Dumb Money by Daniel Gross

book jacket with cartoon of dollar sign and cone dummies hatDumb Money: How Our Greatest Financial Minds Bankrupted the Nation by Daniel Gross, (2009)
The author writes for Newsweek and other column on money and economic subjects. This is a slim (101 pages) volume that has a great deal of detail on aspects of the 2008 financial meltdown without too much talk about LIBOR and tranches.

You can tell the author has a sense of humor by the name of the first chapter title: WTF. The utter disregard for the average person for the banksters is revealed in a quote the author cites of the still not-ashamed-enough to keep his mouth shut, Henry [Hank] Paulson (“former Goldman Sachs CEO running the financial system, quickly shifted to a clueless groper in the dark”) and the pathetic excuse for a human Alan Greenspan (BTW, married to Andrea Mitchell, broadcaster). He is, however, an undeniably interesting man when you read his Wikipedia entry. For example, he attended Juilliard, no small feat to get in, and played in a band. Music and match do often go together. But I guess it was too hard to make a living, so he moved on to economics (NYU summa cum laude). A note in the Wiki entry is that he specifically asked that his 1977 PhD dissertation be removed from NYU after he became Chairman of the Fed. Barron’s supposedly got a copy of it anyway (should be PUBLIC, especially now retired) and

notes that it includes “a discussion of soaring housing prices and their effect on consumer spending; it even anticipates a bursting housing bubble”.[17]

There is also a fascinating connection to Nixon because one of his band mates, Leonard Garment, later became Richard Nixon’s special counsel; they had been at the same New York law firm.

Alan Greenspan has noticed that this storm we have just lived through is a “once-in-a-century credit tsumami.” Paulson has said that this sort of thing happens “once or twice” every hundred years. What is the difference between once and twice? In this instance, SEVERAL TRILLION DOLLARS IN LOSSES. All we can do now, aside from rage at our vanished home equity, shrinking portfolios, and booming national debt, is try to understand what happened, and why, and how we might avoid a repeat. (p. 11)

The sad part is that it could all have been different. We had already been there and done the Depression. But the smart boys repealed the laws that “interfered” in the magic invisible hand of the “market” and set greed free. President Bill Clinton signed into law in case you were thinking it was a republican.  (So many variables, big and small. Big include the Supreme Court violating all that is sacred in our Constitution. And of course the pull-it-out-of-my-ass economic theory of Milton Friedman giving us the cruel “neoliberalism” that joins traditional Republican fondness for newspeak; by having liberal in the economic title of the THEORY one might assume it was a traditional meaning of liberal — concerned for social justice — but that would be wrong. It is really more dog-eat-dog or winners-losers economic theory. Trickle-down never was ever going to work and anyone who has had a sibling and a particular toy would have known that people don’t generally voluntarily give up any of “their” toys, and only by coercion of parents might they share.

It is so obvious to me that the takers in our economy are not the “welfare queens” or the poor or the unions or the single mothers. The truly great takers are the billionaires and corporation that do not pay taxes and get gargantuan refunds. And all the government is working for them. And they are all working (so to speak) for themselves and their families who now get to inherit obscene millions and billions of dollars and never pay a dime through carefully crafted legal trusts and so forth. The Wal-Mart family is the one most commonly mentioned for obscene wealth because their stores drove out all local companies so there is no longer any local owners that can compete and so you may want to boycott but there is no where else to go locally. If you go online, say to the convenient Amazon, then you are supporting a punitive employment situation for the benefit of a serious Republican donor. We taxpayers subsidize the non-living wage they pay their employees and their abusive practices, such as hiring part-time only to avoid paying overtime or benefits.

