I want to let you in on a little secret. Once upon a time, the Wizards of Wall St. took risks with their own money and, when those risks paid off, they earned handsome rewards. Somewhere in the not too distant past, that changed to the newer model, which nearly sank the world’s financial ship in the Fall of 2008 and likely will again, unless Congress addresses the heart of the problem.
Somewhere around the time that the Glass-Steagall Act was repealed (November 12, 1999, to be precise, by the Gramm-Leach-Bliely Act) the Wizards of Wall St. had a revelation. This light bulb suddenly illuminated, as in the old comics and cartoons, greatly assisted by a major shift of graduate-student-level physicists, weary of stuyding arcane String (Superstring, Membrane, ad nauseum) theories, and math geeks, tired of not making any real money using their mental gymnastics, were looking to escape the hallowed halls of academia.
It was also made possible by the power of modern computing, featuring exponentially increasing memory storage and computing power, enabling billions of calculations in microseconds, all emanating from a computer chip the size of a postage stamp. These academic émigrés were snapped up by the Wizards of Wall St., who called them “Quants,” and set to work, sweating over hot computers, cooking up exotic financial instruments, the understanding of which lay far beyond the ken of mere mortals, to whom an algorithm is a very hard-to-spell word for some kind of math that you did not pay much attention to decades ago when somebody tried to teach it to you. “[A]n algorithm is an effective method for solving a problem using a finite sequence of instructions,” say our pals over at Wikipedia, the People’s Encyclopedia.
Still with me? The Wall St. Wizards and their Quants (their new 21st C Sancho Panza’s) then realized that, without the post-Great 1930’s Depression-era limitations imposed by Glass-Steagall, all bets were literally on (instead of ‘off’). Meaning, they now could take enormous, undreamed-of, risks – the kind that reap fortunes very quickly – and best of all, they could do it using OPM (Other People’s Money), thus eliminating any personal risks to their own Wall St. Wizard-owned homes in Hamptons, yachts, Lamborghinis and other rich-people toys.
OMG (“Oh, my God,” in cyber-speak, for the as yet uninitiated).
From there, it was child’s play to take this newfound revelation and hop onto the speeding train that was last decade’s colossal Real Estate Bubble, as it climbed to dizzying heights during the 2003-6 Go-Go years. This story inevitably lends itself to great P.T. Barnum-like hyperbole and, lest we forget, it was Barnum, the world’s greatest showman of his time, who cynically observed that ‘nobody ever went broke underestimating the stupidity of the average American!’
The Wizards set the Quants to the task of ginning up great, securitized pools of home mortgages, packaging the Good, the Bad and the Ugly in such a way that you could literally turn turds into gold. Take a pile of “C-“ grade home loans, divide them into three piles of (let’s pick a cool-sounding French word for it) Tranches, and call each an “A” Tranche, a “B” Tranche, a “C” Tranche, etc. Next, stuff the prospectus for selling these modern wonders to investors with mathematical gobbledygook that showed any self-respecting pension administrator, say over in Iceland, that this was truly a “no risk” investment that he or she better snap up before all the competitors’ performance ratings outshone theirs.
And, Presto, great gobs of OPM were now at work for the Wizards! They then proceeded to produce profits beyond dreams of avarice for the Wizards of Wall St. – kind of like banks nowadays lining up at the Fed Window, getting literally free money from the Fed, then turning around to lend it out on credit cards (to the mathematically-challenged) at rates of 30%+ — just like taking candy from a baby!
A funny thing happened on the way to the bank . . . “no risk” turned out, once you penetrated Quant-speak and grounded all of this mania in a spot of reality, to mean “no risk” as long as housing prices continued their insane climb to . . . Tulip-mania –
Followed by the TrainWreck that we are still trying to clean up.
This House of Cards only collapsed because, in the end, the Wizards choked on their own incredible greed. Estimates are that these exotic financial instruments they sold still fester on balance sheets world-wide to the tune of some $50+ Trillion; some say even more –vastly more than the world’s entire GNP. Bear Stearns collapsed in the Spring of 2008 because it needed something like $75Billion in overnight, very short-term financing, each night and every night; people gave up buying them when Bear Steans stock nosedived in one week’s time. But, Crédit Lyonnais back in the late Summer of 2007 had first publicly questioned the very ratings which had made all this possible. Could it be that the once priestly class of Ratings Agencies were actually in on this game of using OPM and Quant-designed lunacy to bet fortunes they didn’t have, all packaged up to look perfectly legit, mind you?
Last Friday’s seemingly sudden SEC vs. Goldman Sachs blockbuster civil lawsuit is just the beginning of unraveling this unholy mess of deception and greed. There will be more, lawsuits and, in the process, as the media finally gets to dissect these corpses, we will all see up close and personal just how insidious this all was and still is – right on the eve of legislation being introduced to really address the problem; a Congressional free-for-all that surely will make the Healthcare Wars seem mellow.