Yves Smith on Why We Didn’t See the 2008 Crash Coming

Yves Smith. Photo: PBS

A decade now after the 2008 financial crisis, the cultural and psychological imprint that it left looks almost as deep as the one that followed the Great Depression. Its legacy includes a new radical politics on both the left and the right; epidemics of opioid abuse, suicides, and low birthrates; and widespread resentment, racial and gendered and otherwise, by those who felt especially left behind. This week, New York continues our retrospective on the crash and its aftermath by publishing interviews with some of those who were closest to the events. Here, Yves Smith, who worked at Goldman Sachs and McKinsey before starting Naked Capitalism, the blog that was a must-read financial chronicle of the crisis years, speaks about why so few people saw the crash coming and what makes her sick about the response to it.

Can you describe the economy before the recession and how we got there?
A lot of people tend to mischaracterize the crisis as a housing crisis. If it had merely been the inflated values of housing, we would not have had the whole panic we had in the fall of 2008. The financial system seizing up was the result of derivative debts that were piled on top of the housing debts and created synthetic exposures that were four to six times the amount of the real economy’s sub-prime debts. And a lot of those debts wound up being held by systemically important and fragile financial institutions like AIG, Citibank, UBS. Go down the list.

The longer version of why this happened is that you had deregulation that started all the way back in 1970, when the New York Stock Exchange ended its requirement that exchange members be partnerships. That was a very significant shift that hasn’t been noticed. And as a result of the interest-rate volatility in the 1980s, you had lots of deregulation of banks then, and you had the Federal Reserve’s decision not to regulate derivatives in the ’90s.

And so when you get to the 2000s, there’s a lot more risk. The system is kind of fundamentally unstable. Why was that perception not there?
Now, I wouldn’t say this was universally not recognized. But one of the reasons I started writing my blog in late 2006 was merely by being a finance-experienced person, reading the Financial Times and Bloomberg, you could see what was going on in the financial system was not being reported at all in The Wall Street Journal and the business section of the New York Times. The better-than-average finance person who thought they understood the markets was not getting the real story.

It was very clear reading the Financial Times that with every type of credit instrument the risk was underpriced. The risk was grossly underpriced so that investors and lenders were throwing money in all kinds of different markets at borrowers and not being paid enough for the risk. And that means you’re going to have lots of losses down the road.

Can you talk about what it was like going through that?
People forget how petrified everybody was at the time — in New York in particular. I knew lots of professional money managers who took huge amounts of cash out because they thought the financial system was going to collapse. So that gives you an idea of how bad it was at the time.

Across the board, how would you characterize the response?
One point that is often lost is the Bush administration courteously left $75 billion in the TARP for the Obama administration to use to pay for mortgage modifications, which they never used. Obama had an opportunity when he came in. The country was desperate and frightened. He could’ve done an FDR. He could’ve done almost anything. And yet, the die was cast when he appointed Timothy Geithner as his Treasury secretary. That was announced in mid-November. I mean, Obama is basically don’t-rock-the boat. He may be center-left on social issues, but he’s basically center-right on economic issues.

There was a critical meeting where Obama met with a bunch of senior bankers. And he said basically, “I’m all that’s standing between you and the pitchforks.” And that was when everybody knew he was going to be on their side. He made it official he was on the bankers side. And what really shocked me was in 2009, when the banks decided to pay their staff higher bonuses than they had gotten in 2007.

I lost it. The fact that they couldn’t even have the decency to tone it down for appearances’ sake and pay themselves less and rebuild their balance sheets … They’ve just been bailed out, and they slapped the public in the face. And they paid themselves even higher bonuses in 2010. They slapped the public in the face by taking the bailout money and then paying themselves even more than they’ve ever made.

While there were all these unnecessary foreclosures. There were 9 million foreclosures. Basically about a sixth of the houses with mortgages in the U.S. were foreclosed on. That’s just a stunning and disgraceful figure. And the reason it’s stunning and disgraceful is that before you had securitization, when a borrower got in trouble the mortgage borrower got in trouble.

