I agree in part with Dave, but the actual flaw was the lack of regulation. Frankly we humans have always been wired in such a way that wherever there is lots of money flying around and a general lack of control and regulation, greed and corruption is the inevitable consequence. It is nice to think that it shouldn't happen, but it always does and maybe it always will

Greed is difficult to control in itself, but regulation is designed to control the environment so that it cannot prosper and to limit its effect. The problem is that for a good long while, too many people were on to a good thing so until the systems all went "pop" there was no real pressure for change. Now we all decide we should have seen it coming. You don't say ...

posted October 5, 2008

I would argue that groupthink played a major role in getting where we stand now. Groupthink is the mindset that pushes members of a group into reaching consensus without critically analyzing the decisions made. If in a Board Member meeting 9 out of 10 overtly agree with a proposal and you are the only one questining it, unless you are a highly assertive person you'll probably go with the flow (for fear of seeming silly to doubt the "wisemen council").

Another good example of groupthink is the Bay of Pigs Invasion - 1961.

posted October 5, 2008

Absolutely not. Unless criminal innovation is considered in the same category as "innovation"

The financial crisis is a massive Ponzi scheme. The people involved in creating it should be behind bars.

1. Late 1990s, democratic congressional leaders pressured Fannie Mae and Freddie Mac to become tools of social change by "making homes more affordable".
2. Fannie and Freddie did as asked, then loosened lending guidelines deliberately buying bad loans and paying their executives to push them. Congress had no effective oversight, and often cheered them on. Most on the banking committee, took huge payoffs from Fannie and Freddie to maintain the status quo. Usually this is considered conflict of interest and corruption.
3. This led to accepting loans with no documentation at usurious rates from people who couldn't afford to pay them back at normal rates. This is usually considered ignoring your fiduciary responsibility - a criminal act.
4. Countrywide, the worst of the bad brokers, knew when they started pushing exotic loan products that they'd result in massive defaults, but didn't care because they were selling the paper to someone else (F+F). Ordinarily, this would be considered fraud.
5. The bad paper was packaged, securitized, and resold. This hid how bad the loans were. Normally, this is considered money laundering.
6. Ratings agencies gave their seal of approval and earned huge fees for treating these "portfolios" as legitimate risks. Loans that would never be paid back even if the housing market didn't collapse were in packages rated as AAA. Normally, this is considered fraud.
7. Investment banks sold these "mortgage backed securities" to hedge funds, mutual funds, other banks, etc. spreading the risk to the entire world financial system. 401(k)s and mutual funds are loaded with this garbage because we had no way of knowing how bad it was. The banks knew full well a lot of the MBS debt was questionable at best, but it earned big commissions. Normally, this too would be considered fraud, or minimally misrepresentation.
8. The housing market overinflated (prices growing at 10-15%. largely due to actions of F+F and Wall Street money thru MBSs), prices starting falling, many loans were "underwater" (many were underwater before prices fell), and people began defaulting.
9. Creating "value" at the top of a pyramid by continually adding more suckers at the bottom is normally referred to as a Ponzi scheme and that too is illegal for good reason.
10. Lobbyists fought at all levels to keep these bad things happening, threatening lawmakers to work against their re-election, withdraw financial support, call them out as "irresponsible" or threatening the financial system. Minimally, this is highly unethical. If lobbyists want to make a case for something, make it in public -- on the airwaves, in the press, and fully disclose who they are and their financial interest. Otherwise, ban lobbying.

It goes far beyond greed. Criminal activity at each step of this debacle should be prosecuted, and the executives involved should be forced to repay as much as possible out of personal assets. Congressional idiots who created this mess should all be jailed for life, stripped of their assets and especially their houses -- including most of the democratic leadership, and a good chunk of the republicans too.

All this is on the public record, but will the media do a "real" investigation and report it, the way they did Watergate or the Monica Lewinsky scandal? Will it be positioned as criminal behavior if they do? Their social agenda blinders likely prevent them seeing the basic truth that you can't lend money to people who can't afford to pay it back, and charge them higher interest than those who can afford it.

If the government wants to subsidize "affordable" houses, they should be honest about it and supplement incomes of the poor directly, but banking guidelines should not be manipulated to create such a house of cards.

posted October 5, 2008

A crisis occurs if outcomes deviate from a certain value set about what should be the norm. The question surely is: Do we want total capitalism?

In which case this is not a crisis but a natural development based on interesting choices and decisions. Whether they were right or wrong depends entirely on your value set.

Now, do we see the fall of the US pre-eminence in the world market? It looks like it.

posted October 5, 2008

Yes, absolutely.

The lunatic invention of derivatives is the cause of this -- what Warren Buffett long ago called instruments invented by "madmen".

