Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon

Most books about major business events tend to focus on the most recent activity, to concentrate on consequences rather than causes, and to emphasize the perpetrators’ personalities more than their background, casual forces, and motivations.

Reckless Endangerment is not like most books. The author’s style is straightforward, nearly dispassionate, stacking incident on top of incident, adding fact upon the growing fact pyramid, providing an ever-growing list of acts of malfeasance. The cumulative, affect is analogous to a frog being boiled to death from water whose temperature is slowly, almost imperceptibly increased over time. Instead of focusing on the aftermath of the mortgage crisis or even its most visible evidence in 2008, Reckless Endangerment devotes only a few pages to what occurred in 2008 or even 2007. Rather, the authors investigations take them up river to the sources of the problems. In their exploration, they exploring the intersection of the personal agendas, initiatives, and decisions of certain key personalities in the 1990s and how they influenced and shaped the motivation for their subsequent conduct.

A particularly important contribution of this book is the top-down, macro policy, meta force, strategic analysis of the role of different participants. In telling the story, the authors concentrate on three major players, including the Federal National Mortgage Association (FNMA), aka Fannie, which quasi-public/private enterprise emerges as the primary culprit and ultimately dominant guilty party; Goldman Sachs, the investment bank, whose former CEO Henry Paulsen presided over massive financial transfers of wealth from the public treasury to the extraordinary disproportionate benefit of his former firm; and Countrywide Mortgage, an originator of mortgages that emerged to be the most dominant and, ultimately, most destructive of all of the market participants. These three players—representing, respectively, investors in housing finance, investment bankers packaging mortgage loans into mortgage-backed securities, and mortgage originators were joined by Washington policymakers, and borrowers—all five parties unwittingly and unconsciously pursuing system destructive actions, that combined to cause the defiling and near destruction of the financial commons. The wrongdoings that are the subject of this searching study were made possible and ultimately aided and abetted by misguided and irresponsible public policy.

First, in the 1990s Fannie officials promoted to the Clinton Administration the idea that by liberalizing lending standards many households which heretofore had been precluded from owning houses, would be able to own them.

Next, the regulations governing allowable bank activities, specifically the Glass-Steigall Act, which precluded commercial banks from engaging in the more risky financing arrangements, that were long the province of investment banks, was repealed, to allow CitiBank to merge with the Traveller’s Group.

Then bank regulations were generally relaxed through less stringent bank capital requirements, enabling banks to leverage their balance sheets, engage in more and more aggressive borrowing. At the same time that the Federal policy makers deregulated and liberalized the regulatory regime governing the banking system, they tilted the overall system to bias big banks relative to small banks.

The effects of this deregulation were magnified by dramatic lowering of the Federal Funds rate, meaning that the banks could borrow money that would then be used for loans at even lower costs.

The effect of a lower interest rate is to reduce the cost of borrowing, thereby enabling the borrower for the same amount of debt service payments to borrow more money, making loans more affordable not only meaningfully expanded the mortgage financing markets, but as fees charged to borrowers are calculated as a function of the size of the mortgage loan. Larger mortgage loan sizes, in turn, leads to higher bank profits.

These policies disproportionately favored the big banks, which are most significant contributors to politicians’ campaigns and special interests. So far.

One of the most damning patterns reported by Ms. Morgenson and Mr. Rosner is the propensity of major financial institutions regulated by Washington to provide substantial incentives, benefits,and inducements to the very officials who were supposed to regulate them.

In 2003 Fannie CEO Franklin Raines proclaimed, “We are compulsive about managing risk.” Notwithstanding Fannie’s protests, it was found to be significantly undercapitalized, a condition that is the diametric antithesis of the premise of risk management, since strong capitalization is fundamental for an enterprise engaged in the business in which Fannie pursued.

Shortly thereafter its CEO Franklin Raines was forced out, as were various successor executives, until overwhelming mortgage losses led to takeover by the US Government.

Authors Gretchen Morgenson and Joshua Rosner describe their book as “an economic whodunit . . . investigating the origins of the financial crisis means shedding light on exceedingly dark corners in Washington and on Wall Street.” Though they assert that the understanding they seek “can keep anything like it from happening again,” more than 300 pages later, their unhappy conclusion is the source of anything but optimism, as they write, “Will the debacle like the credit crisis of 2008 ever happen again? Most certainly because Congress decided against fixing the problem of too big too fail institutions when it had its chance.” Reckless Endangerment tells of the interplay of the government monopoly power without restraint of oversight. Our most important financial institutions evolved into enterprises in which political skill trumped risk sophistication, enabling the anomaly of lavish corporate lifestyle, perks, and executive rewards, all cloaked in the pretense of public purpose.