December 16, 2010
All the Devils Are Here
Posted by Usha Rodrigues

Bethany McLean and Joe Nocera's All the Devils Are Here gives a masterful postmortem of the financial crisis, detailing in particular the problems of subprime mortgage lending, credit default swaps, Goldman, Fannie and Freddie, and AIG, combining myriad stories into an immensely readable whole.  I'd already read McLean's The Smartest Guys in the Room and Nocera's Good Guys and Bad Guys: Behind the Scenes with the Saints and Scoundrels of American Business (and Everything in Between), and it was to the latter title that my mind kept returning. 

What makes the book such a compelling read is that the authors aren't shy about assigning blame.  Various traders, bankers, regulators, and CEOs are painted as voraciously greedy, naive, detached, venal, or wilfully blind.  Still, the authors end up in a much more nuanced place than the Inside Job, at least by Erik's account (although we do get some "righteous catharsis" along the way).  In the epilogue they answer--or at least acknowledge--David's question: Why aren't more bankers going to jail?  "[I]t is very hard to find the line between delusion, venality, and outright corruption.  Much of what took place in the crisis was immoral, unjust, craven, delusional behavior--but it wasn't criminal."  There are bad guys in the story, but they don't go to jail.  The good guys are largely Cassandras, cautionary voices that went unheeded, giving us at most a series of "what ifs". 

I'm left not with the tired questions of more regulation or less regulation, but instead with the problem of how to motivate the regulators to use the powers they already have to regulate.  McLean and Nocera conclude that regulators lacked the will to do their job.  How do we give them that will?  The bad guys' incentive to generate the exorbitant fees thrown off by the ever-changing devices of financial innovation--that's  concrete and oh-so-tangible.  Yes, please, I'll take a $20 million bonus, thank you very much!  Arrayed on their side are lobbyists who make their living making the case to legislators that innovation increases liquidity and risk is under control.

What of our good guy regulators?  If Paulson-like, they step into avert a runaway train already in progress, sure they get some glory. But which regulator has ever been lauded, let alone financially rewarded, for stopping a gravy train before it runs away?  I haven't been watching financial cycles all that long, but it's not hard to see the pattern: financial innovation and attendant wealth creation, pressure on regulators, lax regulation, crisis, intense regulation, financial innovation and attendant wealth creation.  Lather, rinse, repeat.  We want regulators to be like Odysseus, resistant to the siren call of Wall Street.  But All the Devils Are Here details many individuals who tried to address problems in subprime lending, in the derivatives market, in banks, at Fannie Mae.  They were ridiculed, bulldozed, ignored.  The Cassandrian pleasures of "See, I told you so" are pretty meager on the one hand.  But on the other hand, even if they'd succeeded, the only reward they'd get is that of a job well done. 

I don't have any answers to this puzzle.  It just seems to me the incentives are all out of whack. 

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