"Houston, We Have Our Scapegoats"

Posted by: Michael Mandel on December 13

So far this financial crisis has been marked by an unsatisfying search for a scapegoat or villain. So far Congress and the press have tried to pin the “villain” label on Wall Street investment banks, credit-ratings agencies, mortgage brokers, and Alan Greenspan.

All of these are logical candidates, but up to this point the villain label has not stuck to any of these. Wall Street investment banks (including large banks such as Citi) put together the bad mortgage-backed securities, but they held onto big chunks of the securities. As a result, either they have gone out of business when the securities turned bad(Bear, Lehman, Merrill), absorbed huge losses (Citi), or been forced to turn themselves into commercial banks (Goldman, Morgan). That suggests they were mostly guilty of stupidity and greed, rather than any systematic attempt to rook buyers.

The same thing goes for the credit ratings agencies—it’s hard to say that they conspired with the Wall Street banks to pawn off bad paper, when the banks themselves held onto the same paper in sufficient quantities to drag them under.(Conflict of interest alert: Both S&P and BusinessWeek are part of McGraw-Hill). And the mortgage bankers were guilty of plenty of fraud—but everyone knew they were doing immense amounts of legal no-doc loans. Despite being completely out in the open, these are blowing up in large quantity. Finally, Alan Greenspan’s low interest policies may have helped set the stage for the crisis—but many of the bad loans were made well after Greenspan and Bernanke started raising rates.

In many ways, the financial crisis is like a natural disaster. So big, so overwhelming, that virtually no one (including myself) anticipated its magnitude, even well after it started.

But the horrendous Bernard Madoff affair—which could result in losses of up to $50 billion—is much more understandable, and yield a much more satisfying set of scapegoats: The evil financial adviser, and the funds who invested with him. The fact is, there seems to be plenty of people who suspected that there was something wrong with Madoff’s operation, and steered their clients away from him. And then there were other investment operations who simply didn’t do enough due diligence. This did not require rocket science, or predicting the unpredictable—it just required a check on his accountants.


Of course, Madoff and the funds who invested with him were not directly responsible for the housing bubble or the financial crisis.
But remember: The poster child scapegoats for the tech bust were not the people running the dot.com firms or the venture capitalists who financed. Instead, we remember Worldcom and Enron—a natural gas company, for heaven’s sake—as the corrupt companies.

The same thing is going to happen this time. The unrequited blood lust of Congress and the press is going to fall on Madoff, the funds who placed their money with him, and more broadly, the whole hedge fund industry. Houston, we have our scapegoats.

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Reader Comments

CompEng

December 13, 2008 10:26 PM

That's too bad. Isn't stupidity, greed, and herd instinct bad enough when it's accepted on a cultural rather than a personal level?

Joe Cushing

December 13, 2008 11:51 PM

When the stock market was down 30% and other markets were also down about the same, hedge funds were only down 15%. (NPR Marketplace) On the surface this sounds pretty good. They did half as bad as the market. Not a bad accomplishment. Given the level of leverage at a hedge fund they should have all lost 300% give or take. Another words they should have collapsed. What this means is, hedge funds have not just done a pretty good job, they have performed phenomally well. It's enough to make me consider them as a possible career path. It's too bad they might be scapegoats because that means they might be treated harshly by congress.

Thomas A. Coss

December 14, 2008 11:53 AM

The problem with simple, incomplete conclusions, is that they lead to incomplete, and harmful solutions.

I'm only partially OK with this when my 15 year old daughter pursues the most lascivious outfit to ware given her simple assessment of the weather. Her misjudgments are, by in large, contained to her later discomfort and my own. In the case of Congress who write laws, however, the consequences last for decades.

When the auto executives came to congress explaining their situation, the best congress could come up with is a means to embarrass them in to $1 salaries an agreement that they will now spend more time in security lines at commercial airports.

We live in a complex, first derivative world economy, and to be candid, if any member of congress doesn't know what that is, they should be prohibited from voting.

