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Some Ramblings - Inside Job
By Srinivas Kanchibhotla
inside job

At some point during the housing bubble crisis, which triggered world wide recession, it was estimated that the percentage of homeowners who could no longer pay their mortgages and so willfully walked away from their contractual obligation was a WHOPPING 6%. How could that be? How could a mere 6% hold the world hostage by bringing the financial system to its knees essentially shutting the system down? What about the other 94%? Could they not cover for the bad debts of their home owning brethren? A more pertinent question, what has mortgage crisis in US got to do with the financial systems of the rest of the world? 'Inside Job' is an in depth investigation of what is probably a financial conspiracy of epic proportions that involved the worst of everything in a capitalistic economic system - practices, governance, policies and regulation. In the aftermath of the tornado, when the world is still busy picking up the pieces, let alone start rebuilding, it becomes amply clear how collective dereliction of duties and abnegation of responsibilities at the highest levels can allow unchecked human greed to decide and dictate its survival and thriving ways and means, at the expense of the rest of the world, quite literally. And when the blame game starts to find one person, one party, one policy responsible for this horrid mess, the people at the top come together breaking ranks and party lines in a show of camaraderie and protect their flock, making sure that the most they got for ruining systems and lives is a little wrap on the wrists. But aren't those 6% contract breakers the real villains here, felling the first domino? Why blame the 'poor' Wall Street? And the rabbit-hole gets bigger, deeper and wider as the documentary turns its focus on all the key players in the conspiracy - bankers (investment and commercial), politicians, government regulators and even the academicians.

During the 80s, at the height of Reagan era deregulation/pro-market policies (who in fact (in)famously remarked, that government is not the solution to the problem, government is the problem), government oversight and regulation got handed its first defeat at the hands of intense lobbying of Wall Street's financial firms, which resulted in the merger of commercial and investment banks. So what's wrong with that, aren't both of them banks anyway? Simple, commercial banks which made its living by lending out the same money that people saved in their institutions went a step further and donned the role of a broker by betting (though it is termed quite misleadingly as investing) the money in the stock market for want of bigger and faster returns. It doesn't take a financial genius to predict the end result of such foolhardiness - Savings and Loans crisis, which brought down the banks and with them, the economy (and almost finished the career of the then Presidential hopeful senator who went by name of John McCain). One would imagine that the powers that be took a notice or two from the devastating effects and refrain from heading the same path with impunity again. Mark Twain once said, history does not repeat, it rhymes. So, not the same exact crisis, but a similar one, and with even more devastation the next time around. This time it was Mr. Clinton's time in the 90's. Buoyed by the economic success brought about by the technological and internet revolution, the government, at the behest of pandering politicians, relaxed the rules on owning a house, dubbing it as the ultimate realization of the American dream. And Wall Street, which was just dusting up falling hard on its face propping up facile internet companies and contributing to the dot-com bubble, found a new muse. Right up till that point, the Street, rightly or wrongly, speculated on real ideas, practices and innovations, be it in manufacturing, commodities and even internet. The crash of internet hit Wall Street firms, which by then got accustomed to double-digit growths and triple-digit index soars, hard. So how would the Street start marketing the oldest commodity in the world, land, in a new way to earn the same insane ROI's as the internet stocks delivered?

In hindsight, all the conditions were set right for the perfect storm - Wall Street still had some money to play around, after the internet crash and burn, and the real estate market was just steaming up, thanks to non-existent standards in lending practices and due diligence. Again conventional wisdom states that, bad economy or otherwise, if one can no longer a mortgage, the lending institution which owns the mortgage would evict the owner, take possession of the home, and put it back on the market and cover its losses. Right? WRONG. And here is where Wall Street should either be roundly applauded for its innovation or soundly vilified for its greed. Instead of letting the mortgage stay with the lending institution (bank), which in fact put up the money for the home in the first place, the geniuses at the financial firms figured a way of splitting the mortgage up and sell it as just any other stock in the market, essentially spreading the risk around, in case the mortgage failed. The practice was named, quite ironically, securitization. In this system of spread bets, no one institution owned up all the risks. The lending institutions opened up the flood gates on mortgage applications pairing people and houses, without checking any antecedents, as they washed their hands off them anyway, once the paperwork is finalized. No income, no problem, no job, not an issue, bad credit, just the right candidate. Sign here, here and initial there. That's all it took to own a home, the ability to sign at areas marked X. The financial firms then took those mortgages, sliced them up and put them up for sale on the trading floor. So what's in it for the lending and the financial firms, signing up as many people as they can attract? Commissions and fees. The mantra is simple - sign up by the hundreds of thousands and rake in billions.

