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Ratings Agencies Among Top ‘Devils’ of Meltdown, Authors Contend

November 18, 2010 at 4:58 PM EDT
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Paul Solman speaks with Bethany McLean and Joe Nocera, authors of "All the Devils Are Here: The Hidden History of the Financial Crisis" about the villains of the financial crisis. It's part of his ongoing series, Making Sen$e of Financial News.

JEFFREY BROWN: Next: a “who done it?” look at the financial crisis. NewsHour economics correspondent Paul Solman has our conversation.

It’s part of his reporting Making Sense of financial news.

PAUL SOLMAN: At the Museum of American Finance on Wall Street: the co-authors of “All the Devils Are Here: The Hidden History of the Financial Crisis.”

Bethany McLean, famous for breaking the Enron story, is a contributing editor at “Vanity Fair” magazine, Joe Nocera, a columnist for The New York Times.

Bethany McLean, Joe Nocera, welcome.

JOE NOCERA, co-author, “All the Devils Are Here”: Thank you.

BETHANY MCLEAN, co-author, “All the Devils Are Here”: Thank you.

PAUL SOLMAN: You frame this book as a look back at the whole financial crisis, so I thought I would frame this interview as a: Who is the biggest culprit?

JOE NOCERA: I certainly would put the rating agencies right at the top of my list of bad guys, or my list of devils.

A place like Moody’s took a culture that had a reputation for some integrity, and completely corrupted it in a drive for market share and profits.

PAUL SOLMAN: So, biggest culprit, ratings agencies; you agree?

BETHANY MCLEAN: I do agree. If they hadn’t taken subprime mortgages and rated enormous quantities of them AAA, meaning they gave those bonds the same credit rating as the U.S. government debt has, this — this whole thing couldn’t have happened, because debt that is rated AAA is precisely the debt that is snapped up by the largest quantity of buyers all around the world, buyers who are not capable of doing the detailed work to analyze these bonds by themselves.

And yet there is still this myth that these buyers are supposed to be sophisticated buyers, and they’re supposed to understand what they’re getting into. And the cornerstone of this myth, the thing that makes it all work, is the rating agencies, because the investment banks say, well, we sold AAA securities.

PAUL SOLMAN: But don’t you cut ratings agencies any slack? I mean, the incentives are all there for the ratings agencies to do what they did, no?

JOE NOCERA: I don’t cut them any slack at all. They are supposed to be protecting investors. That’s what their job is. They’re not supposed to be in cahoots with the Wall Street firms that are ginning up these securities.

And yet that’s what they did. They used to rate normal, old- fashioned corporate bonds. And then — then this new form of finance arose called structured finance. And that’s all these, you know, mortgage-backed securities bundled into CDOs, so on and so forth, all this complicated stuff.

It became a growth area, a profit area that far outstripped the old fuddy-duddy business of rating government bonds. So, the rating agencies raced, jumped on it. And it just flew. And then the top executives really started to drive the place around the profitability of structured finance. And that’s really what happened, more than any other single thing.

PAUL SOLMAN: But isn’t that what happened at Fannie Mae and Freddie Mac?

BETHANY MCLEAN: A slightly more complicated story with Fannie and Freddie, because they were set up to serve this noble purpose, to enable homeownership. And we can have a debate about how noble a purpose that — that actually was.

But there were these odd entities that were half-private and half-public, meaning they had this mission to serve the public good by boosting homeownership, but they also were privately-held companies that were traded on the stock exchange, with a responsibility to produce profits for the bottom line, and, even more importantly, executive bonuses that were tied to those bottom-line profits.

JOE NOCERA: The dirty little secret of Fannie and Freddie is that they jumped into subprime, not for political reasons, but because they were being left behind by the private market, and they were losing market share because, subprime was becoming so big, it was kind of starting to take over the securitization market. Fannie and Freddie needed to be in the securitization market, so they dove in with both feet.

PAUL SOLMAN: OK, Republicans or Democrats, who is more responsible?



JOE NOCERA: Both. Republicans want to blame Fannie and Freddie and the government, because they have a hard time accepting the notion that the market failed. Democrats want to blame it on the marketplace, on Wall Street and subprime companies, because they have a hard time accepting that the government didn’t do its job. The fact is, neither party did their job.

