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Interview With Joe Nocera

"The risk models turned out to be quite flawed and should not have been given the weight they received."

HBO

What were the initial seeds of the 2008 financial crisis?

Joe Nocera

It's a big question, but I think it really starts with the origins of subprime lending, which is a form of lending that is intended to allow people who can't afford a 20 percent down payment and a normal, "prime" mortgage, to own a house. That sounds like a worthy goal, but over time it became horribly distorted. Eventually it became a means through which mortgage companies that specialized in subprime mortgages could just hand out loans to anyone with a pulse, take the fees and send those mortgages off to Wall Street.

Wall Street then bundled those loans into what's known as securities, which are basically bonds that are stuffed with thousands of these loans. That's what eventually becomes known as "toxic assets." The reason they were toxic is because they were mortgages that were bound to eventually default. Once the housing bubble burst, home prices declined, people were no longer able to refinance their homes, and so they defaulted in huge, unprecedented numbers. When that started happening, all of the banks that held these securities on their books were suddenly in a lot of trouble. That's really what brought us to the brink of disaster.

HBO

And why would the mortgage companies want to back those subprime mortgages?

Joe Nocera

Nobody had any skin in the game. Instead of a bank holding a loan on its own books, it would sell the loan to someone else and get a fee. They sold more and more loans and got more and more fees because if the person defaulted, it wouldn't really be their problem. They didn't care if the original borrower could pay it back or not. Similarly, Wall Street didn't really care either, because they were selling these bonds to investors. You would think the investors would care, but because these bonds were somehow rated AAA, everyone thought they were safe.

HBO

Why didn't the rating agencies do a better job of rating these products accurately?

Joe Nocera

There are two reasons for that. First, the entire system was hooked on these very mathematical risk models. The ratings agencies relied on these models to tell them that the chance of default was minimal, therefore they could rate the securities AAA. But the risk models turned out to be quite flawed and should not have been given the weight they received. The less noble reason is that the rating agencies made huge kinds of money rating these derivatives and bonds. It was a pot of gold for them and once they discovered how much money they could make doing this, there was no turning back.

HBO

In the book you wrote with Bethany McLean about the lead up to the crisis, 'All the Devils Are Here,' you start with the securitization of mortgages at Salomon Brothers in the '80s. What was new about what they were doing?

Joe Nocera

When securitization originally came about, it did two really powerful things. Firstly, it took what had previously been a very local means of finance, the local mortgage lender, and effectively nationalized it. The second thing it did, by turning these loans into something investors could buy, was free up lots of capital so that banks could make more loans. And the fact that these loans were all bundled into something else was itself an innovation that had never been done before. There hadn't even been something called a "mortgage desk" when this first came about. Over the course of time, mortgages became one of the most popular instruments that Wall Street would end up trading.

"The government had a responsibility to understand the products that were putting the country at risk. They didn't do that."

HBO

Is there a reason why derivatives trading was not regulated?

Joe Nocera

The late '90s was a time of tremendous deregulatory emphasis. So a lot of the rules and regulations got tossed overboard. Also, derivatives didn't come under any obvious regulation when they were first invented. There were various fights throughout the '90s about whether they should be regulated at all. Ultimately, Congress passed a law that specifically exempted derivatives from regulation. So when the crisis came along, the government had no idea that, for example, AIG had all those credit default swaps out there or who the counterparties were to Goldman Sachs. They had no clue as to how much bad stuff was out there.

HBO

So was it a political failing that led to this kind of environment?

Joe Nocera

I think it was. The government had a responsibility to understand the products that were putting the country at risk. They didn't do that.

HBO

What was the role of Fannie Mae and Freddie Mac in creating the crisis?

Joe Nocera

That's a complex issue. Many Republicans will say that the investment banks followed Fannie and Freddie off the cliff and that they're the ones who are essentially at fault. I'm of the opinion that the banks would've gone down that way anyway. At the peak of their power, Fannie and Freddie either owned or insured half the mortgages in America. And that was the only business they were in. They had nothing else to cover themselves if anything happened to the mortgage market. When the bubble burst, they were in an extraordinarily vulnerable position.

"there were a lot of people who saw something like this coming, but they were largely ignored. People had to know, but they didn't want to stop the machine that was making all this money."

HBO

If mortgage-back securities were a risky proposition, why did all the banks have them?

Joe Nocera

They didn't think of it as a risk. They thought of it as free money.

HBO

Did any of the major investment banks stay clear of investing in them?

Joe Nocera

Goldman sidestepped it a little bit. They saw what was going on before anyone else and they sold off many millions of dollars worth of them. JP Morgan sidestepped the issue somewhat as well. They were never on the verge of going under because they held enough capital. There's a moment in the movie when Tim Geithner is trying to pair up the commercial banks with the investment banks. The reasons he's trying to do that is that the commercial banks are funded by bonds, which are a safe pool of money, whereas the investment banks are funded by the kind of overnight, temporary loans that can vanish in a nanosecond. Part of the reason Lehman failed is because the market lost confidence in them and they werent able to make those kinds of loans anymore.

HBO

In the film, Lehman Brothers CEO Dick Fuld is heard blaming the company's issues on short sellers. Was that just an excuse?

Joe Nocera

They certainly weren't the cause of it. There are always people who are looking to make money betting against a company. But the problems Lehman had were real. I also think it's pretty hypocritical for big shot Wall Street guys to blame short sellers for their problems, because a lot of them made money that way themselves.

HBO

Were there inherent conflicts of interest in banks packaging the CDOs they'd be selling against, as Goldman did with the Abacus deal, or is that standard procedure?

Joe Nocera

I think there was definitely a conflict of interest. They were able to get them off their books by taking advantage of their customers and selling them things they didn't necessarily want. You could say they were acting dishonorably.

HBO

Did anybody see the crisis coming?

Joe Nocera

Absolutely. One thing Bethany and I realized in researching our book is that there were a lot of people who saw something like this coming, but they were largely ignored. People had to know, but they didn't want to stop the machine that was making all this money.

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