Part III

Reckless Endangerment

We’re up to Part III of John’s breakdown of the books of the financial crisis. Click here for Part I, and here for Part II.

Reckless Endangerment: How Outsized Ambition, Greed, And Corruption Led to Economic Armageddon

by Gretchen Morgenson and Joshua Rosner, 2010


Reckless Endangerment is one of a specific subgenre of financial crisis literature, which might be called the “Blame X” genre. Human nature being what it is, there is a lot of demand for books that find someone or something to blame for the whole ordeal.

Reckless Endangerment’s targets are Fannie Mae and Freddie Mac, the government-sponsored entities (GSEs hereafter) designed to aid the housing market, and specifically Jim A. Johnson, the CEO who brought Fannie Mae to new heights (or depths, depending on your perspective). Morgenson and Rosner lay almost all the blame for the financial crisis on Johnson’s reckless efforts to expand Fannie’s market share: “A Pied Piper of the financial sector, Johnson led both the private and public sectors down a path that led directly to the eventual crisis of 2008.”

The GSEs are frequent targets of this kind of criticism, and for good reason: The bailouts of Fannie Mae and Freddie Mac created by far the biggest losses of all the government bailouts of 2008-09: The costs have already exceeded $180 billion and could reach $363 billion (conversely, Treasury claims to have actually profited on TARP*). And they were terribly run companies before that: In 2004, they were charged with massive accounting irregularities that led to the resignation of their CEO, and several executives were implicated in the “Friends of Angelo” bribery scandal.

*Though those claims should be taken with a grain of salt, as we’ll see later.

Morgenson’s book does a thorough job of portraying the extent and nature of corruption that was almost inherent to the GSEs. Particularly appalling is the incestuous relationship between the companies and the government. The entire concept of a “government-sponsored enterprise” sounds almost Orwellian: The institutions were created as government agencies* during the New Deal, but Lyndon Johnson partially privatized them, in what was essentially an accounting gimmick, when costs related to the Vietnam War made government expenditures look bad.

*TIMEOUT: What the hell do the GSEs do? They don’t actually lend money to borrowers or homeowners, so what do they actually do? Basically, they buy mortgages from smaller lenders, creating a secondary mortgage market. This frees up liquidity for those lenders to extend more loans, which ultimately makes it easier for borrowers to borrow. Originally, the GSEs simply made money by collecting interest on the loans they bought, but eventually they started securitizing some and selling them to Wall Street banks.

One of the themes of Reckless Endangerment, though, is how the GSEs never really lost, or wanted to lose, their government-affiliation, even as they became indistinguishable from other private companies. The GSEs wanted to have the best of both worlds: They wanted to serve their shareholders, but also the public; they wanted a federal stamp of approval for their “mission,” but no serious regulation; they wanted to be free to pursue profit, but protected from potential losses.

Indeed, even Johnson himself is an example of the thin line between governments and markets that the GSEs lived on: Johnson was the executive assistant to Vice President Walter Mondale, then started his own consulting firm, then chaired Mondale’s Presidential campaign, then went to work at Lehman Brothers before becoming the head of Fannie Mae. As such, he understood how important government was to Fannie (in 1995, the CBO estimated that the “implied government guarantee” amounted to a $7 billion subsidy for Fannie Mae that year alone), and much of his success as CEO came down to his political influence: He quashed repeated efforts to fully sever the connection between the GSEs and government.

While Morgenson and Rosner paint a convincing and sometimes harrowing portrait of the GSEs’ inner workings, they are less convincing of their central thesis: that the corruption and ineptitude of Fannie Mae and Freddie Mac directly caused the financial crisis. They point to the Boston Fed’s infamous 1992 paper on discriminatory lending policies and then-HUD secretary Andrew Cuomo’s decision to push the GSEs into the subprime market in 1997 as instances that lowered lending standards. And it’s true that these moments, as well as various other openly political attempts to “extend the dream of homeownership to all Americans,” did play a role in the deterioration of lending standards.

But a much bigger reason was the increased competition in the secondary mortgage market. Indeed, Reckless Endangerment even mentions companies like NovaStar, IndyMac, and Countrywide Financial—companies whose entire purpose was to offer nonstandard mortgages, or mortgages that could not be sold to Fannie and Freddie. In other words, there was an entire private industry of companies willing to grant the loans that the GSEs were legally prohibited from making. Eventually the GSEs pressured their regulators to lower their standards, but not merely to appease politicians who wanted more homeowners (though the support of politicians didn’t hurt), or even in greedy pursuit of more profits (though they weren’t going to turn that down), but merely to keep up with the market.

Overall, the image of the GSEs is one of terrible, horrible, no-good, poorly run companies that failed because they were terrible, horrible, no-good, poorly run companies. They didn’t cause the crisis—in a weird way, they were victims of it, since by the time the GSEs entered the subprime market, lending standards had fallen so low that there was no profit in it. Still, though, the most salient fact may be this: The mortgages backed by the GSEs defaulted at a much lower rate than their privately-backed counterparts, even among the subprime loans. In other words, the GSEs had higher standards than the rest of the market. They deserved to fail, but for other reasons—general incompetence and a misunderstanding of basic accounting, basically. And they shouldn’t be blamed for anyone else’s failure.

