One day in June 2005, my colleague Nell Henderson and I hiked over to the Bond Market Association to get ourselves educated on collateralized debt obligations and related products. I was editing The Washington Post’s Wall Street coverage, and Nell was covering the Federal Reserve, and we both had a feeling this might be a corner of the market in which troubles could occur. A couple of hours later our heads were spinning, but at least we felt like we had a better sense of how some of these increasingly complicated financial instruments that were flooding the markets worked.
What we didn’t have was a story to write, or so we thought. What would we have said? That there is a rapidly growing, unregulated market in these things that might turn out to be pretty risky? We had been assured repeatedly all afternoon that the people who dealt in these products were constantly on guard, looking for risks and figuring out how to defuse them. But more than that, we both knew that there isn’t much appetite for speculative stories about complicated issues in most newsrooms. Once the crisis occurs, once you can quote government officials referring to credit-derivative obligations and credit-default swaps as “toxic assets,” it gets easier.
Still, I wish I had gone further and considered other options. I wish I had walked downstairs to where the Real Estate section was segregated from the rest of the business staff to find out more about the connection between the subprime loans they were writing about and these new types of securities. I wish I had learned back then, instead of in the course of writing this story, that the market for asset-backed securities, loans secured by mortgages or other debt, had grown by 45 percent the previous year, mostly because of loans backed by housing, and had surpassed the market for corporate debt for the first time in history. And I wish I had suggested a meeting of the real-estate staff, the reporters who covered the economy, and those who covered regulatory agencies, markets, and banks to explore the connections.
The retrospective me also would have wondered more about other areas of the economy that were unregulated. And I would have been more intellectually curious about why such a creature of Wall Street as Securities and Exchange Commissioner William H. Donaldson would feel so strongly that hedge funds needed to be registered, and would pursue doing so at his own political risk.
But even in hindsight, I think it would have taken a miracle for business journalists to have foreseen the current crisis in its magnitude and depth. Beat reporters saw the pieces of it, and columnists who took a broader view warned about the buildup of risk. But even those who predicted disaster, I think it’s fair to say, didn’t know how widespread it would become or how unprecedented the government’s reaction would be. A New York Times editorial warning in September 2006 that “in a market so vast and dynamic, everyone knows that if mortgage defaults should rise, damage could reverberate throughout the financial system,” probably didn’t leave many readers thinking seriously that two years later we might be talking about a second Great Depression.
Nonetheless, there are certainly lessons to be learned about how to change some structural and cultural biases that might have gotten in the way—including the segregated silos we sometimes fall into in our beats, and a bias against speculative “this trend could be dangerous” stories. It’s not as sexy to prevent disasters as it is to cover them, but maybe we should rethink that, and learn to view warnings and prevention as one of the most important parts of our jobs.
One of the biggest obstacles to understanding, however, was out of our control: it was the decision to let major financial markets full of new types of housing-related investments expand with little or no federal oversight. No regulation means no transparency. Reporters and investors alike were kept from seeing what was going on behind the curtain.
What happened? In short, mortgage lenders began to pool and sell mortgages to raise more money to lend. Then those pools morphed into more complex products, which transferred the risk further and further away from the original lender. The original mortgage pools got packaged with others into collateralized debt obligations (CDOs) or collateralized mortgage obligations (CMOs) and sliced into different levels of risk, graded by rating agencies as safer than they turned out to be. Financial institutions like aig then issued credit-default swaps as a way for players to insure against losses. At each stage, investors borrowed, piling more debt on a slender reed of equity.