Plausible Deniability

Near the end of the movie of The Big Short, Steve Carrell’s character more-or-less turns to the camera and tells the audience, “don’t even think of blaming the financial crisis on poor people and immigrants,” after which the voice-over narrator comes on and scolds  Americans in general for blaming poor people and immigrants. It’s a surpassingly didactic moment in an surpassingly didactic film, that doesn’t just try explicitly to teach the meaning of collateralized debt obligations and credit default swamps and mortgage back securities with out-of-narrative celebrity cameos (“Here’s Margot Robbie in a Bubble Bath to explain”), but has a clear missionary purpose to the narrative sections of the film as well.

Basically the entirety of The Big Short is about smart white guys showing off how smart they are– at least three different groups of financiers recognizing the scope and insanity of the housing bubble and making big bets to short the market and make money when the walls of Jericho come tumbling down. In a typical scene, almost identical to a scene in Margin Call a few years back, a wonky protagonist scrolls through endless lines of Excel tables where the credit scores and probabilities of default of thousands of borrowers combine to make it almost inevitable that the securities formed out of these mortgages will go bust and become valueless.

The Big Short spends a lot of time telling you how smart these guys are (I think at one point Christian Bale’s character literally wears a t-shirt with a bunch of math equations on it) just like Margin Call spent a bunch of time telling you how smart its protagonist was, detailing his PhD in aeronautical engineering and speaking impressively of the “model” that will allow him to unravel the impending collapse of the global economy.

This is, to put it plainly, bullshit.

You didn’t need to be that smart to know there was a housing bubble in 2005. Everyone I knew said there was a housing bubble. I walked into a 2-bedroom apartment on Nostrand Avenue in Brooklyn with drug dealers outside where none of the cabinets closed correctly and there was a noticeable slant to the floor listed for $650,000 and even I knew there was a housing bubble going on, and Brooklyn was nowhere near the worst place for the bubble. I can believe that you needed to be pretty smart to make money betting against the bubble, let alone convincing banks to create the credit default swaps that would allow you to do so and convincing your investors to go along for the ride. But just knowing there was bubble? Come on.

This is important because if it was obvious that there was a bubble, then it becomes pretty clear that the financial crisis was not the result of a successful scam by Wall Street of the rest of the economy. Sure, there were scam artists, but there were a lot of willing marks, not just on Main Street in Vegas or Phoenix or Miami or the Inland Empire, but on Pennsylvania Avenue as well. Like the con-man says in David Mamet’s House of Games, “It’s called a confidence game. Why? Because you give me your confidence? No. Because I give you mine.”

This goes beyond Bush giving impassioned speeches for expanding credit to low-income families in 2002 and 2003, and eliciting commitments from Countrywide and other lenders to do exactly what they did- expanding their book of low-income and minority-targeted loans by hundreds of billions of dollars, in what became eventually the Toxic Assets that TARP tried to detoxify. It went beyond the huge expansions of Freddie and Fannie and other government housing programs in the 90s, that was in absolute dollars terms a much larger contributor to the bubble than subprime. (Subprime is defined, in the graph below, as only the portion of 2008 debt that was neither in the Freddie/Fannie portfolio nor eligible for Freddie and Fannie: 1.5 trillion out of the 11.9 trillion 2008 value of US mortgage debt. )

It even goes beyond the extensive numbers of individual borrowers who knowingly took out loans they couldn’t possibly pay back.

One question that almost never gets asked- or almost never gets asked seriously- is why the banks were making so much money to begin with. If the vast majority of housing debt was benefiting from an implicit guarantee by the federal government, why was there so much money to be made by laundering and securitizing and mixing and mashing different debt streams and paying off the ratings agencies and pulling the wool partially over people’s eyes. The fact of the matter was that the government clearly wanted – both in terms of stated public rhetoric and explicit public policy, as well as whatever behind-closed-doors stuff was going on in the early 2000s and before-  the huge expansion of private debt we saw. It was the goal. So why let Wall Street make so much money off of it?