I spoke with Matt Bruenig earlier, and he characterized the legacy of the recession as directly upward wealth change.
Trump is crowing about this 4.1 percent GDP growth, right? Yet if you look at the statistics, real worker wages have continued to be flat for this period. The crisis itself was the greatest looting of the public purse in history. The crisis itself was a huge wealth transfer. The Obama administration should have forced a lot more recognition of the losses. These losses were real. They should have forced more loan write-downs. And recognition of the loss to the financial system. And they should have had a huge stimulus to offset the downdraft of recognizing those losses. And in fact the Japanese, early in their crisis, they said the biggest mistake we made was not writing down the bad loans in the banking system. “Don’t repeat our mistake.”

And we did this in a more indirect manner by having the Fed engineer these super-low interest rates that were a transfer from savers to the financial system. Economist Ed Kane said that basically savers lost $300 billion in income a year. So that reduction of income right there, you see today. There’s a Wall Street Journal story about how pension funds are in crisis. There’s not a single mention of the fact that the zero-interest-rate policies are the reason why the pensions are in distress. All retirees and long-term savers, life insurance, they’re all in the same boat. It used to be that if you were a saver or an asset holder, you could get a decent positive return doing something not crazy. And the Fed took that away. The big reason the pensions are in crisis is because of the way we dealt with the crisis.

We have this fallacy that normal people should be able to save for retirement. If public pension funds, which can invest at the very lowest possible fees, can’t make this work, how is Joe Mom-and-Pop America gonna be able to do this? Again, it’s back to the stagnant worker wages. So, great, we’re not paying people enough, housing prices are very inflated. We’ve got this horrible medical system that costs way too much, and how are people supposed to put any money aside when their real estate and their rents and their health costs are going up?

Why do you think we have Trump? I mean, even though he did a big bait-and-switch, as we all know, there were a lot of people that lost their homes, their community wasn’t what it used to be, particularly if they lived in the Rust Belt. And then you have these people on the coast saying, “Oh, they should go get training. It’s disgusting.” I mean, let them eat cake is let them get training. What you hear from these coastal elites: People over 40, even over 35, are basically unhirable. Are you gonna train them? They’re gonna waste their time thinking they can get a new job? I mean, that’s just lunacy.

What have been some of the political ramifications of this?
I think the Republicans, because they’re sort of loud and proud, that’s the way they behave — it’s easier to point fingers at them. And in some sense they are more vocal proponents of bad ideology, but there’s this great tendency in politics and in business to present whatever was done as being terrific and successful when it wasn’t. This is one of my criticisms of the Obama administration, but now appears to be true of the Democratic Party generally, that they think the solution for every problem is better PR.

So it’s very disturbing, the lack of sort of real postmortems, of lessons learned, in any of that.

When you think about the present, it seems there’s an obvious connection between the crisis and the political moment today: Trump and politicians like Bernie Sanders or Alexandria Ocasio-Cortez. How would you characterize that through line?
It’s different forms of questioning the orthodoxy and neoliberal economics. We’ve had this paradigm, and the mainstream of both parties completely buys into this paradigm; they just have different flavors as to how they approach it. Even Elizabeth Warren disappointingly believes in this, how anything the market dictates is sacrosanct and shouldn’t be questioned when how markets function are completely determined by the rules you use to operate this market. And “free markets” in particular — and I see people use that all the time and I wanna throw up. Free markets is a completely incoherent idea, and yet you hear people say this all the time with absolutely seriousness.

I guess less and less so now with younger generations.
Oh, that’s right, with socialism now being a good word among young people. It’s cool to be a socialist if you’re young, I gather. Some of them saw their parents lose their homes. Some of them came of age, graduated from college in 2008, ’09, or ’10 and couldn’t get a job and had all that student debt. Their lived experience shows them that what they’re being told in the papers isn’t true.

*A version of this article appears in the August 6, 2018, issue of New York Magazine. Subscribe Now!

Yves Smith on Why We Didn’t See the 2008 Crash Coming