Hello, and welcome to Investor’s Bookshelf. In this episode, I’ll be unpacking All the Devils Are Here: The Hidden History of the Financial Crisis.
I’ll take about thirty minutes to walk you through how the executives and employees of mortgage lenders, financial firms, and government regulators—driven by good old-fashioned greed—jointly touched off the 2008 subprime crisis.
I’m sure you still remember the financial tsunami unleashed by the 2008 subprime crisis. In that meltdown, none of Wall Street’s five big investment banks was spared: Lehman Brothers went bankrupt; Bear Stearns and Merrill Lynch were bought for bargain prices; and Goldman Sachs and Morgan Stanley became bank holding companies.
The crisis also forced the U.S. government to place the once high-flying mortgage giants Freddie Mac and Fannie Mae into conservatorship, and to commit over $170 billion to rescue what was then the world’s largest insurer—American International Group (AIG).
In short order, the crisis spread worldwide, battering financial markets in Europe and beyond. Greece was the first to confront a sovereign-debt crisis, followed in turn by Spain, Portugal, and Italy—casting a shadow that still lingers over the European continent.
So how did this ferocious subprime crisis come about, and who should be held responsible? In the aftermath, people advanced all kinds of answers. Some blamed the loan originators that perpetrated wholesale fraud; others pointed to the overzealous financial innovation of Wall Street firms; still others argued that government monetary policy and supervisory structures were the real culprits. Each camp had its say, leaving the truth even murkier. But one perspective was largely overlooked: human nature.
After a deep investigation, the authors found that the crisis did not happen by accident. Long before it spun out of control, there were plenty of warnings and telltale signs—yet greed still drove people down a road of no return.
It was the frenzied pursuit of profit that led lenders to cheat, pushed “financial innovation” off the rails, moved ratings agencies to slap AAA labels on junk bonds against their better judgment, and left government watchdogs captured by the very institutions they were supposed to regulate.
“Hell is empty, and all the devils are here.” Borrowed from Shakespeare’s play The Tempest, the book’s title is also the authors’ explanation for the subprime crisis: greed in human nature rivals the devil himself—and that, they argue, is the deepest cause of disaster.
To get to the bottom of why the subprime crisis occurred, the two authors—journalists by trade—made full use of their reporting craft. They gathered information from many channels, poring over news stories, magazines, books, and academic papers, and mining testimony before the U.S. Senate and the Financial Crisis Inquiry Commission (FCIC).
Most impressively, they interviewed hundreds of people involved in the saga: executives and employees at Wall Street firms, mortgage originators, ratings agencies, AIG, Freddie Mac, and Fannie Mae; and officials at federal bodies such as the Treasury Department, the Federal Reserve, and the Office of the Comptroller of the Currency. They also spoke with community activists, legislators, lobbyists, and other grassroots figures.
From this wealth of sources, they excavated what they regard as the deepest root of the subprime crisis—human greed—and then threaded a series of vivid stories along a timeline, from the postwar boom in the mortgage market through the gestation and eruption of the subprime collapse, patiently laying out the crisis’s causes and consequences.
At this point you might ask: What exactly is “subprime,” and why did it trigger a crisis? In simple terms, “subprime” refers to loans made by lenders to people with poor credit or without the capacity to repay. The subprime crisis began when those borrowers defaulted.
But a handful of defaults would never have produced a catastrophe of this scale. The financial tsunami arose because Wall Street investment banks bundled tens of thousands of subprime loans together and then, on the back of those bundles, engineered a wide array of financial derivatives. In the process, the default risk embedded in subprime loans was repeatedly extracted, concentrated, and then shrouded—rather like refining and enriching uranium from relatively harmless ore until it yields the destructive force of an atomic bomb.
Why, then, make loans to people with bad credit? Because there was money to be made—indeed, when subprime first took off, everyone seemed able to profit.
What sounded like a “never-to-return” proposition—issuing high-risk subprime loans—was transmuted by Wall Street’s financial alchemy into high-yield securities that everyone scrambled to buy.
In the late 1990s and early 2000s, America’s subprime market appeared to be thriving: people with weak credit who couldn’t afford homes were able to move into houses of their own via subprime, realizing the American dream of “a home for everyone”; banks and mortgage companies, by selling loans to Wall Street, quickly recycled capital and booked profits; Wall Street financiers made a killing selling subprime-linked securities; and investors who bought them pocketed returns well above benchmark rates.
