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The biggest lie of the financial collapse
April 5

The biggest lie of the collapse of the financial industry is we can't understand it. It's supposedly so complex, only the Wall Street high rollers can figure it out, and they can't be bothered with the anger of the wee folk in the hinterlands, by which I mean those of us more than a couple blocks from Merrill Lynch HQ. Can we understand this stuff? Can I get a "Yes We Can!", because we can understand this stuff. It's not intuitive certainly, and a bit of homework is required, but please don't think for a second you have to take some CNBC pundit's word for anything.

So fellow wee folk, I hardly propose to explain everything about the banking crisis in a blog post, but I do propose to explain a couple terms you've have probably heard but not heard explained, just to prove that you can understand what's going on.

A collateralized debt obligation (CDO) is basically of bunch of debts bundled together. Instead of buying one mortgage, paying off the lender in exchange for the right to collect the balance, some companies bought a bunch of mortgages, stuck them together, and sold them as a CDO. Supposedly this reduced risk because whereas buying one mortgage meant losing the whole investment if the borrower couldn't pay and the house couldn't be sold, buying a CDO meant losing only a little of the investment if one mortgage went bad. Buyers could even buy pieces of CDOs, so they owned a fraction of many different debts. Great idea, provided almost all those mortgages were low risk, which is what buyers of CDOs assumed. However, the demand for CDOs meant lenders lent to riskier and riskier borrowers in order to generate the mortgages they resold, so the CDOs were full bad debts.

A credit default swap (CDS) is an insurance policy on a debt. Let's say you grant a mortgage but you have doubts the borrower will pay it off, or you buy corporate bonds but you have doubts the corporation will pay them off. You buy a CDS, and pay the insurer a premium, which obligates the insurer to pay back the debt if the debtor defaults. So when the corporation goes into bankruptcy and doesn't pay its bondholders, the bondholders go to the insurance company and ask for their money. This is great for the insurance company if almost all the debtors are good for it, and great for the CDS buyer if the debtor defaults. Of course, if lots of debtors default, as happened, and the insurer assumed it wouldn't have to pay off on many policies and didn't keep any cash on hand, as happened, there is a crisis.

One more concept if I may, but again you'll see you can understand this. You may have heard the term "naked" like in "naked CDS". It means basically making a bet without putting up any money. A naked CDS was purchased by someone who did not own that which they insured, so they would not lose their investment if a debt went bad, but they did hope to get paid off by the insurer. It would be as if we could buy fire insurance on someone else's house, perhaps thinking it was a firetrap that was likely to burn, so if it burns we get paid the value of the house, but if it doesn't, we lose our premiums. So we go to an insurance company to buy a policy on someone else's house, and they think it won't ever burn, and sell us the policy. Thinking this is easy money, they sell insurance on that house to ten people, even though, if it burns, they can pay off only one or two, which means they're insolvent, and all their policy holders suddenly have no insurance on their houses. You can see why this isn't be legal. It is legal with CDSs however.

So CDOs have gone bad in huge numbers, AIG can't pay off more than a tiny fraction of the CDSs they sold on those CDOs, so CDS buyers can't get paid when their CDOs go bad, so their risk is suddenly much higher, and the greater risk makes their CDOs worth much less. Those counting the former value of their CDOs among their assets find they may not have enough assets to stay in business.

And yes, there's more to it than that. Much more; this was just the start. I never said it was easy, just comprehensible. So now comes the homework.

The best explanation of how the subprime mortgage market grew and blew up was broadcast on This American Life, The Giant Pool of Money. In fact, this American Life has been the single best source for understanding how the mortgage industry devolved into such a crisis. They followed that first program with Another Frightening Show About the Economy and Bad Bank. They have transcripts for those just not into audio, and MPR carries the program at 3 PM Saturday and 8 PM Sunday.

To understand just what AIG did to bring so much anger upon itself, read Matt Taibi's article at Rolling Stone, The Big Takeover. You'll get angry at what the people at the top of Wall Street were pulling and are pulling, but more important, you'll understand it. Then reward yourself with a treat: you knew something was wrong about AIG exec Jake DeSantis complaining of his bad treatment over his bonus, but it was hard to put your finger on it. Taibbi put his whole fist on it.

Feel free to send more useful explanations for laymen.

"To initiate a war of aggression, therefore, is not only an international crime; it is the supreme international crime differing only from other war crimes in that it contains within itself the accumulated evil of the whole."
US Supreme Court Justice Robert Jackson, who successfully prosecuted Nazis at Nuremberg for the crime of aggressive war, thereby establishing the precedent that starting a war is, in and of itself, a war crime.