The usual answer is that the government, like everyone else, was bought off by Wall Street, by $220,000 speeches and by $10,000,000 per year golden parachutes for Washington functionaries who play nice.  The reason we privatized profit and socialized risk in the housing market was because it suited Wall Street and what suited Wall Street suited the politicians they bought off.

I don’t think this is wrong, but I just don’t buy that it’s the whole story. The real reason that Wall Street was able to make so much money off of the bubble is the same reason The Big Short is a stupid movie for smart people: Wall Street gave everyone plausible deniability. Wall Street made the money, and they also took the fall, at least in the court of public opinion. Yeah, nobody who mattered went to jail. But first of all, I’m genuinely confused about exactly which laws are claimed to have been broken, and more importantly, I think it’s unlikely that the Justice Department ever really wanted to expose just how compromised D.C. was in pushing for what Wall Street did.

To be crass, it’s the same reason the CIA turned suspected terrorists over to Morocco and Egypt to be tortured and interrogated after 9/11, rather than attaching the electrodes themselves, the same reason we fight proxy wars by funding one group of guerillas over another rather than sending troops ourselves. The U.S.’s central role in the global economy, like its hegemonic role in the global military balance of power, is inevitably  going to be fraught with contradiction and moral failure. This isn’t to say that it’s not the role of a somewhat free press and a somewhat free people to investigate those failures, point them out, try to hold people to account.

But it’s interesting that in none of the movies about the financial crisis does a villain appear, and Jack Nicholson in A Few Good Men– style, yell out “you want the truth, you can’t handle the truth.” Perhaps this is because we really can’t handle the truth, and perhaps this is because the people who fund movies aren’t interested in us really exploring it. At least since Dr. Strangelove in the early 60s, and perhaps before, Hollywood has eagerly held a light up to the dark side of American foreign policy, and the role of U.S. military and intelligence personnel in abetting various bad acts. But the softer sides of the U.S. government are rarely given comparable scrutiny. The combination of immigration and domestic economic policy that would lead, as Michael Lewis reported in one of the articles that the book of The Big Short was based on, to a Bakersfield, California, Mexican strawberry picker with an income of $14,000 and no English being lent every penny he needed to buy a house for $720,000 is simply laid at the door of a few douchebags in pinstripes without any further need for self-examination or broader reflection.

My guess is that the folks who matter did learn a lot from the 2008 financial crisis, that it was a central reason for the shift in media and governmental priorities away from promoting bourgeois middle-class lifestyles for lower-income and minority groups and accelerating the cultural shift towards a post-bourgeois, more atomized future, with the engine for continued American consumption coming from smaller and more numerous households and more open borders rather than from nuclear family-level debt. But perhaps because of the centrality of that cultural shift to the priorities of our current time and to the people still shaping it, the explorations of the recent history that catalyzed it tend to be rather willfully dumb.

4 thoughts on “Plausible Deniability

  1. I think that you’re overlooking (or perhaps I missed it) the easiest explanation. Banks are financial intermediaries. They get paid by their customers to intermediate. Intermediation can be difficult at scale, and therefore they get compensated handsomely–plus again, scale, given their fees are typically percentage based. More simply, banks made (debt-based) money because everyone was making (debt-based) money, and they lost money when everyone lost money. The banks didn’t see the crisis coming because as long as everyone kept borrowing (including the banks), they (and everyone else) would continue to make money.

    The cause of the crisis was contagious optimism, followed by contagious pessimism (i.e. bank run). In the end, housing prices didn’t keep rising, but they also didn’t fall nearly as much or nearly as widely as people thought they would. But selling begets selling, particularly for money market funds and CDOs, that were forbidden from “breaking the buck” (i.e. linked to MTM valuations) or holding low rated assets. With everyone selling, MTM valuations were impossible, so ratings and values continued to drop, triggering even more selling. However, those firms that were not so limited by collateral and/or rating restrictions (like the U.S. Treasury and Fed), made a lot of money buying those “toxic” assets.

