Gillian Tett, an economics writer for the Financial Times, interviewed a bunch of people at JPMorgan and other banks in the wake of the Great Crash, and produced a book titled Fool’s Gold: The Inside Story of J.P. Morgan and How Wall St. Greed Corrupted Its Bold Dream and Created a Financial Catastrophe. Based on exclusive access to Jamie Dimon among others, Tett concludes that JPMorgan is a brilliant company that just got greedy. She advocates the rationale that forms the basis for the decision of President Obama not to prosecute banksters, that insufferable arrogance and greed aren’t crimes. Now, in a clear case of confirmation bias, Tett brings us a paper that investigates whether “mid-level managers in securitized finance were aware of the housing bubble and a looming crisis in 2004-2008 using their personal home transaction data”, which you can read here.
I assumed this paper was published in the Journal of Irreproducible Results, the Onion of Science. But no, this paper was published by two business school professors from the University of Michigan and one from Princeton, who apparently are quite serious. They looked at housing transactions of 400 investors and issuers who attended the 2006 American Securitization Forum, including “vice presidents, senior vice presidents, managing directors, and other non-executives who work at major investment houses and boutique firms”. The point was to see if these people made bad personal housing choices, on the ground that if they really thought the housing market would crash, they wouldn’t have bought, or they would have sold before the crash. No, really, that was the idea.
Here’s how the authors describe the motivation for the study.
Despite its simplicity, disagreement about whether Wall Street was fully aware of broad-based problems in housing has remained relatively unresolved, owing to the difficulty in disentangling behavior motivated by beliefs from behavior motivated by job incentives. P. 2
Or, you could phrase this like Tett does:
When American financiers were flogging subprime mortgages back in the credit boom, were they completely delusional? Or were they driven by cynicism and greed? Did they, in other words, know that the housing market was a bubble – or did they actually believe their own hype, even as the frenzy grew?
It is a question that armies of lawyers and prosecutors have asked in recent months, as the public flails around seeking a culprit to blame for the financial crisis. Unsurprisingly, many politicians and prosecutors have tended to err on the “greedy and cynical” side.
See, flailing public? You thought the problem was whether these people cheated investors. But no. Fraud isn’t a problem. The problem is whether they were a) delusional or b) greedy. This is the framing relied on by President Obama and his administration: if these people were cheating investors because they were crazy then that’s just fine, no jail for them; but if they were only greedy and cynical, well, that’s not fine, but still, no jail. Whether they cheated people is utterly irrelevant. The only question is their frame of mind when they were cheating people, and that only matters when it comes to finger-wagging. The cheating part is just fine.
The good professors inform us that there isn’t any evidence in the housing data that the cheats thought the market was going to crash, which I’m sure makes the defrauded investors feel better. These mid-level people in the securitization industry are the ones who knew what was in the due diligence reports from the likes of Clayton Holdings. They knew that the real estate mortgage-backed securities they were flogging were packed with mortgages that did not meet the guidelines stated in the offering materials. They couldn’t have been surprised when these RMBSs lost billions of dollars within a year of sale. Those sales increased the bonuses of the mid-level agents, enabling them to buy the big houses and second homes that form the basis of this paper. The professors are very interested in how those people felt while they were selling garbage.
The business professors are laboring under a delusion themselves, the rational agents hypothesis: “a rational agent is an agent which has clear preferences, models uncertainty via expected values, and always chooses to perform the action with the optimal expected outcome for itself from among all feasible actions”. That is just laughably silly, and no one actually believes it. Here’s how our professors hide the silly:
To the extent that homeowners have thick skin in their homes, they have maximum incentives to acquire information and make informed buying and selling decisions, even if they are subject to poorly designed incentives on the job.
They admit that there are other reasons why people buy houses, for example, consumption value, or getting kids into good schools. They miss all the other reasons people over-invest in houses, like showing off their wealth. They don’t ask if these people thought their properties were safe because there are plenty of rich people who would want the same homes. They ignore the role criminal prosecutions play in deterring fraudulent sales of securities. Other than that, the paper is mostly harmless.
Tett, on the other hand, finds confirmation of her theory that it’s all a matter of “groupthink and wishful thinking – not deliberate malevolence – that poses the biggest risk in finance.“ In her view, the securitization people were sweet decent people who thought they were doing investors a big favor by selling them garbage securities. Obama, Timothy Geithner, Eric Holder and Lanny Breuer all agree with Tett. And screw all those investors who lost billions.
Image: Ruined house, Penfield vicinity, Greene County, Georgia, circa 1936. 8×10 inch acetate negative by Frances Benjamin Johnston. From www.shorpy.com via Flickr.