"A refusal to look back inevitably means moving forward in blindness."
Philip Alston, the U.N. special rapporteur on extrajudicial executions, on the resistance of the Obama administration to investigating human rights abuses by the Bush administration.

"Why is it that strong women are so often called bullies and ballbreakers, while strong, opinionated men are often called, simply, Justice Scalia."
Salon editor Joan Walsh, on the bigoted attacks on Sonia Sotomayor already on the day of her announcement.

"In Minnesota, Secretary of State Mark Ritchie has made military ballot protection a key priority of his Department. The result is that twice as many military ballots are actually cast, and half as many are rejected, as the national average in 2006."
The National Defense Committee, in an article on their web site praising Minnesota's efforts to encourage absentee voting by military personnel stationed overseas.

"We're seeing massive resistance to the cramdown proposal. That's a proposal to allow bankruptcy judges to reschedule a mortgage on a primary residence. They're fighting this thing tooth and nail. Now the fact is, the people fighting it are the last people who should get the ear of anyone. And it goes to show me they haven't really learned any lessons. A lot of these folks--large banks, Wall Street firms--they have the attitude that "Heads I win, tails you lose." No matter what happens, we always get ours."
Rep. Keith Ellison, on how the bailed out banks are fighting against bankruptcy reform.

''Scores of banks failed in the Great Depression as a result of unsound banking practices, and their failure only deepened the crisis,. Glass-Steagall was intended to protect our financial system by insulating commercial banking from other forms of risk. It was one of several stabilizers designed to keep a similar tragedy from recurring. Now Congress is about to repeal that economic stabilizer without putting any comparable safeguard in its place.''
The late --- and correct --- Paul Wellstone, expressing opposition to repealing the law that prevented financial corporations from entering other types of financial business, like preventing commercial banks from becoming investment banks. This repeal was a large part of making the (collapsing) conglomerates possible.

"The facts revealed reflect the way the U.S. government has consistently tried to cover up the truth of Binyam Mohamed's torture. He was being told he would never leave Guantánamo Bay unless he promised never to discuss his torture, and never sue either the Americans or the British to force disclosure of his mistreatment."
Reprieve Director Clive Stafford Smith, speaking about a British court's ruling that the Bush administration tried to get Mohamed to plead guilty to something, anything, and keep quiet about his treatment as a condition of release.

"We spend hours and hours and hours arguing over $10 million amendments on the floor of the Senate, but there has been no discussion about who has been receiving this $3 trillion."
Sen. Bernie Sanders. I-VT, on the mostly unreported spending by the Federal Reserve to prop up the big financial corporations.

"The AIG scandal is significant and has resonated so powerfully because it is a microscope that enables the public to see what and who has wreaked the destruction that threatens their security and future and, most important of all, to realize that these practices haven't ended and the perpetrators haven't been punished. The opposite is true: those who caused the crisis continue to exert control over what happens and continue to have huge amounts of public money transferred in order to enrich them."
Glenn Greenwald, explaining why the AIG bonus scandal is both symbolic and important.

"Why are we talking about this in the White House? History will not judge this kindly."
Attorney General John Ashcroft, during a principals meeting about torture methods.

"There was no scientific consensus in the 1970s that the Earth was headed into an imminent ice age.

A review of the literature suggests that, to the contrary, greenhouse warming even then dominated scientists' thinking about the most important forces shaping Earth's climate on human time scales." Thomas Peterson of the National Climatic Data Center, who surveyed scientific research from 1965-1979 and showed that contrary to what climate change deniers keep asserting, there was no consensus on global cooling. That means the point that climate scientists must be wrong now because they were wrong then is itself based on a false assumption.

"We do not know where George Will is getting his information, but our data shows that on February 15, 1979, global sea ice area was 16.79 million sq. km and on February 15, 2009, global sea ice area was 15.45 million sq. km. Therefore, global sea ice levels are 1.34 million sq. km less in February 2009 than in February 1979. This decrease in sea ice area is roughly equal to the area of Texas, California, and Oklahoma combined.

It is disturbing that the Washington Post would publish such information without first checking the facts."
statement on the web site of University of Illinois' Arctic Climate Research Center, responding to an assertion by global warming denier George Will that they said sea ice area is the same as 1979.

"It has often and confidently been asserted, that man's origin can never be known. But ignorance more frequently begets confidence than does knowledge: it is those who know little, and not those who know much, who so positively assert that this or that problem will never be solved by science."
Charles Darwin, whose 200th birthday is coming up on February 12.

"The thing I like most is it says you can get these complex traits evolving by a combination of unlikely events. That's just what creationists say can't happen."
evolutionary biologist Jerry Coyne, commenting on an experiment that was able to observe a mutation that changed one species into another.



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This letter has been read by the acting president and approved as within his definition of national security.