Sunday, December 21, 2008

Chain of Blame

I just finished reading Chain of Blame by Paul Muolo and Mathew Padilla.  The subtitle, "How Wall Street Caused the Mortgage and Credit Crisis," summarizes nicely the premise of the book.  My interest in the book is professional in that it tells the story of the collapse of the industry in which I have worked the past 17 years.  It is also personal in that it heavily covers my employer for most of those years, Countrywide Financial, and its CEO Angelo Mozilo, my uncle.

Since the revelation of the high default rate of subprime loans two years ago, many articles have been written, and news stories aired attempting to describe how it happened.  With few exceptions I have found that reporters rarely understand the topic they are attempting to cover, and the seem little concerned about inaccuracies in their stories.  Typical to the nature of today's media and culture, they simply searched for a villian.  Countrywide, as the universe's largest mortgage lender, was an easy target.  With the benefit of hindsight, anyone, even a talking head, or a grandstanding politician can see that mortgage lenders (including Countrywide) made some poor business decisions that led to grave consequences.  But there is much more to the story.  There is a complex web of players which the authors describe in personal detail.  Muolo and Padillas's book does an admirable job of laying out a historical context to the crisis as well as connecting all of the players in the mortgage loan market.

Muolo and Padilla described how Wall Street firms view the securitization of mortgage loans (specifically subprime) as a tremendous revenue generator.  The quality of those mortgages was largely ignored by the rating agencies, and misunderstood by investors.  The lenders funded loans based largely on what Wall Street would buy rather than prudent risk analysis.  It was the decline in housing prices nationally that started the delinquencies of loans, and ultimately the collapse in the credit markets.

There are some inaccuracies in the book to be sure, but overall it was very thorough and informative.  I also recommend reading the Conde Nast Portfolio (December 2008 issue) article titled, "The End," by Michael Lewis.  In this article Lewis (also the author of Liar's Poker) blasts Wall Street firms for their role in the financial crisis.

Have a Merry Christmas!

Monday, December 15, 2008

A Scam Older than Ponzi

The longstanding Ponzi scheme of Bernard Madoff that was recently revealed has a lot of people talking.  All of the talk is for good reason.  People were shocked that such a high profile fixture of Wall Street could be running a scam that is older than Ponzi himself.

Most people are familiar with the term "Ponzi."  There are enough con-artists in the world that most people have come across a scam that involves paying old investors with funds acquired from new investors.  If you haven't been bilked by one yourself, you may know someone that has.  Being curious I looked up "Ponzi" on Wikipedia and found the father of the Ponzi scheme.  Charles Ponzi was an Italian immigrant who in 1920 bilked  investors out of millions in Boston in a much publicized scam involving the arbitrage of postal reply coupons and postage stamps.  Ponzi was not new to the business of scamming investors in 1920.  Years prior he worked in a bank in Montreal that had made some bad real estate investments.   The bank's owner, Luigi Zarossi, deceived depositors by paying interest with money from new depositors (  So Ponzi did not invent the Ponzi scheme, it was around long before he arrived.  I am certain that there are stories of Ponzis as old as human history itself.

So if the scam is nothing new, how did some of the smartest and wealthiest people in the country (and the world) get "ponzied" by Bernard Madoff?  Con-artists have existed throughout history, because it is human nature to believe what one wants to believe.  "I believe in him because will I benefit by believing in him," is not said aloud, but more likely is a conversation of the subconscious.  Madoff was a charismatic man who had a sterling reputation.  He created an image that made people to feel privileged to give him their money.  Never mind that his touted "returns" for investors over a 20 year period were incredibly unrealistic.  Investors even paid taxes on the returns that Madoff told them they earned.  When an investor wanted their money out, he paid them with a smile (and another investor's money).  He even turned away potential investors which improved his reputation.  It wasn't until he admitted that it was a multi-billion dollar Ponzi scheme that the story has now unravelled.  

What is our lesson from all this?  Is the answer to trust no one, ever?  I suppose that is the cynic's answer.  However that sounds like a miserable way to live life to me.  I prefer Ronald Reagan's philosophy of "trust but verify."  There are some that considered doing business with Madoff, but chose not to.  JP Morgan Chase declined to do business with him because they could not "reverse engineer" his methods (CNBC, Dec 15, 2008).  On the other hand, Madoff's clients assumed that he was much smarter than they were, so they would simply trust him.

While I have never been the victim of a Ponzi scheme (I certainly am not wealthy enough to be one of Madoff's clients), I have come across them.  More often though I have been directed what to believe by others that I believed to be smarter than me.  In my case it was the corporate Kool-Aid that was being served to me and other employees which I drank with enthusiasm.  The lesson I have learned from my experience is the same lesson Madoff's clients have learned, believe what you see and not what others tell you to believe.