There Are Idiots

Ezra riffs on an underlying theme of Michael Lewis's new book on the financial meltdown, The Big Short. He starts by referencing Larry Summers and goes on from there.

Larry Summers famously wrote -- but sadly, did not publish -- a paper that began with a timeless bit of wisdom: "THERE ARE IDIOTS," Summers said. "Look around." That paper was written decades ago. Maybe it's time to finally publish it. Particularly that second line.

Michael Lewis's latest book, “The Big Short,” is an attempt to explain the financial crisis, and in doing, it goes through correlation errors and collateralized debt obligations and mortgage fraud and all the other financial arcana the meltdown forced onto the front pages of our newspapers. But in the end, Lewis's explanation is simpler than all that: There were idiots. And no one was looking around.

The worst of the idiots were the ratings agencies: By slapping that "AAA" seal of approval on packages of bonds made from packages of subprime loans, they said those bonds were no riskier than treasury securities, which are considered virtually risk-free. In retrospect, their analytical mistake was almost comically ridiculous: They figured that each subprime mortgage was a unique little snowflake unto itself, and that what happened to one was irrelevant to what happened to others. Nice thought. In reality, when the teaser rates vanished and the loans revealed their true nature, they all went belly-up at the same time, for the same reason. The rating agencies' idiocy was the idiocy that made everyone else's idiocy possible, because it was what they all pointed to in justification.

But why were they justifying it? The downside risk turned out to be tremendous. And yet the big banks were full of idiots who were selling bonds based on mortgages they knew nothing about. They were run by idiots who were rolling in profits coming from underlings selling bonds based on mortgages they knew nothing about. As things began to go south, they started aggressively selling those packages of bonds to smaller investors who were also dumb to the nature of the underlying asset.

And you could drill down further. There were consumers buying into mortgages they didn't understand at prices that were too good to be true. There were regulators who refused to see the very excesses they were supposed to stop. There was a media that occasionally mentioned the odd divergence of housing prices from their historical norms but didn't see the enormity of the problem.