Just when nearly everyone believed housing prices wouldn’t fall and subprime securities were as reliable as U.S. Treasuries, the crisis struck like a blow to the head. As benchmark interest rates rose and subprime defaults stayed stubbornly high, Wall Street’s subprime products plunged in value. Financial institutions rushed to dump subprime securities and foreclosed homes, which only drove housing prices lower and amplified the panic selling of assets—ultimately triggering the subprime crisis.
Looking back, it was precisely because profits seemed available to all that greed became universal—and no one could wash their hands of it. In the book, by profiling the personalities and conduct of players across the subprime ecosystem, the authors sketch three archetypal “devils”: first, the mortgage companies that engaged in fraud; second, Wall Street financial institutions, blinded by lust for profit; and third, government agencies captured by money and power.
Next, we’ll look at how the leaders of these institutions, spurred by incentives, together set the subprime crisis in motion
Part One
First, let’s look at how the executives of mortgage companies, driven by greed, shoveled out subprime loans and, at the very root of the subprime supply chain, set the crisis in motion.
As their name suggests, mortgage companies make loans to homebuyers and then sell those loans—directly or indirectly—to Wall Street for profit.
In the 1990s, the federal government rolled out a national housing strategy advocating “innovation-driven financing to help homebuyers who lack cash or can’t meet down-payment requirements,” which effectively gave policy cover to a subprime mortgage market rife with irregular practices.
The authors’ reporting shows that many mortgage companies paraded under the high-minded banner of “putting more people in homes,” but what they truly cared about was profit—how to carve out a bigger slice of the subprime pie.
To maximize earnings, fraud and fakery became standard tools. Specifically, subprime lenders deceived borrowers on interest and sales charges, while deceiving investors about loan quality. In the scramble for market share, they descended into cutthroat competition, with disastrous results.
Deceiving borrowers meant luring customers with enticing but booby-trapped loan terms that steered them into paying steep interest and fees. For example, the book highlights First Alliance Mortgage Company, an early star of the subprime market, whose go-to business model was “deceptive sales.” Its salespeople knew next to nothing about mortgages; when pitching, they disclosed neither the loan principal nor the fact that interest rates would jump sharply after a time. Because higher “points” on fees brought fatter commissions, many sales staff charged borrowers more than twenty points; it was less salesmanship than outright extortion.
Beyond duping homebuyers, lenders also deceived the Wall Street firms that bought their loans—because once a subprime loan was sold, whether and how much the borrower repaid no longer mattered to the originator.
Former insiders told the authors they wrote zero-down loans with no income documentation; to dump these low-grade credits on Wall Street, they doctored credit reports, pay stubs, bank statements, and more. Look around the office, they said, and over half the employees were altering files; more than three-quarters were fabricating documents. Scissors, white-out, and glue were standard-issue for new hires.
Because most prime mortgage business was controlled by the government-sponsored enterprises Fannie Mae and Freddie Mac, private firms piled into subprime, and competition among lenders grew ever fiercer. In 2004, the largest subprime player, Ameriquest Mortgage Company, not only forged documents without scruple but even hired hackers to steal rival lenders’ borrower lists; loan officers would then cold-call those homeowners and tempt them into refinancing with lower teaser rates, so the company could collect yet more fees and mint new profits. This practice did little to house the poor; it simply kept cash flowing to the firm.
In this mortgage market free-for-all, the phenomenon economists call “Gresham’s law” was on full display. Whenever one lender refused a borrower, that borrower could turn to subprime shops like Ameriquest that never said no—so the less scrupulous the lender, the bigger its market share.
To protect their turf, once-respectable lenders began copying Ameriquest’s playbook, including Countrywide Financial, which had once been the biggest of them all.
Countrywide’s founder, Angelo Mozilo, had long railed against the dangers of subprime and refused to touch it. But later in his career, his stance began to waver. Mozilo understood that low-quality subprime outfits had changed the rules of the game; refusing to go along risked putting his company out of business. In the end, Countrywide waded into subprime. To preserve the empire he had built—and to chase enormous profits—Mozilo chose to look the other way at the industry’s fraudulent, unethical practices.