    In general though, I agree that it is implausible to believe that “Wall Street” maintained a trillion dollar conspiracy (nor is that the lesson of the Big Short, despite the scolding voice over). Wall Street is comprised of thousands of independent agents and firms with a high degree of churn all committed to making money, frequently off each other. If a trillion dollar secret existed, it would quickly make it into the price of the security. The best part about Michael Lewis, is that he wrote an article in January 2007 chiding the “warmed over prudence” regarding derivatives expressed by Morgan Stanley and Citi at Davos, earlier that month. The article has since been taking down from Bloomberg, but is available here (

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    1. You’re right, and perhaps I’m being too clever by saying “why they were making so much money in the first place.” Banks have been making a lot of money for a long time, and are bound to make more in a time of rapid global growth and cohesion. But I still think that a significant portion of the crisis was due not just to government subsidy or private malfeasance, but due to the way subsidies were hidden rather than explicit- the Bush Administration working with Countrywide to expand their subprime book as a “prime” example. This is what I mean by plausible deniability.


      1. I definitely take your point, and it’s a good one. I wonder though, whether Countrywide’s relationship with regulators was really so hidden from other market participants.

        However, what I’m suggesting is that the “toxicity” of the mortgages (and the notes they secured) was less important than it commonly believed. Securitization and, in particular, tranching was designed to spread the risk of default on the underlying mortgages. Defaults (and home price decline) were certainly more severe and pervasive than anticipated, but not so severe as to cause (widespread) losses to anything but the riskiest tranches. Put another way, the change in expected cashflow was not big enough to explain the trillion dollar contraction in the credit markets. (As I noted above, certain firms, including the Fed (and Treasury) made a lot of money by acquiring notes and restructured notes backed by the same collateral–at pennies on the dollar–that continued to pay out for years.)

        The issue (of many) was twofold: structural and informational. The structural component has two liquidity-related parts. The first is that many of the “structured” notes (e.g. CDOs), but mortgage backed securities, generally, involve some kind of arbitrage between long-term assets (mortgages) and short-term liabilities (bonds, commercial paper, etc.). The structure partly depends on the ability to raise/roll new debt to payoff bondholders’ principal should they ever decide cash out, or when their notes expire. If credit markets are lively, funding isn’t a problem, but if they slow, the collateral (Mortgage Backed Securities (MBS) and ultimately mortgages) can become illiquid and bondholders cannot (immediately) be made whole. That liquidity problem is related to the second part of the structural issue. To protect bondholders, many structures, and the rating agencies (and money market funds), used mark-to-market (MTM) valuations to price the collateral, i.e. they measured the safety of the structure based on the ability to sell the MBS-collateral (and not just their creditworthiness). That makes the structures particularly vulnerable to a bank run because if the market tilts sell (as opposed to sours on a single asset), then marketwide MTM prices will fall, forcing more structures to default/sell (in a seller’s market)– ostensibly to protect the bondholders.

        That leads to the informational part of the issue. Bondholders depended on other bondholders to make it worthwhile to roll their debt. In other words, even if bondholders determined that the underlying collateral was not so bad as to reach the higher tranches, the structural-liquidity issue created the risk that the higher tranches would still be wiped out by the forced selling, downgrades and inability to roll debt. It’s hard to be the first to buy into a structure that depends on liquidity to function, and without knowing whether other investors would similarly step in to reverse their losses, or would continue to cut bait. Going long couldn’t be done alone, even if you didn’t panic.

        If regulations are to blame (and they’re certainly partly to blame), it would be Reg 2a7 (money market funds) and European Basel regs that incorporated ratings into their capital requirements. Those incentivizeed MMF to seek out the riskiest high-rated assets (and investment banks to procure the highest returns for the high-rated assets), i.e. if all A-rated assets are regarded as equally risky, then why not buy the CDO returning 700bp, as opposed to the corporate returning 400bp? It also meant that as illiquidity caused asset value to fall, structures would be downgraded thereby forcing money market funds to sell, given their limitations on holding lower-rated assets.

        More broadly, regulation is to blame insofar as it created uniformity in portfolio composition and then similarly forced many large investors to act as one.


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