It is like inventing a paper airplane that might appear to fly for a while but will inevitably crash because there is nothing to keep it aloft.

Derivatives created a giant house of cards that was (and remains) basically a massive ponzi scheme aimed at trying to extract profits from scrip paper that was not there to be extracted. In other words, this invention was a "fraudulent" invention in that it simply was not a breakthrough and was destined to be a failure. It is like one of those Heath Robinson perpetual motion machines that serves no valuable purpose and will stop functioning at the slightest hiccup.

[Note from BBC History: Heath Robinson was an English cartoonist and illustrator, best-known for complicated and outlandish inventions he portrayed. 'The Sketch' and 'The Tatler' regularly published his work and his cartoons of crazy inventions soon captured the public imagination. Essentially he was caricaturing the age of the machine and the self-importance of some of the people caught up in that age - creating complex inventions that achieved absurdly simple results, while the audience looked on solemnly. The term 'Heath-Robinson contraption' came into official dictionary use in around 1912.]

Notice what this says about Heath Robinson contraptions:

"... captured the public imagination ... caricaturing the age ... and the self-importance of some of the people caught up in that age -- creating complex inventions that achieved absurdly simple results, while the audience looked on solemnly."

Wall Street became caught up in this derivatives scheme and, full of their own self-importance, and thinking they could do no wrong, and refusing to see that derivatives were a sham that produced nothing, they brushed off any criticism of them. Instead they continued to slice and dice, and then trade multiple times over, to preposterous levels of leverage, scrip paper that bore no resemblance to the original underlying value -- and the value of which could no longer be determined.

They ignored the sage of Wall Street, Warren Buffett, when he called derivatives a "time bomb" and the "weapons of mass destruction of the financial system." He refused to deal in them, and condemned them.

Similarly, the regulators and monetary authorities stood by, merely muttering concerns but doing nothing about the ever-building house of cards. In fact, they made it worse by lowering interest rates to absurd levels (which under-valued -- placed a negative value on! -- the true value of real money), and by adding mortgages to the mix. The latter then caused the housing bubble which still has not been fully deflated.

As well, of course, the external auditing firms failed to raise any red flags or cautions about these so-called "assets". In reality, these "assets" were liabilities, and thus totally on the wrong side of the balance sheet! That is how ludicrous are derivatives. And now almost twice the price will have to be paid to unwind the mess and restore the balance sheets of any bank which does not collapse in the interim.

This so-called bail-out is only buying time. Many trillions of dollars are required to rectify this situation. It could take a decade to resolve the situation, unless there is a sudden collapse of the global financial system. The contagion will spread, with rescue efforts for one bank after another, in a domino effect -- as this "paper airplane" spirals back down to earth.

So the invention looked good "on paper", but it was a Heath Robinson cartoon that millions of people somehow though was a real money machine.

It was just a huge hilarious circus act. Unfortunately, millions of innocent people will suffer the consequences, while greedy bankers have lined their pockets with huge bonuses for having traded ever-increasing volumes of worthless junk.

posted October 5, 2008

Abdul,
It's not about standards in innovation, rather standards in the implementation (of the innovation).

Stuart

posted October 5, 2008

The "problems" possibly are mostly

How Wall Street Lied to Its Computers
http://bits.blogs.nytimes.com/2008/09/18/how-wall-streets-quants-lied-to-their-computers/
Subprime = Triple-A ratings? or 'How to Lie with Statistics'
http://www.bloggingstocks.com/2007/07/25/subprime-triple-a-ratings-or-how-to-lie-with-statistics/

GAO has been doing database of corporate restatements. Basically financials are inflated, the bonuses taken on the inflated statements and possibly later the financials are restated ... but the bonuses aren't forfeited.

A lot of it is leveraging the lack of transparency as part of fiddling the books.

Toxic CDOs had been used two decades ago during the S&L crisis to obfuscate underlying values.

Getting triple-A rating on toxic CDOs allowed unregulated mortgage originators to continue funding their operations and unload all the mortgages they could possibly write ... w/o having to pay any attention to loan quality. Then lots of institutions and retirement funds would snap up these supposedly "safe", triple-A rated toxic CDOs.

Speculators taking advantage of things like no-documentation, 1-2 percent intro, interest only mortgages ... basically could treat the home owner market like the unregulated 1920s stock market.

long-winded, decade old-post discussing many of the current problems, including needing visibility in CDO-like instruments
http://www.garlic.com/~lynn/aepay3.htm#risk

Links:

• http://bits.blogs.nytimes.com/2008/09/18/how-wall-streets-quants-lied-to-th...
• http://www.bloggingstocks.com/2007/07/25/subprime-triple-a-ratings-or-how-t...
• http://www.garlic.com/~lynn/aepay3.htm#riskm

posted October 9, 2008