Thomas A. Coss


Mike

December 14, 2008 04:46 PM


Is there any doubt now how about how hopelessly corrupt our system is, and how WORTHLESS the SEC is??

I say throw Chis Cox and Maddow in the same cell..they can be bunkmates, and save us some money.

conryw

December 14, 2008 06:01 PM

I don't buy it for a minute. These people are not scapegoats, they're guilty. Greenspan, Phil Gramm and too many others to name - both Democratic and Republican - even Hank Paulson.

Furthermore, to call this a natural disaster is laughable. This is an entirely human made catastrophe as a result of systematic pealing away of the regulations that were put in place after the great depression, resulting in the fox guarding the hen-house.

"Shadow banking"? Sounds to me like something Pablo Escobar would do.

Sloppy language. Sloppy thinking.

CompEng

December 14, 2008 07:52 PM

Joe,
if the hedge funds managed to pass most of the risk on to other agents and jumped more quickly than other institutions due to better information, I suppose you could say they did a good job for themselves.
I don't know if they really suckered the rest of the economy into taking the fall, but if they did, I'm not clapping.

LAO

December 14, 2008 10:58 PM

It is not just a scapegoat that we need; we need a succinct phrase that neatly sums up the essence of what happened (and continues still), a phrase that enters the language and is repeated like an old cliche to convey the warning for generations to come -- like "they drank the kool-aid" has come to mean that unwary people can be brain-washed into falling for an insane scheme.

Joe Cushing

December 16, 2008 10:32 PM

CompEng,

Hedge funds don't have better information. They are just better at analyzing the information that is out there. This is a good thing for all of us. If they do everything right they send markets down earlier when they are too high. They also send markets up earlier when they are too low. This reduces volatility for the market overall. Most people like less volatility. Since they were only down 15% when everyone else was down 30% multiplied by leverage, hedge funds seem to me a great thing for society. The economic externalises (something you seem to be especially concerned with in all of your posts) are positive; yet they are made out to be villains.

CompEng

December 17, 2008 09:13 AM

Joe,
That is the theory, and to the extent that they operate according to theory, you're absolutely correct. However, large players in the market with a lot of money actually do tend to have better information sources and more political clout than you do. Things that you could never get away with as an individual... they can (naked short selling being an important example).
Anybody in the business of sales makes their money by knowing more than you do about their field. So I feel obliged to be skeptical. If these players are small relative to the size of the local trading market and act individaully, then they will reduce volatility. IF they are large or act in packs, the reverse is true. Worse, some of the computer trading these guys do has been shown to increase volatility (sell on the way down, and buy on the way up, but do it with faster computers).
No, I think a lot of the money these guys make is not by better analysis of the long term winners (although they do that to and rightfully benefit from it), but by other means.

LAO

December 17, 2008 12:32 PM

Joe, The 15% down figure for hedge funds was stated before anyone gets to see the impact of year-end redemptions and forced sales into a down market. Redemptions are bound to be high because of so many other losses that have to be covered. I thought the mid-November deadline was for redemption requests, not for actual return of invested money. If you have any data about redemption progress, let me know, because I'm a little bit scared that we're still in for more shocks (I'm being facitious because the funds apparently don't have to reveal much). Madoff investors who had other monies in hedge funds will be hitting the next redemption window, too. Then there is the problem of hedge funds that don't actually hedge, because that is not a requirement.

It pains me that the best a bright person can do is fiddle with other people's money, and nobody seems to notice that very little is going to trickle down to replenish the supply of people with money to perpetuate such careers.

CompEng

December 17, 2008 01:45 PM

One more thing...
a lot of the information I've picked up on trader tactics might not apply to hedge funds. Sadly, it's always been peripheral to discussions from news sources like NPR, so I may be painting certain players unfairly. Part of my problem with them is prejudicial: I don't trust investment institutions very much. I don't think a business model based on sales and what is essentially gambling is likely to instill real integrity in an institution. So despite realizing they play a very important role in the economy, I don't actually respect them.

Joe Cushing

December 20, 2008 10:47 AM

I never claimed they picked long term winners.

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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