Bailout NationBailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy

by Barry Ritholtz, 2009


Barry Ritholtz is a prominent financial writer, and much of his book, Bailout Nation, is taken from posts that originally ran on his blog, The Big Picture. It’s not surprising, then, that the final product reads a lot like a long blog post*: It’s full of lists, asides, tangents, weird charts, political cartoons, and hyperbolic rhetoric. Of course, there are a lot of benefits that come with this. Specifically, Bailout Nation is probably the most fun book of its kind. When it comes to books about the financial crisis, it’s practically a beach read.

*Not that I would know anything about that…

What makes a book like this fun? Well, for one, Rithholtz is not one for ambiguous statements. Most of these books hedge every conclusion and clean up every condemnation. Bailout Nation, on the other hand, is full of statements like this: “I expect future historians to wonder why so many of these folks weren’t heavily medicated and placed in protective custody, for the only rational explanation for their behavior is that they have gone so far round the bend as to be completely and totally insane.”

Serving up this kind of red meat is likely to please the reader* and satisfy the demands for clarity that often go ignored in other books. There is a danger, of course, that such screeds can come off as oversimplified finger pointing, and there is certainly some of that in Ritholtz’s book. He is so anti-Fed, for example, that he fixates on the Fed-orchestrated bailout of Long Term Capital Management in 1998.  He calls it “one of the greatest—and most terrible—examples of moral hazard ever known.” He paints a nearly direct line from that deal to the investment bank implosions of 2008, stating that the latter firms absorbed so much risk in part under the assumption that the Fed would bail them out of any trouble.

*Particularly this reader, who was by then on his fourth account of perhaps the greatest fuckup of the last decade, and was frankly getting a bit eager to blame someone.

It’s true that the Fed orchestrated the bailout of LTCM, and it’s certainly true that the banks assumed they would be bailed out of any problem, but it requires some big oversimplifications to make a causal connection between the two. There were major differences between LTCM and Bear/Lehman/Merrill Lynch. For one, no government money was used in the LTCM bailout. Second, LTCM was a hedge fund, not a bank, and it was bailed out, for the most part, by its own creditors. Finally, LTCM was an outlier—a hedge fund reliant on unusual practices and strategies—and was not a casualty of a common shock; whereas LTCM was an exceptional bailout, the investment banks faced an industry-wide panic in 2008.

For the most part, though, Ritholtz avoids these types of oversimplifications. In fact, he is able to structure his attacks around a central idea: that bailouts are really bad, and that the economy has become hopelessly dependent on them. This is not the most sophisticated thesis, of course, but the argument is compelling. Ritholtz portrays the gradual creep of government into private markets as a series of isolated “just-this-once” incidents that add up to a trend over several decades.* And he is precise enough to avoid pointing fingers at everything; though he thinks pretty much everyone is stupid, he distinguishes between the stupid villains and the stupid victims.

*But Ritholtz is not, thankfully, some anti-government extremist who uses the financial crisis of 2008 to attack government itself. He makes a clear—and convincing—distinction between the bailouts of the last 30 years and the rescue programs of the New Deal. And despite his harsh criticism of the Fed’s actions under Alan Greenspan and Ben Bernanke, he stops short of a Ron Paul-esque, “End the Fed” prescription.

Perhaps the most enjoyable aspect of Bailout Nation, though, is that he actually offers solutions. So many of these books are long on explanations and short on solutions, but Ritholtz knows what his readers want, and he provides it. Of course, some of his proposed solutions are wildly impractical or downright impossible (a few seem to involve time-travel), but for the most part they seem sensible.

And what the solutions lack in feasibility, they make up for in directness. For example, to combat the Too Big To Fail problem, Ritholtz simply says: “Limit the size of the behemoths to no more than 5 percent of the total U.S. deposits. If we have to break up the biggest banks—JPMorgan Chase, Citigroup, Bank of America—so be it.” Of course, if a politician suggested that, he’d be denounced as a socialist, but coming from an asset manager on Wall Street, it just seems sensible.*

*When talking about derivatives, Ritholtz says, “Any derivative that might require a future payout should be treated like an insurance product, subject to regulation by state insurance boards.” This was actually something a number of states actually attempted, but federal regulators preempted them—a glimpse into the seedy nature of federal regulation.

There is, of course, a sense in which a book like Bailout Nation is not all that practical. Its solutions are unrealistic, its explanations somewhat simplified, and its reporting is not nearly as thorough as Sorkin’s or Lewis’s or even Morgenson’s. If you only read one book about the financial crisis, I would not suggest this one. But if you do read another book and it leaves you feeling angry and resentful—as it likely will—then you might want to follow it with Bailout Nation. Ritholtz’s scorn and common sense offer a cathartic release. He is just as angry with these people as you are. You are not alone.


One response to this post.

  1. […] passion, though. In some ways, the best thing about reading him is his refusal to hold back. Like Ritholz’s book, there is something viscerally pleasing about reading someone so obviously angry, and Taibbi is […]


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