Well, let’s be honest here – I’m sure that you saw that it would all “end badly” back in 2004. As many of us here at the Pigg were discussing at this website as the peak neared. But did you realize the extent of what AIG was up to? I doubt it. Did you realize what Paulson and Magnetar were up to? I doubt it. The intricate maze of CDOs? I doubt it. I could go on.
I think plenty of folks – many fellow Piggs – strongly suspected that housing prices were going to drop significantly, we’d have a wicked recession, and that some number of banks were going to fail – and this was an extreme outlier view back in the mid-noughties – but with the exception of a small handful of folks (maybe Taleb and a few others – I would add Paulson and Magnetar but in fact they helped to MANUFACTURE the crisis), very very few folks predicted the extent of the damage. Most folks who identified the bubble and tried to profit from it probably started a few years too early (because the bubble should have been arrested back in, say, 2002) and had their asses handed to them by the time it actually burst. Such is that nature of markets. I’m not excusing anyone here – make no mistake – just pointing out that there’s a very large gulf between saying, “Houston, we have a problem” and saying, “Bernanke, the financial system is about to collapse.”
Anyhow, I think when you’re heavily compensated not to see something, you’re unlikely to see it. You put blinders on and say, “No one else is seeing anything, so everything must be copacetic.” Compensation – especially when it’s enormous – blinds people to alternate scenarios.
And here’s the other major problem with our “financial leaders” from the last several years: most of them arrived at their position as a result of adverse selection. Allow me to explain through use of an example.
A business partner of mine rescued an ailing bank during the mid-90s. Recapitalized it, cleaned it up, ran it extremely well and sold it in 2001. He sat back and said, “Things are getting crazy. Time to hit the eject button.” Everyone made a crappile of money. But the bubble kept inflating. Anyhow, based on his considerable prior success he was asked to run a much larger bank a couple of years later. He thought things were even more crazy but he was bored, took the job and didn’t invest any of his own money. He got there and basically said, “Folks, we gotta slow this train down and tighten up some things because it’s really crazy out there.” He was fired within a year. He didn’t really care because he didn’t need the money. But the larger point is this: most of the cautious bankers (or financiers, if you prefer) had been weeded out by the time the bubble burst. They had either sold, retired or just moved to the sidelines (like my friend). Most of the folks who remained at the top had only known expansion and bubbles and couldn’t really fathom any other condition. And if they could fathom it and tried to slow their companies down, they were pushed out. If you saw that the emperor had no clothes, you were long gone by 2006. So, the length of the previous expansion engendered a LOT of adverse selection in the top ranks of banks, investment banks, etc.
So, combining adverse selection with blindness-via-compensation, I find it very easy “to believe that so many people who had that much power were so completely incompetent.” In fact, in hindsight, it looks fairly predictable.[/quote]
Absolutely, the most cautious players were pushed out — many of whom tried to sound the alarm years before things actually collapsed, as I’m sure you know. The fact that things continued for so long contributed to making them look like discredited idiots…relics from the “olden days” who didn’t get “modern financial innovation.” I was personally sitting on 30-40% unrealized losses in my short positions for over a year because I had jumped in too soon (shorting homebuilders, financial firms, insurance companies, some retailers who benefitted from the bubble, etc.).
A lot of people on the blogs were indeed warning about CDSs and the securitization problems — definitely in 2006, and some before that. I knew the pension funds were going to have problems because I was monitoring what they were getting into at the time (real estate, MBSs, and CDSs, among other bubble beneficiaries). I just find it difficult to fathom that “nobody knew.” They knew, but they were also pushing out those who were most vocal about sounding the alarm. IMHO, the people who pushed the “Chicken Littles” out (often firing them) are the real criminals, among others.
IMHO, John Paulson entered late in the game, and was NOT the cause of any “crisis.” He saw that the crisis was coming, and looked for a way to make the most money from it. Not saying that what he did was ethical, just that the danger of things blowing up already existed before he entered his trades. I think he’s a scapegoat for those who won’t confess to the real problems…just like Lehman’s failure is being credited with “triggering the crisis.” Um, no. Lehman’s failure was a **RESULT** of the crisis. The crisis was happening between 2001-2007 (or thereabouts), when securities that were sure to blow up were being created and sold as “a way to spread risk around.” Yeah, it spread risk around alright…all around the globe, and it affected almost every single financial institution.
