Reflection 42: It’s Not As Bad As You Think – It’s Worse

I thought that – after six plus decades of living, two careers, and innumerable experiences in both the public and private sectors – my capacity for surprise at the depth of our moral and intellectual corruption had played itself out. Then, I read Michael Lewis’ book, The Big Short: Inside the Doomsday Machine.

Lewis tells a story that we know all too well: The explosive growth and ultimate collapse of the subprime mortgage market, in 2008. When I started the book, I was reasonably well informed about most of the movable parts that led to this historic economic debacle. I also had a sense of the greed, herd mentality, and short-term mindsets that fueled it.

But Lewis provides an unusually vivid and detailed roadmap for how it all worked and, equally, for the attitudes and taken-for-granted ways of operating that made it possible. Knowing in a general way that something is corrupt and unseemly is one thing. Getting a blow by blow description of the many, many wildly corrupt choices that so many made, at so many different levels, is quite another.

One of the story’s most powerful lessons is the sheer depth and virulence of the manipulation and self-aggrandizement that seemed to be the unquestioned mindset of virtually every participant. This was no benign financial bubble, where a product (“dot com” companies, silver, tulips in 17th century Holland) caught fire and had its price driven up by irrational optimism and the market’s herd mentality.

In this case, really clever people used their enormous economic power, and an unbounded lust for outsized profits, to create a highly suspect product: Subprime mortgages. They then transformed them, through financial sleight-of-hand, into a blue chip seeming investments – triple A rated bonds – to be sold (and re-sold) to unsuspecting investors. The pay-off: Enormous fees for the corporate originators of the mortgages and bonds, and multi-million dollar salaries and bonuses.

Lewis’ story vividly illustrates the extent to which we have devolved into an atomistic, every person for himself society. The fate of our fellow citizens, the financial system, and the country – all of these are someone else’s problem. Indeed, even Lewis’ “heroes” – a handful of people who saw what was coming – were focused, not on its social consequences, but on how to “short” this ill conceived market in order to make their own financial killing (hence, the book’s title).


An aspect of Lewis’ narrative that graphically illustrates this larger pattern of pervasive, systemically engrained corruption involves the role of the rating agencies – Moody’s, Standard and Poor’s, and Fitch. These companies provide risk assessing “grades” for bonds and other financial products. And their importance is unquestioned. Indeed, many pension funds and other investors are limited by law or internal guidelines to “safe” Triple A rated investments.

One glaring problem with the system – one no one hides – is the fact that the investment banks pay the rating agencies to grade their bonds. A reasonably intelligent investor would, you would think, be concerned that the agencies might go easy on the people who pay their bills. But as Lewis explains, the structural problems go much deeper. And this is where his story – here and elsewhere – becomes revelatory.

In many respects, the mistakes of the rating agencies and banks were identical. Wanting to flog the money machine – rather than slow it down – no one, seemingly, thought to systematically examine the underlying mortgages. Instead, the prevailing belief was that the bonds’ diversity (the mortgages were drawn from all over the country), an ever-rising housing market, and other macro factors ensured their safety.

Because their sole reason for being is to assess risk, you would think the rating agencies would have gone farther. And, in fact, they did have “secret” formulas for assessing each offering’s risk. But, as Lewis points out, rating agencies are populated with people who can’t get jobs at Goldman Sachs and the other, sexier banks and hedge funds; people who, in terms of intelligence and drive, are typically overmatched.

So when it came to ensuring the quality of the bonds backed by subprime mortgage pools, here is what we, the public, were left with: Secret formulas crafted by relative lightweights – whose dedication was already compromised by their firms’ dependence on fees received from the very companies whose products they were rating.

And – no surprise here – the financial heavy weights at the investment banks systematically gamed the rating agencies so-called secret formulas. They quickly figured out their weaknesses, exploiting them so that lousy products could still get a Triple A rating.

In other words, bald cheating was routine and, indeed, was seen as smart, aggressive business. Never mind that the junk that flooded the system was sold to the investment banks’ own customers; people to whom, you would think, they felt at least some duty of loyalty and fair dealing.

To illustrate how this gaming process worked, Lewis describes one aspect of the rating agency’s formula: Their use of FICO scores to measure the credit worthiness of the borrowers who held the underlying mortgages. To earn a Triple A rating, the FICO scores of the borrowers, in the pool of mortgages being rated, had to average out to at least 515.

Quickly figuring this out, the investment bankers realized that no distinction was being made between a “thick” FICO score – based on years of credit history – and a “thin” one. So, they would bring the overall average up by finding borrowers with high FICO scores but no reliable credit history; a person, for example, who once got a credit card, paid the bill, and never bought on credit again. And rather that craft a portfolio of 515s, they further gamed the system by balancing the 400s (almost certain to default) with an equal number of 650s – thin or otherwise.

This cynical manipulation of the rating agencies and, in turn, the purchasers who relied upon them, is just one of many stories that Lewis tells. We also learn about CEOs who didn’t understand the markets their most profitable products were traded in; reckless and sociopathic traders who were rewarded with multi-million dollar bonuses; and a system where virtually every major player’s reflexive response to the market’s looming collapse was to hide the truth as long possible – so they could sell as many of their bad investments to others, including (with no apparent compunction) their own customers.

In short we are given an in-depth X-ray into a system where lying is routine, loyalty nonexistent, and profits the only measure of success. And, sad to say, the tepid reforms that have been passed in the aftermath of the market’s meltdown have done far too little to alter this culture.


Lewis’ story, by driving home the depth and pervasiveness of these behaviors, reminds us that reform efforts are far more challenging, today, than they were even 40 years ago. When a behavior becomes the norm, we lose our ability to view it as dysfunctional. That is why entire populations can embrace fascism (as in Germany and Italy); genocide (as in Rwanda or the Balkans); and countless, senseless wars throughout history.

My sense is that we have reached that point in business. Many smaller businesses continue to operate in the old fashioned way – offering good products at a fair price; treating employees and others with some modicum of respect. But as you move up the pyramid in terms of size, the qualities that Lewis describes are, increasingly, the unquestioned norm.

We live, after all, in a world where Donald Trump is celebrated media celebrity even as he sells his name to unscrupulous developers and a bogus university. So one very serious challenge we face, if we hope to make things better, is to remold our collective consciousness so that, once again, fraud, recklessness, negligence, self-dealing, price gouging, and so on are viewed as disreputable – and not as business as usual.

Lewis’ narrative is also a dramatic reminder that, as ordinary citizens, there is so much we don’t know. Being reminded of that fact, another important take away is the huge price we pay when our leaders temporize in their critiques – as they habitually do – when it is politically expedient.

When Bush invaded Iraq, for example, virtually every political leader went along with it because, given the country’s prevailing mood, it was the “smart” move. In that case, however, since the issues were clear and the arguments against readily available, the consequences were somewhat contained.

But the subprime mortgage crisis stands in stark contrast to Iraq. As Lewis’ detailed accounting vividly demonstrates, we ordinary citizens had virtually no ability to understand the crisis as it unfolded – or, even now, after the fact. In this case, our willingness to tolerate endemically cautious, politically driven leaders – leaders who refuse to lead – is even more dangerous. Given the unavoidable, and increasing complexity of the world in which we live, we desperately need leaders who will actively identify and explain problems – and, crucially, speak aggressively and fearlessly to power.