The Financial Crisis- Whose fault was it?

HLS hosted a panel on Thursday titled “Lemmings or Victims? Getting to the bottom of Wall Street’s role in the current financial crisis” with Professors Allen Ferrell and Howell Jackson and Mark Gordon of Wachtell, Lipton, Rosen & Katz. The panel was moderated by Jonathan Zittrain (indisputably the best moderator ever).There is a video of the panel on the Web, so I’m only going to note some interesting points…

Prof. Ferrell showed a list of the top MBS underwriters of 07 (firms that purchased mortgage against which securities were issued) and surprise~ surprise~ Lehman Bros. was on the top of the list, followed by Bear Stearns and Morgan Stanley.

“There were predictable and unpredictable things about the crisis but what happened to Bear Stearns was dramatically unpredictable,” Ferrell said. He said that Bear had the assets by any measure of capitalization, but that the reason it went under was because it wasn’t able to get cash for its U.S. treasury bonds and that no one (before the financial) crisis thought this would happen.

Gordon, somewhat defending himself from JZ’s introduction, said that the crisis could be one of the “few cases where you can’t blame the lawyers first” and went on to explain how RMBS (securities issued out of pool of mortgages) go to Inner CDOs and  Outer CDOs and how “nobody really knew where the money was going.” Even risk managers did not fully understand, he said. Ferrell added that a large percentage of these CDOs were synthetic, kind of like playing fantasy sports. (JZ later summed it up by showing us a stick-figure slideshow that puts the whole thing in a more simple light.)

Gordon said that this structure developed in the past 15 years. “Who would put in these insane incentive structures, you ask, but the reason is that CEOs answered to shareholders and shareholders won’t put up with five years of lagging,” he said.

“My view is that the fundamental problem was massive inflow of capital into US that manifested itself in CDOs. Indiscriminate lending was a fundamental problem and highly doubt regulators could have done anything,” Ferrell said.

Jackson said that the problem was that the financial guys were basing the models on the wrong assumptions (that housing prices would continue to rise) and that regulators were using the same models. “They used the same techniques, falling into the same trap.”

He talked about scenarios of government intervention, but noted that there are still real people who got mortgage and are going into default at a high rate. “What are we doing about foreclosures?” he asked. He also said that back in the “old days” there were real estate bubbles and financial bubbles, but the thing that was different back then was that the lending was done by local banks.

Jack Levin, in the audience, said that the current crisis was caused by a phenomenon similar to the Tulip Craze of the Netherlands because government policies are encouraging people to buy houses they can’t afford. He said that these salesmen (of mortgage plans) were encouraging fraud and people (who should have known better) were committing the fraud.

I’ve posted photos from the panel here.


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