So, G. (no, wait, it's g.) posted an hour long YouTube video that took me about 8 hours to get through, because I stopped, looked stuff up on wikipedia, rewound and listended to again, etc. I wrote as I went along, too, and here's what I wrote (the wikipedia articles are referenced in Part 3).
My understanding of “Crisis on Wall Street” : Princeton economists review recent events on Wall Street and assess the implications for the economy and public policy – September 23rd, 2008
posted on Impolite Company: http://morisey.typepad.com/my_weblog/ and available on YouTube at http://www.youtube.com/watch?v=Wj_JNwNbETA
Guy 2:
"Here's how Wall Street got into the housing business, and here's why it went so very, very wrong."
He's saying that when the dot-com bubble burst, the big 5 Wall Street banks had to do *something*, and all the real debts and stocks (securities) they were used to (GE and GM, as he says) were all, "No, thank you! That bubble burst HURT!" - so Wall Street wandered over to the housing market. And Wall Street was all, "hey, take a look at these mortagages! They're just like GE and GM securities!" And the credit rating agencies bought it (or played along), and rated the mortgages (or mortgage bundles, once they were up to Wall Street level) the same way they rated GE and GM - really safe, sorta safe, not really safe but you might get lucky, etc. And then Wall Street kept really safe for itself. Since they were (alledgedly) really safe, they had low capital (I think he means captital ratio - the difference between how much it's really worth and how much the market thinks it's worth. Since they were "rock solid," the difference SHOULD have been near zero. Thus, they were cheap). Then he's talking about the past 25 years - light regulation meant that the banks were free to innovate and take risks (and innovation means taking risks, right? Cause you're inventing new things, they're untested), and were largely successful - so they got REALLY big - 25% of the S&P 500 and a large fraction of the GDP. Which means, basically, that a large part of our economy has been tied up in money. It's sort of like Richard Gere's character in Pretty Woman - instead of making things to make money, we've been buying and selling things to make money. And then he says, "is that really a good idea? Smart economists have been trying to figure it out." 2 years ago, the fed raised interest rates, and the era of cheap credit was over - basically, the ability for these banks to keep growing up and up and up hit its limit - and because of the house-of-cards nature and lack of transparency that Guy 1 talked about, everybody flipped out and indeed things started going down and down and down.
Lessons he talks about -
Interestingly, he seems to be saying that bubbles are not a bad thing - we want to feed the bubble. And his point is that in the dot-com bubble, we got a lot of good companies (YouTube, Google), and the housing bubble meant that we got lots of new houses. But these bubbles are inevitably going to be messy - when you innovate, a lot of things ultimately aren't going to work. You can fuck up royally. Put another way, to find the one good thing, you have to go through a lot of bad things. And I see what he's saying - it's sort of a basic tenet of creativity. BUT, he says, that housing is fundamentally different, and nobody recognized that. He doesn't really say why in any but an axiomatic way, from what I can tell - housing is bad because housing is harder to get rid of, because there's less of an ability to control a soft landing - that's the definition of bad, yes, but what about houses makes them like that compared to, say, shares of Google?
Don't blame the messenger - he's basically arguing for more transparency instead of less. This seems like a no-brainer to me. Except, I guess, if the stock market (and "capital") is all about getting more money than things are worth, I can see why obfuscation could be considered a good thing. But obfuscating requires trust, and I don't think we should trust these over-confident investors.
But then he's talking about poor regulation, which is odd, because it sounded like he was crediting lack of regulation for innovation before - but in this case, he's talking about the parties doing things that were obviously wrong - getting too far into debt, issuing too many AAAs - obviously you can't have THAT many rock-solid securities (if you do, you have no capital!), and you can't be taking THAT many risks and reasonably expect to come out ok. Sure, sky-dive, but don't just jump out the plane and hope to encounter a parachute on the way down...
The past does not equal the future - here, I think he's basically saying that, in contrast to "if you do the same thing you'll get the same result," "if you do something different, you'll get a different result." Wall Street thought housing was safe, because it always had been in the past - but housing had never been traded by Wall Street before, and that trading changed the game, and their was no model for that. He's saying a weakness of the financial industry as a discipline is that it only understands the past, it doesn't attempt to insert new variables and see how that might change things.
And finally, he says that the silver lining is that we're being forced to deal with the debt overhang sooner rather than later. what? Oh wikipedia... Ok, the debt overhang is when you have more debt than you have ability to pay it, and it de-motivates you to make good investments, because your creditors are just going to get all of your money anyway - so why bother working hard to make good investments? I don't entirely get this - when individuals are deep into debt, their incentive to get out is so they can get more credit, and so they will stop being called by debt collectors. Maybe high finance doesn't get harrassed the way people do...but with his comparison to Japan, he seems to saying that it took them 10 years to get it together and deal with the fact that they were out of money, and maybe we'll figure it out sooner than that.
GUY 2 Definitions:
CDO: http://en.wikipedia.org/wiki/Collateralized_debt_obligation
Securities: http://en.wikipedia.org/wiki/Securities
Debt Overhang: http://en.wikipedia.org/wiki/Debt_overhang
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