The lure of profits was so great that even Fannie Mae and Freddie Mac—institutions with the public mission of “a home for every family”—couldn’t resist. Around 2005, they too joined the subprime feast, all in the name of “maximizing shareholder value.” By contrast, firms that held the line were vanishingly rare. The book recounts one banker who, once he grasped the risks, halted all subprime business and wrote off a newly purchased subprime software system worth hundreds of thousands of dollars. Over the next two years, he watched peers rake in millions, buy private jets and mansions, and turn him into an industry punchline. In the face of brutal competition and profit pressure, how many companies were willing to “stay clean while the world is muddy” and forgo easy riches?
To sum up: Chasing outsized profits, mortgage companies flocked to subprime, gouging borrowers with hefty fees while falsifying documents to dupe the buyers of those loans. In the heat of competition, compliant lenders risked being driven out by bad actors; ultimately, the rich rewards of subprime seduced them into defecting and embracing it. In the loan market, human greed was on full, unrestrained display.
Part Two
Having covered mortgage-company executives, let’s turn to how Wall Street investment banks and the rating agencies’ financiers helped precipitate the subprime crisis.
After the crisis, many tried to absolve Wall Street firms and the financial instruments they created—but were Wall Street’s bankers truly innocent? Absolutely not.
The authors portray Wall Street as teeming with brilliant, endlessly inventive players, yet their appetite for profit far outstripped that of the mortgage shops—and the damage they wrought was correspondingly greater. Compared with the mortgage companies’ crude document-forging with white-out and glue, Wall Street’s plundering of investors was far more concealed. Wall Street investment banks occupied the pivotal hub of the subprime chain: buying loans from mortgage originators to securitize, and then selling those securitized products to investors. At every step their greed was plain to see. The rating agencies that serviced Wall Street played the role of enabler for fees, taking a large slice of the securitization pie. Now we’ll tell this part of the story in more detail.
First, how did Wall Street and loan originators collude? As noted earlier, lenders doctored paperwork to get loans sold—but Wall Street willingly took those loans not because it was gullible, but because it was profitable. One investment-bank executive admitted that subprime loans yielded roughly six times the returns of prime loans; chasing profit, Wall Street not only bought such loans indiscriminately but actively encouraged originators to flood the market with more of them. For example, the First Alliance Mortgage Company—an early subprime star—received backing from Lehman Brothers.
In 1995 Lehman executives even instructed First Alliance in writing to “aggressively market to vulnerable borrowers.” When state attorneys general later accused First Alliance of fraud, Lehman had extended $150 million in financing to the company and helped sell $400 million of its subprime securities—transactions that proved highly profitable. After First Alliance collapsed in 2000, Lehman was fined $5 million for aiding fraudulent practices; relative to the gains from subprime sales, that fine amounted to little more than a slap on the wrist. To hit profit targets faster, some Wall Street firms acquired subprime lenders outright, and in some cases banking performance metrics effectively forced originators to become subprime shops.
Next: how did Wall Street hide risk and reap large fees through securitization? Three financial instruments deserve mention. The first is the mortgage-backed security (MBS), which Wall Street sliced into senior, mezzanine, and junior tranches—senior tranches often rated AAA and marketed to risk-averse institutions like pension funds, while the junior tranches offered the highest yields and the greatest risk. The advent of MBS opened the Pandora’s box of mortgage securitization and whetted Wall Street’s appetite for subprime paper.
The second instrument was the credit-default swap (CDS)—a risk-transfer contract that functions like insurance on a financial product, shifting credit exposure to counterparties willing to underwrite it. CDS structures were pioneered at J.P. Morgan (notably in work led by Blythe Masters) and let some otherwise unsafe subprime exposures appear to carry investment-grade protection.
The third invention is the collateralized debt obligation (CDO), which repackages the worst slices of mortgage-backed securities, slices them again into new tranches, and often buys insurance or uses other credit enhancements so that the top tranches can qualify for AAA ratings. Junior tranches could themselves be re-tranched—CDO-squared, CDO-cubed, and so on—meaning that junk could be repackaged into instruments that nonetheless received top ratings.
