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.
The quest for more mortgages to package led to the subprime market, which helped keep the housing bubble expanding—until it burst. Warnings of risks were met by assurances from Alan Greenspan, then the Federal Reserve chairman, and others that the smart, self-interested people would keep risks at bay. They didn’t, and here we are.
If you go back and read stories written over the past decade, you will find plenty of good reporting that pointed to emerging problems. The Economist warned in 2002, for instance, that “a housing bubble is more dangerous than a stockmarket bubble, because it is associated with more debt. A steep fall in house prices would harm the global economy far more than a slump in share prices.” And there were stories dating back to 1998 in The Wall Street Journal about Commodity Futures Trading Commissioner Brooksley Born’s warnings about risk in the unregulated over-the-counter derivatives markets and how her quest to regulate them was steamrolled.
Now that the economy is unraveling, there has been terrific forensic reporting, including This American Life’s brilliant radio segment “The Giant Pool of Money,” which took listeners through all the steps, from a U.S. marine facing foreclosure (his mortgage broker stated his income as $195,000 when it was actually about $37,000) to one of the companies that created CDOs. The New York Times contributed “The Reckoning,” a great explanatory series of articles that looked at pivotal events and players in the financial crisis.
Even if we couldn’t have nailed this story of a lifetime, many of us can think now of steps we wish we had taken. So the questions are: What can financial journalists learn from this, and what can we do better? What didn’t we see, and why didn’t we see it? And where should we have been looking?
First, some mitigating factors: while the problems that led to the current crisis were building, financial journalists had their hands full with other major stories. We were incredibly busy covering the fallout from the previous scandals, many of which involved cooking the books. There were trials and pleas all over the place: Enron, WorldCom, Tyco, HealthSouth, Adelphia, and Martha Stewart, just to name some of the more heavily covered legal proceedings. There were also stories to be done on the end of the tech bubble, the mutual-fund scandals, Richard Grasso’s departure from the New York Stock Exchange, fights between the regulators and Fannie Mae and Freddie Mac over accounting problems, concerns about the growth in consumer debt and leverage in the markets, and the growing role of sovereign wealth funds. The “Maestro,” Alan Greenspan, was handing over leadership of the Fed to Ben Bernanke. And then came rising interest rates. In Washington, we also had the downfall of the city’s oldest and most respected bank, the Riggs, which turned out to be cozying up to money-laundering dictators. On the regulatory front, there was the Sarbanes-Oxley Act, a law designed to make sure corporate financial reports were more reliable in the wake of so much accounting fraud, and the transfer of the chairmanship of the Securities and Exchange Commission from Donaldson to the more hands-off Christopher Cox.