Despite the implication, I am not completely obsessed with Inside Job, a documentary post-mortem of the 2008 financial crisis. It’s just that I have five sections of my introductory investing class each year and we’ve been watching the movie as the culmination of the course since its release five years ago. Without further delay:
Most shocking moment It’s a tie!
- Larry Summers trying to intimidate CFTC Chairwoman Brooksley Born into silence by menacingly staring her down during her very public Congressional testimony (at 24:59), and
- Harvard Professor Martin Feldstein, who, after being asked if he had any regrets in his role as a member of AIG’s Board of Directors (which presided over its implosion, necessitating a taxpayer bailout in excess of $150 billion), to which he replied “No.” This occurs at 1:23.55. Feldstein’s nonchalant answer is so stunning that the interviewer is left speechless.
Person who should be most embarrassed Fred Mishkin, who showed himself to be a buffoon on so many levels. He acknowledged that everything he said about Iceland in his paper defending its deregulated financial system was incorrect. He had no idea that many top financial institutions such as Lehman Brothers, Fannie Mae and Freddie Mac had AA or even AAA ratings until just a few days before they imploded. He acknowledged attending meetings where consumer advocate Greenlining presented evidence of abusive and predatory mortgages being offered to unsuspecting borrowers, to which his response was “So, what do you do?” Here’s an idea: immediately prohibit those types of mortgages.
A strong runner-up is John Campbell, Chairman of Harvard’s Economics Department. He saw no conflict of interest in his professors becoming wealthy by cashing in on the prestige of their positions at Harvard. It took the interviewer using a scenario of a doctor prescribing a medicine that he or she has an ownership interest in to get Campbell to understand what conflict of interest means. Upon achieving this “aha” moment, Campbell froze and could only utter “um” and “ah” for the next several seconds.
Biggest revelation That the tentacles of the financial industry are so far-reaching they’ve corrupted the study of economics itself. Basically, professors traffic in the prestige of their universities by providing cover to Wall Street firms that want a highly reputable third party (like only an Ivy League institution can be) to assure Congress, the public and critics that its latest financial innovation is perfectly safe (and couldn’t possibly blow up the world).
It’s really sad that a wide-eyed freshman who plops him or herself down in a classroom at a university has to worry about whether the professor at the front of the room has been compromised.
The Top 10 themes
- The gradual tearing down of financial industry restrictions across several Presidential administrations. An example is the post-Great Depression era Glass-Steagall Act that was instrumental in ensuring decades of a scandal-free financial industry. It’s been written that banking used to be boring and needs to go back to being boring.
- The battle to ensure derivatives (ie, financial bets among firms) would not be regulated, meaning no one would know which banks or insurance companies had bet on what, with whom, or in what dollar amounts. In favor of regulation was Brooksley Born, CFTC Chair. Against regulation were Larry Summers, Under-secretary of the Treasury, Alan Greenspan, Federal Reserve Bank Chair, Robert Rubin, Secretary of the Treasury, Arthur Levitt, SEC Chair and Phil Gramm, U.S. Senator. She was right and all of them were wrong. Within a decade, derivatives were used to unjustly enrich irresponsible CEOs who in the process destroyed their companies and crashed the global financial system. In the final analysis, all of the heavyweights who got the most important issue of their lifetimes tragically wrong left with their reputations intact. Sadly, accountability is only for some.
- The “deja vu all over again” feeling those old enough to remember will have when reminded of the late 1980s Savings & Loan (S & L) Crisis. That was a dress rehearsal for the real thing some 20 years later. Only, during the S & L Crisis, hundreds of executives weren’t given lucrative consulting agreements after their departures to ensure their former firm’s had access to their “institutional knowledge”. Instead, they were given orange jump suits and jail sentences. For more on why no one was held accountable, watch the PBS Frontline film The Untouchables.
- The mortgage industry being allowed to create loans with terms allowing anyone to qualify for a mortgage. An example was the Pick a payment mortgage, as in “Honey, we’re still short on funds, so let’s pick a payment of $0 again this month.” Lenders didn’t care about the borrower’s ability to repay because they’d soon sell the loan to Wall Street banks which would then bundle them up and sell them to investors around the world. Robert Gnaizda, head of consumer advocate Greenlining, personally met with the Fed Chairmen Greenspan and Bernanke and on several occasions showed them examples of these types of mortgages. To Gnaizda’s astonishment and deep disappointment, Greenspan and Bernanke did nothing.
- The “regulatory capture” (as Nouriel Roubini calls it) by the banks of the Congress and regulatory agencies, with there being five banking lobbyists for each member of Congress. An example was the five-member SEC board conversing with the Wall Street banks (it was their job to regulate) and asking what they thought would be appropriate limits on the amount of money they could borrow and bet with. The SEC decided to approve a ratio of 33 to 1. For comparison, 10 to 1 is outrageous. If you bought a $10 stock with $9 of borrowed money and $1 of your own, the stock falling just 10%, from $10 to $9, wipes you out. Instead of keeping the markets safe, the SEC gave the green light for it to become dramatically more dangerous.
