Economist Viewpoint

Evil Wall Street

Evil Wall Street Exports Boomed With 'Fools' Born to Buy Debt

By Mark Pittman

(Bloomberg) -- Tom Bosh lowered the telephone receiver into its cradle, making a decision on the way down. "We're not buying any more," he told his traders at Bank of New York Co. "Nothing."

It was May 2007, and Bosh, who managed $25 billion from the bank's 13th-floor trading room above Times Square, had just hung up on Ralph Cioffi at Bear Stearns Cos. a dozen blocks away. Bosh had invested $50 million in notes from an issuer Cioffi controlled, and he was ready to pull the plug.

"I had a bad feeling," Bosh, 45, recalled. "Cioffi was just bulldogging everyone." He was saying, these assets are good, the collateral is paying down, and I know more than you. "That type of attitude."

Bosh's premonition, a month before two of Cioffi's funds blew up, struck a death knell for structured finance, the system Wall Street banks devised to fuel more than two decades of unprecedented borrowing. The system allowed financial companies to lend beyond their capacity and outside the reach of regulators -- until it crashed this year.

While the collapse was most visible in the stock markets, the cause was the loss of confidence in the world's biggest bond market, structured finance. So far, it has led to the worst financial crisis since the Great Depression, the disappearance or takeover of more than a dozen banks, including three storied Wall Street firms, and almost $3 trillion in government expenditures and guarantees to contain the contagion.

Biggest U.S. Export

The bundling of consumer loans and home mortgages into packages of securities -- a process known as securitization -- was the biggest U.S. export business of the 21st century. More than $27 trillion of these securities have been sold since 2001, according to the Securities Industry Financial Markets Association, an industry trade group. That's almost twice last year's U.S. gross domestic product of $13.8 trillion.

The growth over the past decade was made possible by overseas banks, which saw the profits U.S. financial institutions were making and coveted the made-in-America technology, much as consumers around the world craved other emblems of American ingenuity from Coca-Cola to Hollywood movies. Wall Street obliged, with disastrous results: two-thirds of a trillion dollars in bank losses, about 40 percent of them outside the U.S.

"Securitization was based on the premise that a fool was born every minute," Joseph Stiglitz, a professor of economics at Columbia University in New York, told a congressional committee on Oct. 21. "Globalization meant that there was a global landscape on which they could search for those fools -- and they found them everywhere."

Eager Adopters

European banks, in particular, were eager adopters. Securitizations in Europe increased almost six fold between 2000 and 2007, from 78 billion euros ($98 billion) to 453 billion euros, according to the European Securitization Forum, a trade organization.

Three Icelandic banks borrowed enough to buy $228 billion of assets, most of them securitizations, turning the country's financial system into a hedge fund. All three banks have been nationalized by the government, leading Prime Minister Geir Haarde to advise citizens to switch from finance to fishing.

In Germany, one bank, Landesbank Sachsen Girozentrale, bought $26 billion worth of subprime-backed investments, putting the state of Saxony on the hook for $4.1 billion.

In Japan, Mizuho Financial Group Inc., the nation's third- largest bank, acquired an entire structured-finance team, which proceeded to lose $6 billion issuing mortgage-backed securities.

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