Summary
Highlights
The global economy is still reeling from the financial crisis that occurred over three years ago. Wall Street received a bailout while Main Street did not. The financial sector, larger than America's manufacturing sector, wields immense power and global reach, ultimately leading the world into the worst economic crisis since the Great Depression. Despite banks claiming to create wealth and responsibly invest trillions, the 2008 recession destroyed $11 trillion of American net worth, leading to widespread anger and the Occupy Wall Street movement demanding accountability.
The origins of America's financial crisis can be traced back to a 1994 gathering of young JP Morgan bankers in Boca Raton, Florida. Their goal was to find a way to reduce risk in banking. This led to the development of credit default swaps, a type of derivative ensuring a loan against default. Initially, these were innovative tools to offload risk, first used in a deal involving Exxon. These swaps allowed banks to bypass capital requirements, enabling them to make more loans and fueling a massive credit boom seen as an unambiguously positive development for the global economy.
As other banks realized the profit potential, the credit derivatives market exploded. It was largely unregulated and opaque, making it incredibly profitable for bankers who could charge huge spreads, far exceeding those of traditional financial products. Critics like Brooksley Born warned of the dangers of unregulated derivatives, predicting massive taxpayer bailouts. However, the banks, with the support of figures like Alan Greenspan, lobbied hard against regulation, arguing it would hinder market efficiency and America's financial dominance. This deregulation coincided with the repeal of the Glass-Steagall Act, leading to larger banks and a largely unmonitored derivatives market.
With the successful introduction of credit default swaps, the next application was to consumer credit risk, particularly mortgages. Bankers began bundling subprime mortgages—loans to borrowers with poor credit—into collateralized debt obligations (CDOs). These CDOs were then sliced into tranches and made more attractive to investors by purchasing credit default swaps, despite the inherent risks. This practice fueled a housing boom, especially in fast-growing states like Georgia, where predatory lending practices flourished. Former Georgia governor Roy Barnes attempted to implement stricter regulations but faced strong opposition from the mortgage lobby, and the law was eventually gutted.
The big banks continued to package and sell more mortgage portfolios, with increasing amounts of high-risk subprime debt, using credit default swaps to secure favorable ratings. While some at JP Morgan became wary due to a lack of data on mortgage performance, other banks aggressively sold subprime CDOs globally, particularly to naive German state-run banks. By 2005, the total value of credit default swaps was in the trillions and doubling annually. Despite JP Morgan's early concerns, many banks, driven by greed and the belief that housing prices would never fall, continued to engage in these risky practices. The market was a 'pure bet' with no underlying economic interest, akin to gambling.
As interest rates rose and housing prices began to drop in late 2006, the unraveling of the crisis started. By 2007-2008, smart money knew the game was over, and banks tried to offload their toxic assets. Goldman Sachs, however, allegedly created CDOs containing toxic subprime assets and then bet against them using credit default swaps, profiting from their clients' losses. This raised questions about their 'clients come first' motto. Although Goldman claimed its investors were sophisticated, revelations showed German bank IKB, a significant buyer of subprime products, was highly naive. In July 2007, IKB became the first bank to fail due to its subprime holdings, signaling the broader crisis.
By early 2008, it was clear the problem was far larger than anticipated. A broad misperception of risk and the belief that housing prices would not decline nationally proved catastrophically wrong. Confusion reigned at banks like Citigroup, which unwittingly took back risks they had previously offloaded. The credit default swaps, meant to transfer risk, failed when the insurer, AIG, was on the hook for $440 billion and could not pay. AIG's lack of disclosure about its vast CDS holdings left other banks unaware of the systemic risk. The idea of credit default swaps, initially meant to reduce risk, morphed into a 'Frankenstein monster' that spun out of control, causing a global financial nuclear holocaust. The crisis, driven by a few dominant institutions' mismanagement and greed, led to massive taxpayer bailouts and continues to devastate communities with vacant and abandoned properties, particularly in areas like Georgia that were at the heart of the subprime crisis. The complex, global nature of these financial instruments means many properties are now in a 'no person's land,' a tangible consequence of Wall Street's unchecked greed.