As America tries to close the book on its banking crash, ours is still far from over
Published 21/01/2016 | 02:30
'The Big Short' is a huge Hollywood hit movie which gives some insight into what went on inside the financial crash in the United States. Starring Brad Pitt, Steve Carell and Ryan Gosling, the film has been nominated for five Oscars and opens in cinemas in Ireland tomorrow night.
It is reigniting the debate in the US about the causes of the crash, the mechanisms used to clean it up and whether enough has been done to ensure it doesn't happen again.
It has been praised for explaining complex financial derivatives based on sub-prime mortgages in a very accessible way. However, some commentators are questioning whether it over-simplifies its message that Wall Street always wins and nothing serious has been done to safeguard against it happening again.
Just last week Goldman Sachs became probably the last of the major financial players to make a multi-billion dollar settlement with authorities and other litigants over its mis-selling of mortgage-backed bonds.
Goldman Sachs agreed to a $5bn settlement which included a $2.4bn penalty, $875m in cash payments to various agencies and $1.8bn in relief for distressed borrowers.
A Senate sub-committee investigation had found that Goldman Sachs sold mortgage bonds to customers while it was short selling or "shorting" that market, without telling the customers.
Internal emails showed that by December 2006 Goldman was sitting on a $6bn bet on American home loans. That month, senior executives met and decided to sell down that exposure because it was too risky. The executives learned that the mortgage bonds were built on home loans that had often been awarded with no documentation and many had little or no equity.
Emails showed they drafted a seven-point plan which involved "aggressively distributing things" because "there will be very good opportunities, as the markets go into what is likely to be even greater distress."
They parcelled up mortgage-backed assets into new bonds and sold them off to customers while at the same time betting against the market by shorting traded mortgage-backed assets. By February 2007, Goldman had gone from a $6bn bet on mortgages to a $10bn bet against them.
The emails showed that internally many of these assets were viewed as "crap" or described as "cats and dogs" that could be sold to unsuspecting clients.
The Department of Justice were the ones who had to decide whether any of this was actually illegal at the time. Reprehensible and unethical - yes, but illegal, it appears not. Criminal charges were not brought and instead it all became a civil legal battlefield.
Some have linked the timing of the Goldman Sachs payout to the success of the movie on the basis that it has informed ordinary Americans of what happened and enraged many of them.
It is very difficult to say exactly why the settlement came at this point in time. Goldman Sachs' share price in October 2007 hit a high of $235.
By November 2008 it was down to $53.31. It is now trading at around $213, valuing the company at $68.8bn.
The Goldman Sachs settlement deal comes after a raft of enormous payouts made by other banks since the crash. Bank of America made a $17bn settlement. JP Morgan Chase reached a $13bn deal. Morgan Stanley paid out $2.6bn and Citigroup reached a $7.6bn settlement.
The film raises questions about the extent to which stupidity fuelled by greed did the damage, as opposed to fraud and illegality. The simple narrative is that Wall Street won and not much has changed.
However, the reality is a little more complicated. For example, Bank of America reached the biggest settlement and is today a bank with a market value of $156bn. But its settlement was largely based on bonds sold by Countrywide and Merrill Lynch. These were two businesses Bank of America bought or effectively bailed out, in 2009, following pressure from the US government.
Bank of America issued just 4pc of the mortgage-backed bonds that went into default. Bank of America has forked out around $64bn in settlements, penalties and fines since 2010.
Around $150bn has been paid in settlements and fines in the US banking system since the crash, along with SEC charges against 198 entities and individuals. A total of 89 chief executives and other senior executives have been charged. However, there has been very little jail time involved.
On the issue of stupidity versus fraud, some studies have shown that many of those who made millions from dumping junk mortgage bonds on to their clients, had in fact invested heavily in property themselves.
Another part of the simple narrative, touched on in the film, is that Wall Street firms did all of this because they knew they could get away with it and the taxpayers would bail them out. US taxpayers did bail them out, but could Wall Street bankers really have believed that safety net would be there?
When insurance giant AIG insured billions in these bonds based on junk mortgages, did they simply go ahead on the basis that if it all falls apart the US government will bail us out? I don't think so.
The US taxpayer did bail out AIG but if they had not been so stupid in the first place, they would not have underwritten what they did.
'The Big Short' is about rejuvenating the debate about ensuring none of this happens again. Surely that is a very positive thing. It weakens the story to conclude that it has all been fixed and this won't happen again.
It is easier to suggest the government "wimped out", watered down the new rules and it could all happen again.
In a recent interview the film's director Adam McKay suggested the "too-big-to fail" problem is "actually worse in some ways".
That is partially true but not fully borne out. The introduction of the Dodd-Frank legislation did not formally break up the giant banks. As long as that is the case, they can be too big and carry conflicts between one arm of the organisation and the other in which customers come off worst.
The Dodd-Frank legislation does however impose very strict controls on those aspects of Wall Street activity.
The collateralised debt obligation (CDO) which did a lot of the damage is gone. They no longer exist. However, similar financial devices are still around, including private label CMBSs (commercial mortgage-backed securities) and CLOs (CDOs with regular bank loans instead of mortgages).
These are now under much greater scrutiny and cannot be issued to hedge or transfer all the risk. The US mortgage market is also a lot more careful and more closely scrutinised.
Credit ratings agencies are taking a much deeper look inside financial instruments and have raised their game, following investigations and settlements after the last crash.
Our own financial crash in Ireland was different. It didn't involve complex derivatives but more straightforward, old-fashioned collective blindness in over-lending to property.
It wasn't CDOs that sank us. It was under-scrutinised loans for shopping centres in the middle of nowhere.
As America tries to close the book on its last financial crash, we are still grappling with the fallout of our own. Billions in national debt, criminal cases, extradition hearings, state ownership of banks and various other investigations are all still with us. It won't be fully over for many more years to come.
The ingredients for the next financial crisis all still exist - greed, stupidity, group think and pressure to achieve the most efficient markets possible.
The next crisis will simply be something a little different than the last and that is how we won't necessarily see it coming.