- The audacity of Wall Street banks to sell their institutional clients (eg, pension funds, insurance companies) investments backed by mortgages when housing prices were peaking (instead of advising against the purchase), and then betting against the mortgages right after the customers walked out the door with them.
- The terribly inaccurate AA and AAA ratings given to bundles of mortgages (and even companies as a whole) by the “big three” (Moodys, Standard & Poors, Fitch) credit raters and, after so many borrowers defaulted, claiming that no one should have relied on them because they were only giving their opinions. If your highly trained and well compensated doctor misdiagnosed your illness and in so doing gave it time to get much worse, upon your next visit to his office would it be appropriate for him to tell you his diagnosis was just his opinion and that you were foolish to rely on it?
- The ability of Wall Streeters to entertain clients with drugs, call girls and strip clubs, while having their companies foot the bill.
- The circular movement of a small group of people from the boards of directors of the big banks to Washington, D.C. (where they’ll have a Cabinet post or head a regulatory agency) to positions at prestigious universities. Examples from the movie include Larry Summers, Henry Paulson, Robert Rubin, Glenn Hubbard, Ben Bernanke, Martin Feldstein, and Laura Tyson.
- The corruption of the study of economics with professors at esteemed universities being paid huge sums to do research and come to conclusions that the paying companies want. Among the individuals cited for being paid to write papers and / or for collecting enormous sums by the financial services industry are Alan Greenspan, Fred Mishkin and English economist Richard Portis, Additionally, many economics professors make fortunes by “consulting” to and /or serving on the boards of financial firms. The poster child for these practices is Glenn Hubbard.
- Bonus: Many of the companies whose CEOs blew them up had in their employ professionals who attempted to do something about the life-threatening (to the business) activities they witness. When these people come forward, the script is all too common: i) the do-gooder becomes so concerned about the increasing risks the firm is taking that he cannot remain silent, ii) he tries to bring his concerns to the attention of upper management on the chance that is not aware of what is occurring, iv) to his surprise, he learns that the upper management is well aware of the risks being taken, v) the sobering truth being spoken by the do-gooder cannot be allowed to derail the firm’s continued commitment to excessive risk taking, so he is marginalized and ostracized until he quits. At AIG, that man was Joseph St. Denis. Not so ironically, his actual job as Internal Auditor was to be a do-gooder. PBS’ The Untouchables identifies a different path for Citicorp’s Richard Bowen. Bowen’s attempts at contacting upper management were ignored to allow the execs to claim ignorance that anything dangerous was occurring at the bank. If you have a few minutes, look up their stories.
President Obama’s scorecard As a candidate, Barack Obama identified a list of reforms he would work towards as President. Despite the fact that he appointed to his economics team many of the actors who had a hand in creating the crisis, he appears to have achieved much more than the movie gives him credit for. Below, we look at five of the most publicized reform objectives and what became of them:
- Creation of a systemic risk regulator √ This was accomplished in Article I of the Dodd-Frank Reform and Consumer Protection Act, which created the Financial Services Oversight Council. Interestingly, many of the 10 voting members of the Council are heads of the regulatory agencies (eg, the Fed and the SEC) which ignored the multitude of warnings leading up to the 2008 crisis.
- Increased capital requirements √ Capital here refers to the amount of equity (ie, money invested by owners) a business has as compared to the amount of money it borrows. The more capital, the greater the bank’s ability to sustain losses. Long story short, the Federal Reserve Bank in 2013 implemented enhanced capital requirements that exceeded the international Basel III standard, including the identification of “systemically important” financial institutions that receive additional scrutiny. These requirement, however, arrived years after the release of Inside Job.
- Creation of a consumer financial protection agency √ Dodd-Frank also created the Consumer Financial Protection Bureau (CFPB). An argument for the creation of such a bureau was that while a veritable alphabet soup of federal agencies had among their responsibilities the interests of consumers, no one single government entity had this as its sole objective. With the CFPB, consumers now have their champion.
- Reform of the credit ratings agencies No better model was put forth than the previously existing one. So, we’re stuck with a “conflict of interest baked-in” system where issuers pay the agencies to rate their debt.
- Guidelines on executive compensation √ Section 956 of Dodd-Frank requires appropriate regulatory agencies to “issue rules that jointly prescribe regulations or guidelines with respect to incentive-based compensation practices at certain financial institutions”. The agencies proposed an initial set of rules in 2011 and revised the proposed rules in 2016. The objectives are to prevent compensation arrangements that are excessive and which encourage excessive risk-taking. Of course, one might wonder how difficult a task this is if the agencies needed five years to revise their proposed rules and wound up with a document 706 pages in length! One wonders whether the regulations will be so onerous as to do more harm than good.
A backup measure is the awareness of upper level employees that if they are found to have “cooked the books” in order to report substantial profits on which they’ll earn large incentive-based bonuses, firms now have the ability to “claw back” those bonuses. The “look back” period, or the time frame over which bonuses can be recovered by the corporation, is three years. The requirement that corporations implement claw back rules was put in place by the SEC in 2015.
After we’ve invested several periods watching Inside Job, I ask my students to reflect on it by answering several questions. Read their responses by following the links below:
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