single best explanation for why we had a terrifying
financial crisis 10 years ago goes back to how easy it
seems to be to take risks when itís someone elseís
problem often called moral hazard, a term that was
talked about a lot just after the financial crisis but
not as much lately. Now, 10 years out from the worst
days of the financial crisis, itís important to stress
once again that this is a chronic problem. And itís
not something easily fixed with a batch of regulations.
the idea, just imagine what would happen if you had to
decide how much risk to take while fully aware that
somebody else would bear the losses if things donít
pan out. Sounds a little like ďheads I win, tails you
Americans during and after the financial crisis hated
the idea of the federal government propping up private
financial firms, and this was one reason why. These
companies wounded themselves by taking risks in housing
and mortgage finance and if the taxpayers saved them,
the argument went, they would just try it again.
government had to really step up its support after the
investment bank Lehman Brothers collapsed 10 years ago
this weekend, precipitating the scariest week of the
federal government got this one at least partly right by
dodging moral hazard and letting Lehman tip over. Yet a
version of the moral hazard problem existed in spades at
Lehman, and it proved fatal ó to the company. And it
was happening all along the housing finance chain.
mortgage origination business, it wasnít the mortgage
bankerís money. So what mattered was not whether it
was a good mortgage but whether the deal closed.
mortgage-backed securities put together by investment
banks later turned out to have been backed by some
slices of the worst mortgages, the bankers who packaged
and sold the deal still kept their bonuses.
deals went south that the investment bankís customers
fled ó or worse, like Lehman Brothers the company got
caught with too many assets it couldnít unload ó
then the unsuspecting shareholders were hammered.
A lot of
firms put effort into managing risk, of course,
including investors buying mortgages only if the
originator promised to take back bad loans. But there
was a lot of heads I win, tails you lose going on.
this is not a problem unique to financial services or to
that era. Any companyís owners, for example, canít
really know if the insiders are shooting for bonuses and
promotions using shareholder money that they would never
risk if it were their own dollars.
what makes this a persistent problem is the way a lot of
American business is structured, in big publicly held
corporations. Except maybe for company founder CEOs who
never sell a share, nobody who works at one of these
organizations could fairly be considered a business
owner with a lot at risk.
to management to put in place rules and make sure they
are followed, but the incentives for the boss arenít
that much different from a rookie banker trying to close
a mortgage loan. A good example of that coming out of
the financial crisis is the story of Angelo Mozilo,
co-founder of a 2000s-era market share leader in
mortgages called Countrywide Financial.
product for Countrywide back then was something called
an ďoption payĒ mortgage. As it sounds, the borrower
essentially got to decide how much to pay every month.
problem is that the homeowner often didnít pay enough
to even cover the interest due and thus the mortgage
balance only got bigger. As the housing market grew even
hotter, bad became worse as option-pay borrowers were
getting approved with little or no documentation,
including just saying what their income was without
providing so much as one pay stub.
realized a train wreck could lie ahead. He said so, too
ó in e-mails to his colleagues.
about 2 percent of Countrywide during this period, but
that included shares he could get through his stock
options. Mozilo then converted options to stock and sold
nearly $140 million worth, according to a complaint
later brought by the Securities and Exchange Commission.
let his companyís owners take the risk.
must have felt right at home visiting the big investment
banks at the other end of the mortgage-finance pipeline.
By the time the crash hit, they had long since abandoned
the old Wall Street model of partnerships and become
modern, publicly held firms.
Lehman Brothers partner Peter Solomon told the
commission that investigated the causes of the financial
crisis that at one time he and his Lehman partners all
sat together in one big room. They werenít especially
chummy, but because they were all on the hook together
they had to watch each other carefully.
the boom, publicly held Lehman Brothers Holdings, Inc.,
had a balance sheet so leveraged that it had just $1 of
tangible equity to cushion any losses for every $40 it
partner in the business would have allowed that to
after Lehman fell, traders, bond sales reps and
investment bankers in Midtown Manhattan were lining up
on their lunch breaks to withdraw money from their
accounts at Citibank and Chase. They knew how bad it
Financial Timesí John Authers wrote this month that he
saw this happening right in front of him and decided to
write nothing, judging that the last thing the world
needed that week was news that a bank run seemed to be
happening in the heart of the New York financial
hereís another example of just how common the moral
hazard problem is. Those bankers could have been
withdrawing money made by packaging up and selling the
worst of the toxic mortgage securities. Yet by getting
their accounts under $100,000, then the limit of Federal
Deposit Insurance Corp. insurance, they wouldnít have
to worry about Citigroup not making it out of the crisis
still their money in the bank, it just wasnít their
risk. It was ours.