The most accessible and entertaining book about the 2008 financial meltdown was Michael Lewis’s The Big Short, which last year was made into a justly celebrated film. Lewis tells the stories of some of the few investors who got it right, and saw the crash coming. All were out of the mainstream, delved deeply into details as few others did, and made fortunes by betting against the supposedly booming market. They were successful precisely because they saw what almost no one else did.
There were some prominent public voices who also saw what was coming, but as an example of the prevailing consensus, years of dire predictions by Nouriel Roubini earned him the moniker Dr. Doom. Other prescient voices in the years before the collapse included Dean Baker, who was warning of a housing bubble, and Paul Krugman, who said its collapse could lead to a recession. George Soros spoke of a hard landing and the need to stoke demand. Joseph Stiglitz wrote of the greater macroeconomic dangers of unregulated but integrated markets. But in March 2007, Fed Chairman Ben Bernanke spoke for the majority of economic analysts by noting the slowing housing market and that it was hurting some in the subprime mortgage market, while nevertheless finding cause for assurance:
At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency.
Most people agreed. One prominent U.S. senator was not among them: Hillary Clinton.
In a March 2007 speech, Hillary Clinton said:
So when somebody tells you this subprime market thing is no big deal, or maybe, you know what, let the buyer beware, these folks signed on the dotted line, it's their responsibility. Ask them why the rate for all homeowners is so high. Because the economy is not supporting homeownership the way we need it to. And after all, in the absence of an alternative, the subprime market has opened the doors to millions of families and responsible lenders and the market are rightfully casting out some of the worst actors in the subprime industry. But the market will not address the millions of families trapped in unworkable mortgages, hounded by delinquency and facing the grim possibility of foreclosure.
Now there will always be risk, and we cannot absolve it and should not absolve homebuyers of his or her responsibility. But we should make the rules clear and level the playing field.
The subprime problems are now creating massive issues on Wall Street. It's a serious problem affecting our housing market and millions of hard working families.
So what are some of the things we need to do? We need to expand the role of the FHA to issue more mortgages at better rates to these homeowners. We need to give consumers more counseling and information, prevent families from being trapped in high interest loans with pre-payment penalties and in some cases, allow more breathing room from foreclosure. This market is clearly broken and if we don't fix it, it could threaten our entire housing market, which in turn would threaten our entire economy.
In the spring of 2007, the stock market and home prices were soaring, and the general consensus was that the economy was booming. Banks were lending to people who never before would have been able to afford to buy houses, and the easy money from refinancing gave them even more to spend. What these people didn’t understand—and what even many of the people lending them the money to buy or refinance those houses didn’t understand—was that it was all a scam. A pyramid game.
For years, banks had been packaging piles of mortgages to sell as bonds, called Mortgage Backed Securities. Investors were buying them at such a furious rate that banks had a multi-billion dollar incentive to write as many mortgages as possible. This led them to lower the standards of what qualified people for loan, until they were all but giving them away with no fees, no down payments, deferred payments, and absurdly low interest rates that would only balloon later.
As Andrew Ross Sorkin wrote in his definitive account of the crisis, Too Big To Fail:
At the height of the housing bubble, banks were eager to make home loans to nearly anyone capable of signing on the dotted line. With no documentation a prospective buyer could claim a six-figure salary and walk out of a bank with a $500,000 mortgage, topping it off a month later with a home equity line of credit. Naturally, home prices skyrocketed, and in the hottest real estate markets ordinary people turned into speculators, flipping homes and tapping home equity lines to buy SUVs and power boats.
At the time, Wall Street believed fervently that its new financial products—mortgages that had been sliced and diced, or “securitized”—had diluted, if not removed, the risk. Instead of holding onto a loan on their own, the banks split it up into individual pieces and sold those pieces to investors, collecting enormous fees in the process. But whatever might be said about bankers' behavior during the housing boom, it can't be denied that these institutions “ate their own cooking”—in fact, they gorged on it, buying mountains of mortgage-backed assets from one another.
But it was the new ultra-interconnectedness among the nation's financial institutions that posed the biggest risk of all. As a result of the banks owning various slices of these newfangled financial instruments, every firm was now dependent on the others—and many didn't even know it. If one fell, it could become a series of falling dominoes.
It was thought that when those rates did balloon, the hot housing market would guarantee that homeowners could just refinance at their homes’ new market values, giving them more money to spend. The only problem would be if the housing market stalled, home values fell, and people wouldn’t be able to refinance—and thus wouldn’t be able to make their mortgage payments after their interest rates popped. But that couldn’t happen. Almost everyone was sure of it. That multi-billion dollar bond market was built on it. Those mortgages and those bonds were thought to be so secure that billions more was invested in a form of insurance called Credit Default Swaps. But everyone was wrong. The housing market stalled. People couldn’t pay or refinance their mortgages. Tens of billions of dollars worth of bonds built on those mortgages, and on the insurance policies on those bonds built on those mortgages, became worthless. Iconic Wall Street firms collapsed, going bankrupt or being salvaged in fire sales.
Those Mortgage Backed Securities and Credit Default Swaps never should have been created and sold. Even worse, the banks and insurance companies that created and sold them, and that in many cases also bought them, didn’t have anything close to the cash reserves required to cover them once the market collapsed. But worst of all was that millions of people owned homes that they hadn’t understood they couldn’t afford. Millions of people lost those homes.
