All the Devils Are Here

Over the past twenty years, a new genre of non-fiction seems to be emerging: the capitalism disaster post-mortem. It's the story of crashes, frauds, stunning cynicism, and unrestrained greed. We used to have an event a generation or so; now we're having them frequently enough that the books for one event scarcely lose their popularity before there's something new to write about.

The king of the genre is Michael Lewis, at both book length and in shorter articles. But Bethany McLean has already earned her credentials in it: The Smartest Guys in the Room, co-written with Peter Elkind, is by far the best book on the Enron fraud and subsequent collapse. The collapse of the housing bubble followed by the near lock-up of the world's financial system has already spawned shelves full of books, and I'm eagerly awaiting a chance to read Michael Lewis's The Big Short, but when I saw McLean and Nocera on Charlie Rose talking about their book about the mortgage debacle, I had to pick it up right away.

It's sad that the best investigative journalism being published today seems to have to wait for a book publishing cycle or at best is published as a post-mortem in one of the longer news magazines, well after the fact, rather than published while things are happening and it could do more direct good. But at least it's being published, and All the Devils Are Here is an excellent example of its kind. It's a thorough, comprehensive survey of the people and organizations who built the housing bubble and runaway speculative crisis, covering the industry from mortgage originators through banks, Fannie and Freddie, Wall Street derivatives dealers, and investors.

McLean and Nocera thoroughly skewer the completely false idea that Fannie, Freddie, or government affordable housing policies were responsible for the mortgage bubble and the surfeit of bad loans. But they don't, by any stretch, do this by defending Fannie and Freddie. A large section of the book is devoted to documenting in some detail Fannie's aggressive lobbying of Congress, their arrogant and entitled way of handling their business, their complete capture and destruction of their regulatory oversight, and their ability to manipulate the US government into never criticizing them. (Freddie plays little role in the story; one gets the impression that they mostly followed on the coattails of their larger sibling.) But none of that had to do with subprime mortgages, and very little of it had to do with affordable housing. The story of the housing bubble is one with multiple competing villains and very few heroes.

After laying out the background of Fannie and Freddie, plus the background of mortgage securitization, McLean and Nocera trace the beginnings of the subprime market through Wall Street's craving for more financial products and the desire of the banks to get in on the extremely profitable mortgage securitization process without competing directly with Fannie and Freddie. Due to their implicit government guarantee, Fannie and Freddie dominated the securitization of mortgages that met their standards. The banks and mortgage originators sold the mortgages to them, and they took much of the profit. In the quest to make more money and not have to compete with Fannie and Freddie, subprime was perfect. Not only were the mortgages riskier, and hence more profitable, but Fannie and Freddie wouldn't touch them, so the banks could securitize and sell them directly and keep all the profits for themselves. It's only much later, when Fannie was seeing its market share and profit margins collapse because subprime had become so much of the mortgage business, that it entered the subprime world, trying to play catch-up to the banks and mortgage companies.

McLean and Nocera also make short work of the theory that the mortgage crisis had anything to do with affordable housing or government mandates to provide more housing to low-income Americans. Fannie and Freddie did end up playing games to meet higher requirements from Congress on loaning to low-income Americans, but that was late in the game, and wasn't why they went into subprime. Nor did low-income housing have anything to do with what the banks were doing in the subprime mortgage business. Despite all the hype and media attention paid to people who supposedly bought houses they could never have afforded, the vast majority of subprime mortgages were refinances. The huge profits in subprime were largely driven by convincing existing home owners to take out new mortgages on properties they already owned, not by getting more people to buy houses.

This is only part of the story, of course, and McLean and Nocera cover many other angles as well. There's extensive treatment here of the securitization and rating process and of the mathematical games played to try to turn low-rated debt into higher-rated debt. Some companies played that game better than others; Goldman Sachs, for example, which has come out of this crisis as one of the most maligned, did much better than most investment banks because they were much smarter and much more aggressive about risk management. While some of their peer institutions were continuing to increase their exposure to mortgage-backed securities, Goldman was selling them short, making margin calls, and increasing their bets against the market (sometimes in questionably ethical ways, such as arranging deals for a client while simultaneously betting against the client's position without telling the client that Goldman thought the client's position was a sucker's bet). Some of the stories from the stupider companies are reminiscent of Enron: horrible internal communications, executives left on their own to run fiefdoms without effective oversight, and a complete lack of understanding of company-wide risk.

The villains throughout this book are the regulators, who were generally worse than useless, and Congress, who repeatedly failed to fund the regulators properly, caved to lobbying by Fannie and Wall Street firms, and attacked the few regulators who tried to do their jobs. The banks exploited this hole in search of profit, but mostly by combining greed and stupidity in exactly the way that a bank regulatory regime is supposed to prevent. Congress also failed to write reasonable legal frameworks for regulation, leaving companies free to shop from regulator to regulator. Some of the worst abuses were from mortgage originators who managed to slip into cracks in the system where they had no effective regulation whatsoever. And both the executive branch regulators and the Federal Reserve regulators under Greenspan not only let the companies do whatever they wished but argued for federal pre-emption in court to prevent state regulators and attorneys general from stepping in.

The main complaint that I have with this book is that it stops too soon: it covers the foundation of the crisis and its initial unwinding, but none of the subsequent emergency action by the US government, the TARP process, or anything that followed. I'm sure including that would have made a much longer book, but it's a fascinating and dramatic part of the story that feels sorely missing here. McLean and Nocera build the story up to its climax, but then don't cover the climax or denouement, leaving me feeling vaguely unsatisfied. I wish they'd continued the story through at least the beginning of 2009.

I was fairly well-informed about the most recent financial crisis going into this book, so unlike with The Smartest Guys in the Room, it didn't have the same appeal of discovery. But it's a thorough and very readable treatment on a solid factual foundation, just as good investigative journalism should be. Recommended to anyone with an interest in the facts of the financial crisis, particularly anyone who has been deceived by the claims that Fannie affordable housing goals or government housing policy (as opposed to regulatory policy) had much, if anything, to do with the housing boom and explosion of unanalyzed credit risk.

Rating: 8 out of 10

Reviewed: 2010-12-31