By Brian Summerfield, Online Editor, REALTOR® Magazine
Of all the books I’ve read that attempt to get at the central causes of the economic downturn, Matt Taibbi’s Griftopia (Spiegel & Grau, 2010) is the definitely the most vitriolic. It’s also the funniest, and the author’s humor and flair for language help push the reader through complicated, often depressing subject matter.
Interestingly, Taibbi draws many of the same conclusions about the financial meltdown of 2007-08 that Michael Lewis did in his book The Big Short — chiefly, that the system wasn’t brought to the brink by a few bad apples, but rather by extensive rot in the tree itself.
The main difference between his book and Lewis’ is that Taibbi covers a lot more ground. Whereas Lewis offers corresponding narratives of a handful of investors to explain why the financial system collapsed a few years ago, Taibbi focuses much more on the big picture, exploring complex business, political, and regulatory problems that have affected the U.S. economy for decades.
Taken together, these books can give anyone a comprehensible explanation of not just the recent financial crisis, but also how economic bubbles get inflated, then popped.
FROM THE BOOK: 5 LESSONS FOR REAL ESTATE
▪ Predatory lending is real: Although he generally doesn’t get into the impact of these macroeconomic issues on individuals, Taibbi does recount the interesting story of Eljon Williams. An African-American sheriff’s deputy from Dorchester, Mass., Williams owned a three-flat and rented out two stories. One day, he heard a “mortgage expert” on the radio talking about scams that targeted minority home buyers. Williams contacted this man, who then reviewed his mortgage and actually did find some irregular fees. Naturally, when Williams later sought to move up to a two-bedroom single-family home, he sought this individual’s help. However, despite Williams’ insistence on getting a fixed-rate loan, the man put him in an adjustable-rate mortgage. When Williams demanded an explanation after receiving a notice that his monthly payments were going up, the guy initially dodged inquiries, then disappeared. The reason Williams and so many other home buyers were put into ARMs, sometimes against their explicit wishes, was the fact that loan officers collected bigger fees on these loans than the standard, 30-year fixed mortgages.
▪ Credit scores can be artificially inflated: According to Taibbi, many borrowers during the housing boom were able to turbocharge their credit scores with a few tricks. An example he uses is a consumer taking out five credit cards with $5,000 limits and only maintaining a $100 balance on each. Now, that consumer is viewed as “very liquid” by FICO, and easily qualifies for a mortgage.
▪ Investment ratings can be artificially inflated too: In what Taibbi described as an “awesome piece of financial chicanery,” Wall Street was able to take BBB-rated mortgage-bond CDOs — that is, medium risk investments that are just above “junk” — and package them with other BBB CDOs to create a “CDO squared.” (CDO stands for collateralized debt obligation, which is basically a bundle of loans that’s divvied up for multiple layers of investment based on risk and reward.) These CDO-squared investments were then re-rated much higher, attracting cautious institutional investors from, for example, worker pension funds.
▪ The housing boom and bust was part of a pattern: It’s tempting to view the residential real estate bubble in isolation. And many observers do just that, pointing to loose mortgage lending standards and a political push for higher home ownership rates as unique elements in inflating that bubble. This isn’t completely wrong, but Taibbi argues that Wall Street manipulation is the common, unifying thread behind every boom and bust. In fact, right after the housing bubble had popped, another one was being inflated in commodities. Remember the high prices at the pump in 2008? That was due neither to Middle East unrest nor a reduction in global supply — common explanations at the time — but rather because of overly speculative trading in a traditionally stable market. And guess what? It’s happening again right now.
▪ No matter what, the banks always get paid: A big reason these bubbles come into being is the way incentives in the financial sector are set up. Right now, traders and banks on Wall Street make their money not on the performance of their investments, but on the investor capital they can attract to those investments. Taibbi compares their operations to that of a casino. “Investors are betting on oil futures, subprime mortgages, and Internet stocks, hoping for a quick score,” he writes. “In this scenario the major brokerages and investment banks play the role of the house. Just like real casinos, they always win in the end — regardless of which investments success or fail, they always take their cut in the form of fees and interest. Also just like real casinos, they only make more money as the number of gamblers increases: the more you play, the more they make.”
“When a bank falls short of the cash it needs to meet its reserve requirement, it can borrow cash either from the Fed or from the reserve accounts of other banks. The interest rate that bank has to pay to borrow that money is called the federal funds rate, and the Fed can manipulate it. When rates go up, borrowers are discouraged from taking out loans, and banks end up rolling back their lending. But when the Fed cuts the funds rate, banks are suddenly easily able to borrow the cash they need to meet their reserve requirements, which in turn dramatically impacts the amount of new loans they can issue, vastly increasing the money in the system.
“The upshot of all this is that the Fed has enormous power to create money both by injecting it directly into the system and by allowing private banks to create their own loans. If you have a productive economy and an efficient financial services industry that rapidly marries money to solid, job-creating business opportunities, that stimulative power of a central bank can be a great thing. But if the national economy is a casino and the financial services industry is turning one market after another into a Ponzi scheme, then frantically pumping new money into such a destructive system is madness, no different from lending money to wild-eyed gambling addicts on the Vegas strip …”
ABOUT THE AUTHOR
Matt Taibbi is a contributing editor for Rolling Stone and the author of four previous books, including the New York Times bestseller The Great Derangement. He lives in Jersey City, New Jersey.