Looking Behind the Curtains

6463967After watching “Too Big to Fail,” it is clear that the financial crisis in 2008 further exacerbated the problem of “too big to fail.” The fact that “10 banks now hold 77% of all US bank assets” is proof of this (TBF). Clearly we didn’t learn from our mistakes…the size and span of these banks is what caused such destruction. Rather than learn from this, we made these banks even bigger. It is clear, however, that the government had little time to come up with a solution. A solution that, if not effective or executed fast enough, could have ruined the economy. Bernanke emphasizes this when they are trying to get the stimulus package passed: “If we don’t do this now…we won’t have an economy on Monday.”

What the movie didn’t go into too much depth about was how these banks got into such bad shape.  How could the regulators be so unaware of what was going on? How did everything come crashing down? Why were there so many firms in trouble? During my first internship, which was at Brown Brothers Harriman in Hong Kong, one of my coworkers gave me the “The Big Short,” a novel written by Michael Lewis that details the ins and outs of the ’08 financial crisis. The main reasons these banks went undetected for so long was because they were making complicated subprime mortgage loans called Collateralized Debt Obligations (CDOs) and Collateralized Mortgage Obligations (CMOs). Basically, the banks put together several loans, some that were very risky (I.e. a loan made to a person who couldn’t make their mortgage payments) and some that were safe, thinking that the housing market could only continue to go up. Because of the complexity of these asset backed securities and the success of the housing market, the rating agencies were rating CCC bonds as A. Then the housing market collapsed and people couldn’t afford their mortgage payments and defaulted on their loans. More than half of the CDOs issued in 2005, 2006, and 2007 that had the highest rating, AAA, were either downgraded to junk status or lost principal by 2009.  $300 billion worth of CDOs. (www.Wikipedia.org, The Financial Crisis Inquiry Report) Finally, these CDOs were insured by insurance companies (mainly AIG). This is why AIG, which entered into credit default swaps in order to insure the CDOs, was hit so hard during the crisis. Like the movie pointed out, if AIG collapsed, the entire financial system and global economy would have been in severe trouble.

Clearly there are many people to blame for the 2008 financial crisis. The banks that made the loans, the home buyers, the regulators, the rating agencies…There are people that foresaw the imminent collapse but no one really paid attention to them. With the housing market booming, people thought things couldn’t go wrong. But oh how they did. If these banks weren’t so interconnected with the economy and the financial system, the financial crisis still could have occur but not on the same scale. Is it possible to tame the monsters we have created? Can we reverse the mergers and reduce the amount of banks that are too big to fail?


3 comments on “Looking Behind the Curtains

  1. Unfortunately, I don’t think there is a reverse to the size that the banks have become. Rather, I think that the industry will continue to consolidate into fewer but bigger banks. Perhaps the solution is increasing the number of big banks, rather than decreasing it. This way, the effect of one bank going under will be diluted by the presence of additional large banks. These other banks would have to be responsible, and there needs to be some sort of disincentive to take on unnecessary risk.

  2. Michael Lewis is great. He worked on Wall Street in the 1980s, I think for one of those bond-trading firms.

    I am glad you added the ways that complex financial instruments were the root cause.

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