But a question arises, when not all mortgages are created equal, how would an investor on the trading floor differentiate between a risky mortgage (signed by a near delinquent) to a relatively safe one (backed by one with a stable job). And the net widens, implicating the next player - rating agencies. These agencies, which are the final frontier in regulation, were supposed to investigate the inherent risks of the sliced and the bundled mortgages (called Collateral Debt Obligations - CDOs) and award ratings accordingly - AAA, safest for investment....down to DD (very risky) - which could affect their investment prospects. So where does conspiracy come in here? These rating agencies were paid by the financial firms into awarding stellar ratings even to substandard CDOs, just to push them out of the door and into the throats of the unwitting investors, as fast as they could bundle them up. The more CDOs the agencies rated, the more money they made in fees. So technically, when the mortgages went bad and people (those 6%) walked away from their homes, only the investors who bought those bad stocks should be affected. Why was the whole economy taken down? The risk taking didn't end there. Insurance companies were brought in the mix to hedge against those risks. Through another nefarious collusion of Wall Street and insurance companies, a new insurance instrument, called Credit Default Swap (CDS) was created, which acted like an insurance policy against those CDOs. So if the CDOs went bad, the firms which took CDS against the CDOs that they held and traded got paid. Standard operating procedure? WRONG AGAIN.

These are special insurance instruments, where one can bet (insure) for and against the same stock. So if the financial firm took out two insurance policies against the same CDO, one, for when the CDO went bad, and the other, betting that the CDO would indeed go bad, they got paid either way (Heads I win, tails you lose). But why would any insurance company, in its right mind, accept such a bargain, where it is bound in both the scenarios. One, the delusional hope that economy would never go bad and those mortgages would never fail and so would never have to pay those policies, and second, even more important, fees (premiums) on the mind-boggling volume. In the end, it was the volume that killed it all. It was the volume that incentivized such a risk tasking from the lending institutions to the financial firms, from the commercial banks to the insurance companies, that no one could say no to the millions and billions that poured it with little effort. And even more mind numbing fact about the CDS is that, ANYBODY, not just the holders of the CDO's, could bet against those financial instruments. With this last puzzle in place, the trading floor essentially became one giant casino, where anybody could bet on anything for any amount, with the little difference that the house made money, immaterial of a win or a loss. And then the economy tanked.

The free fall of investment banks, commercial banks, insurance companies, the employee pension funds that invested in the CDO's based on their stellar ratings, mutual funds, just about any stock that is even remotely connected to real estate, and with them the global economy that bet big on American real estate and stock market, gave a terrifying glimpse of how interconnected the system and how literal the figurative saying, about a flapping butterfly in Hawaii bringing about a tornado in Taiwan, was. The near bankrupt investment banks that bought, held and traded worthless CDOs made a run on the insurance firms trying to collect their amounts for failed CDOs. The risk for insurance companies soon turned for arithmetic to geometric, and from geometric to exponential in a matter of a couple of days, having gleefully accepted bets (premiums) on the same items for both the outcomes. And there definitely wasn't enough money in the system that could cover all the bets for varying outcomes. And when it was time to pay the Piper, Chapter 11 bankruptcy became the quick refuge. All lending stopped, and insecurity and distrust ruled the roost.

Where do politicians figure in this maelstrom? First, having pulled out all the door-stops on regulation and oversight, which could have if not prevented at least minimized the effect of the fraud of this magnitude from ever being perpetrated, the politicians played, yet again, into the hands of the financial industry and announced trillions of dollars of tax-payers' money as immediate relief, (falsely) claiming that these financial and insurance institutions were 'too big to fail'. And where did a portion of the money go towards - millions of dollars in bonuses and walk away monies, for financial and insurance executives who essentially ran the economy to the ground and ruined millions of lives.

The documentary is aptly titled 'Inside Job' as it has been one, right from the start, making full use of the loopholes of the system, exploiting every one of its weaknesses (buying influence through campaign contributions, affecting legislation through lobbying, and the biggest of all, having the same financial heads from those same financial firms who made some of the ruinous decisions earlier, at all the key positions in the government, irrespective of which party was in power), and maneuvering the administrative machinery to nicely fall in step with the wild, ambitious and even treacherous goals and plans of the financial industry. In the end, 'Inside Job' is a heartburn, a tragedy, a cautionary tale, a searing take on the serious miscarriage of regulation and oversight, to make it all a MUST WATCH. The takeaways, among many other things, can even be the cynical outlook that capitalism has always been and will remain one of the rich, by the rich and for the rich and the influential.

Remember the story from the local lore about the 7 princes and 7 fish? And the reason for the un-dried fish ultimately ends up because of some unrelated little kid putting his hand deep inside the anthill where it didn't belong? Now, was it really those 6% who ruined it for everybody, or a fat-cat in a black suit (Dick Fuld, head of Lehman brothers, for example, who made $485 million dollars in the year of the crisis) who mucked up the system?

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This article is written by Srinivas Kanchibhotla
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