Howard Darmstadter: The Boy in the Bubble
“The theory that there was a systemic fraud against homebuyers always depended on a major implausibility—that you can have a successful business model based on lending large amounts of money to people who can’t pay you back.”
~ Howard Darmstadte
But, Howard, that is exactly what they created…
The Boy in the Bubble
Did widespread fraud really drive the housing crisis? This former Citigroup employee was inside the bubble when it popped.
In the financial crisis of 2008, I lost my job at Citigroup. Thousands of other people in the financial services industry, and millions outside it, also lost their jobs, but, in my case, unemployment might appear an appropriate punishment for my sins. From 2000 until my ejection from Citigroup, I wrote prospectuses and other documents for mortgage-backed securities (MBS) issuances by CitiMortgage, a Citigroup subsidiary. The received history of the financial crisis casts MBS as the major villain, which would make me a villain-enabler.
Renewed attention to the causes of the financial crisis has been sparked by the film The Big Short, adapted from Michael Lewis’s 2010 book The Big Short: Inside the Doomsday Machine, as well as by candidate Bernie Sanders inveighing against all things Wall Street. The book, the movie, and the candidate all assert or imply that the financial crisis was largely propelled by fraud.
In the book, the word “fraud” appears 19 times, “corrupt” and its cognates 11 times, and “criminal” four times. I haven’t been able to check the full movie, but the two-minute trailer manages to use “fraud” three times (and “shady” once), beginning with “When the banks committed the greatest fraud in U.S. history ….”
Many critics have bought the story. Thus, A.O. Scott reviewing the film in The New York Times: “I don’t condone mob violence and I’m supposed to keep my political opinions to myself, but as soon as I’m done writing this I’m going out to the garage to look for a pitchfork,” and then “There is no happy ending to this story, no punishment for the crime.”
The Big Short retails two standard allegations of systemic fraud. First, it argues that lenders issued mortgages to people whom they knew could not afford them. Second, The Big Short alleges that the various financial instruments structured from these mortgages—the MBS and “collateralized debt obligations” (CDOs)—were misrepresented to investors. A trio of economists for the Federal Reserve Banks of Boston and Atlanta have exploded most of these fraud-based theories, but it’s a mythology that fits in so well with popular predilections (the “Wall Street vs. Main Street” mantra) that it will probably never go away.
What nobody told the homebuyers, because hardly anyone believed it, was that the value of their homes would sink dramatically over the next few years. In the preceding years, there had been a huge run up in house prices, fueled by the mass belief that if you didn’t buy now, you’d be priced out in the future—a classic bubble-builder. Much of the 2008 crisis can be traced to this single misperception.