Michael Lewis, the author of Liar’s Poker, delivers a blow by blow account of the final days of the subprime bubble, from the viewpoint of some people who not only predicted the collapse but managed to profit from it by shorting subprime derivatives. (via Tim Bray.)
Some of Lewis’s observations:
- He mentions the central role played by the bond rating agencies, who screwed up in a big way. Amoung other things Standard & Poors apparently relied on a computer model that did not take into account the possibilty that home prices might fall. Most of the institutional safeguards intended to keep something like this from happening relied on these agencies to give reliable ratings. Some sort of reform is probably needed to address the conflicts of interest that they face.
- He thinks the problem really started when investment banks first switched from partnerships to public corporations. A partner is personally liable for the firm’s debts and thus has strong incentives to make sure that it doesn’t take on insane levels of risk. A corporate executive knows that it’s the stockholders who bear the risk, and thus will be tempted to take big risks in order to earn big bonuses.