Why We Must Revisit The Fraud At The Center Of The 2008 Financial Crisis

This is part one in a two-part series on bank culture that encourages fraud.

We owe Michael Lewis and his book Liars Poker for familiarizing us with the coldly self-interested ethic at investment bank Solomon Partners in the 1980s — The period in which the collateralized debt obligation (the famous CDO) was born, and the firm in which it was conceived. Lewis left Solomon because he was convinced their wildly egocentric risk-taking culture would do itself in — and soon.

As it turned out, that self-centered, high-risk culture was not confined to Solomon; it would not bring disaster to an individual bank, but the entire global economic system, and not soon but some 20 years later.

After Lewis’s fears materialized in the near-global 2008 meltdown in far greater proportion than he had guessed, he gave a retrospective analysis repeating the dangerous ethic in investment banks for the New York Business Journal. Lewis tells that he wrote Liars Poker in the hope of persuading recent graduates from pursuing a career in the cold greed of investment banking, but to follow their dreams instead. To the contrary, he was inundated with requests for tips on how to get into the unethical easy money business that he described — just as the Wolf of Wall Street learned. In that movie, after a newspaper exposed his scam tactics, the Wolf thought his days of peddling junk stocks on naive customers were over. Also, to the contrary, in the next day scene, he was inundated by young men waiting outside his office to get in on the unethical and easy fast-buck schemes.

The sociopathic banker subculture that Lewis describes has its mechanism to ensure its survival by training, testing and selecting its members while eliminating the unsuitable ethical types.

Lewis gave a memorable example of the process. He was thrown a small fish, an Austrian banker who only had $20 million to invest on behalf of pensioners — too small to be of interest to anyone more senior. Lewis asked a seasoned trader for a safe recommendation and got “AT&T bonds.” The Austrian banker bit on the hook. As Solomon had a practice of announcing sales over the loudspeaker, Lewis immediately heard his praise, “Congratulations to Michael Lewis for selling $20million of our AT&T bonds.”

The “our” before “bonds” slapped Lewis in the face. He knew something was very wrong. He thought this customer was buying on the open market; if he was secretly buying from Solomon, the bonds were going to tank — and soon they did.

Lewis went to the trader to plead for help. The customer had a new child, a pregnant wife, and a mortgage and was going to get fired. The trader blew Lewis off with, “Who do you work for, him or Solomon?”

Lewis saw the play. He knew that screwing customers was a matter of investment banker pride, with its own term: jamming. Solomon could use its insider knowledge to dump its bad buys off on unsuspecting customers. If Lewis continued to whine about the unfairness, he would simply look a stupid mark taken in by a sharp trader — who could influence his bonus. Instead, he could keep face, pretend he knew all along, and was cooperatively jamming this client for the benefit of the firm. Lewis had to play the game. He passed.

And he learned another lesson. He tried an enlightened self-interest argument. If Solomon helped this customer, there would be more business in the future. It didn’t matter the trader advised. Bank customers really had no option. There would be another bank screwing someone who then would come to Solomon. This customer would go there. Lewis should remember the stockbrokers mantra ‘churn ’em and burn ’em’.

I am reminded of a story that circulated after World War II about a Nazi technique for training SS candidates. They were given a German shepherd pup to raise over their six-month special course. It even slept with the candidate in his bed. At the end, they were summoned into a room with their pet and ordered to snap its neck. If they even just hesitated, they were sent to the front line.

While the comparison is a little extreme, there is a haunting similarity. Once a candidate is made to knowingly do such a harmful act to another, a part of their conscience is darkened. It becomes much easier the next time.

Lewis’ insights are unique among commentators because so many of them tell us what they know only as outsiders. They have no actual experience in the banking world. However, there is another more experienced banker, an expert who was involved in CDO creation at a number of the large banks, such as Merrill Lynch and Goldman Sachs, and has written highly praised technical works on structured financial instruments such as CDOs and CDSs.

She is Janet Tavakoli, a former adjunct professor in the University of Chicago economics graduate department and a prolific author in her own right. Called the Cassandra of the Crisis, she, in my opinion, is one of the very few who actually understands the true cause of the 2008 meltdown— and why the attempts to resolve the financial system are superficial and ignore the root cause of the crisis. And being left untouched, it will likely cause another in which only the 99% will take the blow—again.

Perhaps the image of some leftist economist like Joseph Stiglitz rose in your mind. To the extreme contrary, Tavakoli is a staunch Republican and a Trump supporter. She is a lady who never softens a punch. She writes in words of outrage at the enormous fraud perpetrated by the banks on the global public and the lame analysis by all the mainstream commentators who, in her experienced opinion, don’t have the least understanding of the banking system, the CDO instrument and what was done prior to 2008.

In spite of her background in the CDO area, and her many attempts to draw voter and politician attention to the actual causes of the 2008 crisis before the meltdown, her opinion was, and is, ignored in favor of those with no actual experience in the banking world. Here is the description of her opinion from her website. Note the use of a certain word no other commentator of influence will use: Fraud.

“Ms. Tavakoli gave early warning in articles written for professional finance journals of hundreds of billions of dollars in fraud-riddled structured products that were wildly overrated by credit rating agencies.”

Most relevant to our topic, she published a collection of her articles warning pre-2008 about the serious level of fraud in the CDO market under the appropriate title: The New Robber Barons: How Bankers Created an International Oligarchy. Today’s bankers have a culture that greedily takes, like the Robber Barons of the Gilded Age, without adding anything of value to society.

More on how the investment banking business model changed to letting bankers speculate in the high-risk market using bank assets for their new sky-high personal bonuses in the section Betting Your Money here.

There is an excellent short summary of her unique and insightful analysis of the way the bankers scammed the public that has been perfectly/entirely ignored by the financial press in an interview here.

The usually gentle/reserved, soft-spoken governor of the Bank of England was forced to finally speak out against the unrecognized banker culture of entitlement to big salaries by any means. Part 2 of this series tells what he said and why he is right.

For more on the banking system follow Jan at https://medium.com/@JanWeir1 and on Twitter @JanWeirLaw.

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