Dumb Money was therefore self-sustaining [by rolling over mortgages] — poor, untenable housing-credit choices led inexorably to poorer, even more untenable options. But, as happens during bubbles, practices that later seem obviously ABSURD acquire their own logic. In the Era of Dumb Money, failure was simply not an option — for either borrowers or lenders. The foreclosure rate fell from 1.49 percent in the third quarter of 2002 to 1 percent in the second quarter of 2005. . . . [then a tiny bank in Utah failed and] 2005 was the first year since the FDIC’s 1934 inception in which no banks failed. GOVERNMENT OVERSIGHT, competitive pressures, and improved risk management [!not] played a role. However, Cheap Money and Network Finance played a bigger one. The yield curve was benevolent; securitization allowed banks to distribute risks from local loans to financial institutions AROUND THE WORLD. “Under the recent economic conditions, it’s been difficult to fail,” FDIC chief economist Richard Brown told me in 2005. The lack of failure gave bankers an enormous amount of self-confidence; in tee ball, where it is impossible to strike out, everybody feels like a .400 hitter.

In every boom, there is a delicate moment when it becomes evident that the existing hot trends simply cannot continue. Throughout 2004 and 2005, there were abundant signs of unsustainability in the largest Cheap Money — and the first Dumb Money — business. At the end of 2004, US residential real estate was worth $18.6 TRILLION — more than the entire stock market. (pp. 39-40)

He makes a point that there then was a lot of house purchasing for rental purposes because the cost of the house was so much less than the income it could generate. Previously it had a “P/E” ratio of about 9% and now it became 15% — of course this just sucked money out of people who might otherwise been able to save some money to buy their own home instead of enriching house flippers. The percentage differences were even wider in places like Las Vegas and West Palm Beach where “the ratios were 121.3 and 120 respectively.”

The Magical Market Saving Theory made sense as a national strategy only if asset prices moved in only one direction. It is difficult for a bank, or a mattress, to take away your savings. However, it is quite easy for Mr. Market to do so.

Alas, in the Era of Dumb Money, daydream believers who thought their homes were functioning as asset-accumulation accounts woke up each morning to find their faith rewarded. Incomes were stagnating but consumption continued to rise, because the Shadow Banking system and Network Finance allowed home owners to monetize paper gains. . . .

Long story short (pun intended) the banksters found their yield curve flattening so they wanted to be able to use debt more to return to the profits their “practice of borrowing short and lending long ceased to be highly profitable.” So they wanted to be able to use more debt, that is, to leverage money they didn’t have against what they did have.

There was a catch. The Securities and Exchange Commission, which had an interest in brokerage firms remaining solvent, required broker dealers to maintain ONE DOLLAR of capital for every twelve dollars of debt they held.

In the spring of 2004, Wall Street’s establishment investment banks — Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns, and Morgan Stanley — successfully appealed to the SEC TO WAIVE THE RULES. (Among those petitioning was Goldman Sach’s CEO Henry Paulson.) Funds held in reserve, they argued, could be liberated to invest in mortgage-backed securities and DERIVATIVES. Oh, and the brokers could use computer models to gauge the RISKINESS and VALUE of the new types of securities they would buy. SEC commissioner Roel Campos said he supported the change with his “fingers crossed.” To convince investor and lenders that the business model made sense, the Five Horsemen of the Dumb Money Apocalypse  began to introduce new terms into the debate. Technology enabled them to quantify precisely how much they could lose if things went wrong, how much of the firm’s — and hence investors — capital was at risk every day. VAR — Value at Risk — became a staple of quarterly and annual reports. Lehman Brothers assured investors in 2006 that the firm, which had hundreds of BILLIONS in mostly short-term debt outstanding could lose no more than the $42 million on an OFF DAY. (p. 45)

The 1:12 ratio was increased to 1:30. This meant that these banksters only had to have $1.00 on hand while leveraging that dollar to loan $30.00. Basically money they didn’t have. When it all came crashing down, they did not have the $30 to pay for the debt they loaned against the measly $1 and since they were all in the same boat, no one was going to lend any other firm to cover there losses because they didn’t have the actual REAL CASH either.

If you are a little bit curious about what the whole 2008 crisis was about and why we all got pounded economically, this book does a good job explaining the issues and players in the fiasco. Shockingly blunt, naming names, and clearly describing the mistakes and hubris of the major actors, it is a different take on the topic because of the wonderful non-objective sarcastic and snarling descriptions of what really happened and why.


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