BETHANY MCLEAN: And, after the crisis, it has become very popular for Republicans to say, well, the Democrats caused this with their focus on homeownership, on putting people in homes who couldn’t afford those homes.

But one of the really interesting things, if you go back to the 1990s to the birth of subprime lending, it was never about homeownership.

PAUL SOLMAN: What do you mean it wasn’t about homeownership?

BETHANY MCLEAN: It was never about homeownership, because subprime lending grew out of cash-out refinancings, meaning the ability of somebody to go to a bank, refinance their mortgage, and take cash out of their house in order to live on that cash.

And that enabled consumer spending through the 1990s and through the early part of — of this decade. Most of the business of the major subprime lenders, from Countrywide, to Ameriquest, to New Century, was cash-out refinancing. It wasn’t the first-time purchase of homes by homebuyers. And this was celebrated by Republicans, as well as Democrats.

JOE NOCERA: Homeownership was a giant fig leaf, particularly for the rise of subprime.

I was stunned, in the reporting of this book, how much subprime was about predatory lending. And it was way more than I thought. And then, when you find that a company like New Century, which really, you know, 85 percent of its business is refinancing, 15 percent of its business is homeownership, that’s astounding.

PAUL SOLMAN: What does predatory lending mean in this situation?

JOE NOCERA: Taking advantage of unsophisticated people to put them into loans that — knowing, absolutely knowing, that they can never pay them back, often lying about what the interest rate hike is going to be, prodding them to lie themselves about their income, about their true financial condition.

BETHANY MCLEAN: I — I started this book with a bias toward personal responsibility, and, if consumers got in over their head on their mortgage, that was their fault.

And one of the big discoveries to me in the course of reporting the book is the extent to which these loans were sold; they weren’t bought. And one of the most telling moments were these internal documents from Washington Mutual, one of the big subprime lenders, around 2003 talking about how to get consumers who really wanted safe 30-year fixed-rate mortgages to take out these dangerous option ARMs instead.

PAUL SOLMAN: ARMs meaning adjustable rate.

BETHANY MCLEAN: Adjustable rate mortgages — how to sell those to people, and how to confront a consumer who said, but it doesn’t feel right to me. I want to pay back my mortgage every month. This is what my parents did.

How do you get these people to take out a risky mortgage instead? You told them that home prices could only go up. And the reason Washington Mutual wanted to sell these option ARMs, instead of the 30-year fixed rate mortgages, is that Washington Mutual could turn around and sell these to Wall Street for a lot more money than it could sell the old 30-year fixed-rate loans.

JOE NOCERA: The astonishing thing about the run-up to the crisis is that this situation was happening all over the country. Lots of people on the ground could see it. And, yet, no one in government, whether it was the Fed, whether it was the regulators, whether it was Congress, was willing to do anything about it.

And — and not only that. In some cases, like the bank regulators, they actively pushed back and stopped anybody trying to stop this kind of lending.

PAUL SOLMAN: Is Wall Street any worse than it ever was?

BETHANY MCLEAN: Yes, I think it’s worse.

Wall Street, by the very sleaziness and impenetrability of its practices, set up its own run on the bank, because, when push came to shove, there was no transparency. And, even though in — you can argue that this was a run on the bank, it was a run on the bank created by the way Wall Street did business. So, in the end, they only have themselves to blame.

PAUL SOLMAN: Some people have argued that this wasn’t not quite a plot or a conspiracy, but a means by which Americans who had companies with stuff to sell could get money into the hands of people whose incomes were stagnant, so they could buy this stuff, that is, lend them the money.

BETHANY MCLEAN: I do not think that was ever an explicit plot. In other words, I don’t think any group of people ever sat in a dark room and said, here’s what we are going to do, and it’s eventually going to bring the financial system down, but we are going to keep this party going while we can.

But I absolutely think that was an implicit plot. In other words, in order to keep the U.S. economy going, you had to keep consumer spending strong. In order to keep consumer spending strong, you had to have consumers whose income otherwise wasn’t keeping up have a ready source of cash.

That was cash-out refinancing, by using their homes as piggy banks, and no one wanted to stop that party.

PAUL SOLMAN: You agree with that?

JOE NOCERA: Totally, 100 percent.

PAUL SOLMAN: Joe Nocera, Bethany McLean, thanks very much.


JOE NOCERA: Thanks for having us.