Armed with these three tools, and operating in a low-rate, lightly regulated climate, Wall Street produced a stream of high-yield AAA securities and minted enormous profits—the market for CDOs, for example, grew from roughly $69 billion in 2000 to about $500 billion in 2006. But those same instruments repeatedly amplified and obscured risk, so that when losses began to surface the entire structure toppled like dominoes. One might argue that the instruments themselves are neutral—but in the hands of avaricious Wall Street players they became a devastating weapon.
Finally, let’s examine how Wall Street firms—and Goldman Sachs in particular—deceived clients in the pursuit of profit. Long before the crisis hit, Goldman recognized that many subprime products were toxic and sought every means to strip them from its balance sheet, even at clients’ expense. The authors trace a cultural shift at Goldman that began after it went public in 1999: leaving behind a century of partnership culture and, with newly raised equity, pivoting from client-oriented advisory work toward capital-intensive trading. By 2004 trading accounted for some 75% of Goldman’s profits, while traditional investment banking shrank to about 6%. In trading, Goldman could act as broker-dealer, invest alongside clients with proprietary capital, or even compete against clients—roles that conferred a powerful informational edge, much like a casino dealer who can see players’ cards.
Goldman’s early code of conduct placed client interests first, but after the IPO the emphasis shifted to “shareholder value.” Serving clients became a means to financial ends rather than the ultimate purpose. At the crisis’s onset Goldman protected itself at all costs—aggressively selling high-default-probability synthetic CDOs to reluctant clients to move risk off its books, and in some cases shorting the very products it had sold to customers. These tactics left Goldman relatively unscathed financially, but the revelations of betting against clients and other ethically questionable behavior severely damaged its public standing. In 2008 Goldman shed its independent investment-bank charter to become a bank-holding company subject to more stringent government oversight—but public outrage persisted and helped fuel the “Occupy Wall Street” protests.
At this point you might ask: how could CDOs and other trash be rated AAA? The villains on Wall Street were not only the banks but also a second class of institutions—the credit-rating agencies—that, for fees, became complicit in the scheme. Take Moody’s, for instance. Founded with a reputation for rigor, Moody’s later shifted toward a “service the client” posture as ratings-business revenues swelled. Analysts who once feared the reputational damage of a mistaken rating came to fear more being fired for upsetting key clients. As structured-finance ratings grew, Moody’s profits ballooned and its incentive structure changed—helping explain why tens of thousands of subprime-linked securities received AAA grades before the collapse.
To summarize this section: driven by profit, Wall Street banks colluded with originators in fraud, engineered ever more complex and risky securitizations, and sold those products to clients by any means necessary; rating agencies such as Moody’s, chasing fees and market share, stamped many of those products with AAA labels and thus accelerated the market’s decay and collapse. The Wall Street devils’ actions cannot be separated from the greed at the core of human nature
Part Three
Finally, let’s examine how government officials, driven by greed, turned a blind eye to subprime risks and ultimately helped trigger the crisis.
From the preceding account, we can see that the subprime market was rife with destructive competition, that the market’s invisible hand had failed, and that the government waited until the crisis erupted before stepping in. Why weren’t corrective measures taken sooner? In truth, U.S. government officials were hardly less greedy than the lenders and financial firms: some were beholden to money, others intoxicated by power and status. Next, we’ll look separately at how those two kinds of greed produced official inaction.
First, the subprime industry used its huge profits to mount an aggressive lobbying effort that made it difficult to dislodge the sector’s entrenched interests. As is well known, corporate political donations are an important source of campaign funding in American elections; whoever controls the money can buy influence. After mortgage lenders accumulated vast incomes through fraud and other means, they used donations and lobbying to win protection from federal and state officials. For example, Ameriquest’s founder Roland Arnall and his company were major fundraisers and donors to Republican causes, raising and donating millions to President George W. Bush’s political efforts; Arnall was later nominated as U.S. ambassador to the Netherlands.
Those contributions satisfied officials’ funding needs and made the returns to the industry obvious: officials who pushed for tighter regulation of subprime were thwarted by mortgage-company lobbying and by federal banking regulators. When cities passed ordinances to rein in lending abuses, state-level officials often stepped in to declare municipal rules invalid. When state legislators proposed tougher oversight, not only did lenders and rating agencies line up with the bankers, but national regulators such as the Office of the Comptroller of the Currency also opposed loan restrictions.