In September, Senator Clinton introduced the American Home Ownership Preservation Act of 2007:
Introduced in Senate (09/27/2007)
American Home Ownership Preservation Act of 2007 - Amends the Truth in Lending Act to require certain mortgage originators or lenders with primary responsibility for underwriting an assessment on a home mortgage loan to include a borrower's ability to repay certain associated costs.
Requires a mortgage broker to clearly disclose its relationship to the borrower.
Directs the federal banking agencies to establish a nationwide registry and database system in which all mortgage brokers in the United States must register.
Eliminates prepayment penalties for home mortgages.
Instructs the Secretary of the Department of Housing and Urban Development (HUD) to make grants to state governments and tribal organizations to assist: (1) programs established for foreclosure mitigation; and (2) housing trust funds supporting low- and moderate-income housing.
Amends the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 to direct the HUD Secretary to establish an annual goal for each government-sponsored enterprise to identify and assist homeowners at risk of default or foreclosure on their mortgage, but who would be able to stabilize the situation with fixed rate 30- or 40-year mortgages.
Authorizes appropriations for mortgage fraud enforcement and prosecution.
In November, she warned about derivatives, those complex financial instruments created by bundling and insuring those lousy mortgages, which triggered the financial crisis less than a year later:
Finally, we face new threats that neither the president nor federal regulators have adequately acknowledged or addressed. Take the risk of so-called derivatives and other new financial products that Wall Street is selling.
These products offer new opportunities for investors to diversify portfolios and protect themselves against certain risks. For example, a farmer here in Iowa who's worried about the price of corn could buy a derivative that increases in value when the price of corn falls, so regardless of what happens with his crop, he has a chance to break even.
But derivatives also create new risks. They can swing wildly in value. It isn't always clear who owns them or how much they are really worth. Owners don't always understand the risks, which is why even the investment banks that created them are losing billions of dollars on these derivatives. And the ripples are being felt from Wall Street to Main Street.
I believe in our markets, but markets work best when there is information flow. And a lot of these new financial products are not transparent. The market doesn't have enough information about them, and certainly buyers don't. Today, we need a sensible middle ground between heavy-handed regulation and a hands-off approach to a risk that can hurt the innocent, as well as the sophisticated buyer.
Think about that. While receiving a lot of campaign donations from many people who were working in the banking and financial services industries—for which she is now excoriated—Hillary Clinton nevertheless was warning of the risks inherent to the exact financial products that were driving those industries’ ridiculously obscene profits. Because lack of transparency was exactly what made those products so marketable.
And, finally, we need to start addressing the risks posed by derivatives and other complex financial products. You can't let Wall Street send the bill to your street with the bright ideas that just don't work out.
Derivatives and products like them are posing real risks to families, as Wall Street writes down tens of billions of dollars in investments. Companies are taking the loss of a billion here and a billion there simply because the securities they own are worth less than they thought.
So as president, I will move to establish the 21st-century oversight we need in a 21st-century global marketplace. I will call for an immediate review of these new investment products and for plans to make them more transparent.
Even most people working on Wall Street had no idea what was going on. That was why so many banks and investors were willing to take the bets against the market made by the visionary outsiders described in The Big Short. Those bets against the market seemed easy money to those betting on the market. And a regulatory review, oversight, and transparency were exactly what was needed. But there was none.
Derivatives packaged from lousy mortgages, further derivatives packaged out of the lousy packages of lousy mortgages, and insurance policies on all of them, were so poorly understood throughout the financial industry itself that the small number of people who did understand them were cashing in. They manipulated everyone else on Wall Street, from bankers to bond rating companies to investors, as well as millions of people on Main Street who owned homes they couldn’t afford. It was a massive Ponzi scheme, and it did inevitably crash the economy. And New York Sen. Hillary Clinton was warning about it and proposing to do something about it.
As Amy Chozik wrote in the New York Times a year ago:
It is easy to forget that for years, Mrs. Clinton weathered criticism that she was too liberal, the socialist foil to her husband’s centrist agenda. Economists in the Clinton administration referred to the first lady and her aides as “the Bolsheviks.”
In Mrs. Clinton’s 2008 presidential campaign, she positioned herself as the populist candidate to the left of Barack Obama on several economic issues, angering some of her Wall Street donors and earning broad support among organized labor and working-class voters.
Advisers have lists at the ready outlining Mrs. Clinton’s calls as early as 2007 to eliminate the so-called carried interest loophole, roll back the Bush-era tax cuts for the wealthy, impose tighter regulations on derivatives and place limits on chief executives’ compensation.
And while she now is caricatured and demonized for having taken donations from an industry she actually proposed to regulate before the crash, she now is again proposing regulations that would prevent another one. It’s little wonder that so many who actually pay attention to the details of policy respect her proposals (particularly her focus not only on banks but also on broader markets such as insurers) and her capital requirements, which would force financial institutions to be able to cover the costs of their own risks. Those praising Clinton’s proposals include populist Sen. Sherrod Brown, the Roosevelt Institute’s Felicia Wong and Mike Konczal, Brandon Garrett, and Paul Krugman.
No one would pretend that Hillary Clinton is perfect, but she is a wonk’s wonk who understands policy to a degree rarely matched in modern politics. She identifies problems, delves into the details to understand them, and makes concrete proposals to fix them. She is caricatured because caricatures are easy and slogans are simplistic, but complex policy is neither—and neither is Hillary Clinton.