Beyond money, government officials—especially senior appointees—were often motivated by another kind of greed: the pursuit of political advancement, which put many ill-suited people into regulatory posts. The authors argue that former Fed Chairman Alan Greenspan was one of the principal culprits behind the subprime crisis—not because he was venal, but because of his regulatory inaction.
The book notes that Greenspan’s libertarian instincts conflicted with the Fed’s supervisory mission, “but that did not stop him from serving in government.” When he was nominated Fed chair, Greenspan knew he was an “outsider hostile to most regulatory intervention,” yet he accepted the job. Once in office he focused on monetary policy and sent strong signals in favor of free markets, convinced that market forces could absorb financial risk. That stance both encouraged the financial industry to evade regulation and marginalized Fed officials who favored stronger oversight.
The authors recount a telling detail: a Fed governor once proposed bolstering oversight of subprime lending, but Greenspan ignored the suggestion and avoided the topic. Anyone who has worked in government understands that where leaders focus, so does institutional attention. Under Greenspan’s laissez-faire doctrine, economists who trusted market efficiencies became more influential at the Fed, while those who distrusted unfettered markets and championed regulation found themselves out of favor.
The book also highlights another key figure in the federal government who might have altered the course of events: Robert Rubin, Treasury Secretary under President Clinton. Rubin—formerly a partner at Goldman Sachs—was widely respected for his skills and temperament, and his rapid rise at Goldman did not provoke hostility among colleagues. Unlike Greenspan’s enthusiasm for synthetic CDOs and other derivatives, Rubin had worries about derivatives dating back to experiences in the 1980s when derivative trading spun out of control; with the authority of the Treasury portfolio, he might have been in a position to act.
Yet events did not unfold that way. Though Rubin harbored serious doubts about derivatives, he did not publicly break with Clinton-administration policy. In the 1997 inter-agency debates over regulating derivatives, he sided with most of the Federal Reserve and its allies and rejected the regulatory measures proposed by Brooksley Born, then-chair of the Commodity Futures Trading Commission.
Why did he do that? Some attribute it to personal friction—Born’s lack of political experience and confrontational style made her unpopular—but the authors suggest Rubin’s alignment was self-interested: dozens of Fed and Treasury officials, including Greenspan, supported a deregulatory stance, and siding with the prevailing view better served personal careers and interests. After leaving the Treasury, Rubin became a senior adviser at Citigroup with a compensation package reported to be many millions of dollars a year.
Conclusion
That concludes this episode’s analysis; let us now summarize how human greed swept through mortgage companies, Wall Street financial firms, and the U.S. government, and ultimately produced the subprime crisis.
First, in mortgage firms human greed was displayed in full force.
Chasing huge profits, lenders gouged borrowers with excessive fees on the one hand and falsified documents to deceive Wall Street on the other.
Facing the threat of being squeezed out by low-quality competitors and seduced by the lucrative returns of subprime business, formerly well-behaved firms defected one after another and embraced the unscrupulous practices of the subprime trade.
Second, various Wall Street financial institutions were driven by money to launch a frantic predation on investors.
Investment banks colluded with originators in fraud, engineered an array of high-risk securitizations, and used any means necessary to sell subprime bonds to clients, while rating agencies such as Moody’s acted as accomplices by slapping AAA labels on these securities to attract buyers—ultimately accelerating the deterioration and collapse of the subprime market.
Finally, out of greed, government officials chose to ignore subprime risks and waited until the crisis erupted before bailing out the markets.
Some officials were effectively captured by the industry’s political donations and became protectors of the subprime sector, while high-profile figures such as former Fed Chairman Alan Greenspan and former Treasury Secretary Robert Rubin pursued laissez-faire market doctrines and personal political goals—despite having opportunities to intervene, they opted to stand aside, sending the wrong signals to subordinate regulators.
Reviewing the historical details recounted by the authors, we see that because greed is a fundamental human “original sin,” the subprime crisis—though foreshadowed by many warning signs and perceived by numerous individuals and institutions—became unavoidable as participants from every corner of the system, lured by profits and power, flew headlong toward catastrophe.
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