You can accuse the Germans of many things, but not of being unmethodical nor of failing to master the facts. It was thus with a distinct chill I heard their Finance Minister a week ago smugly say that the financial markets meltdown was a US problem and wouldn’t affect Europe. This foreboding was reinforced as I listened to Angela Merkel yesterday on TV, when it became clear that she hadn’t a bulls notion about what was going on.
Unless something was, as the man said, lost in translation, she didn’t understand not even the basic concept of derivatives. Given that she heads the most powerful economy in Europe, and as she’s apparently a regu

lar reader of this blog, I have taken time out to explain some of the basic concepts underlying the disaster.
Now Angela, the underlying malaise, present all the way through, was
massive conflict of interest at all stages. The politicians stripped away regulatory constraints, the Republicans to see to their paymasters in Wall St. and to appease the frothing free market fundamentalists, while the Democrats gained by using it to enable minorities to buy houses they couldn’t afford. Conflict of interest
Leroy, resident under the bridge at 42nd St. is approached by mortgage huckster. “
Hi there. Would you mind putting away that meths bottle for a moment? Now – while this place is nice and central, the traffic overhead is a pain. How’d you like to own a palatial mansion in the Hamptons instead?”
“You would? Great. Just sign here, and the key is yours”
Thus was born the sub prime crisis. The huckster gets his commission and heads off for the next mark. Conflict of interest. His bosses also make money, but they recognise that Leroy might have some difficulty in meeting his $4000 a month repayments, so they’d like to offload it. They also know that not even a sociology professor would be stupid enough to take this on, even at a premium. So what to do?
Now Angela, are you paying attention? Under this scheme a whole series of asset-backed securities (like Leroy’s mortgage) are pooled to make - in theory - otherwise minor and uneconomical investments worthwhile, while also reducing risk by diversifying the underlying assets. Securitisation makes these assets available for investment to a broader set of investors.
These asset pools ca

n be made of any type of receivable, like credit card payments, auto loans, and mortgages, to esoteric cash flows such as aircraft leases, royalty payments and movie revenues. Typically, the securitized assets might be highly illiquid and private in nature. would be packaged together And the trick here is to mix in some good stuff with the crap, ‘securatise’ it and offload it at a profit. More conflict of interest.
Ok, you might get the sociology professor to buy this, but not the sophisticated money markets – the real target. Now for the conflict of interest
piece de resistance. Enter the rating agencies, Standard & Poor, Moodies and Fitch. These are always described as highly respected, prestigious, blue chip and independent. Just like Arthur Andersons was before the Enron collapse.
Now these agencies gave these
crocks of shit instruments AAA or aaA ratings, as good as it ratings can get. Surprised? Why? For a start, it’s the issuers of these ‘instruments’ that pay the fees of those agencies, not the people who use their advice! And it gets better. The same rating agencies worked with the
crooks issuing banks in designing these ‘instruments’. So, they’re paid by the banks to rate their products, having already raked in massive fees for developing those products in the first place!
The numbers looked compelling. "
Buy this investment-grade collateralized debt obligation and you get a return of up to 10 percent - almost 25 percent more than the average yield on a similarly rated corporate bond". Just like a Ponzi scheme, everyone’s a winner. Sell them and you get commission, buy them and you get commission as well for ‘sourcing’ good products. And just like a Ponzi scheme, reality intruded with increasing force until the whole deck of cards collapsed.

And the underlying conflict of interest was the fact that the main perpetrators, the likes of Lehman’s Richard Fuld and Merrill Lynch’s Stan O’Neal, awarded themselves hundreds of millions of dollars while the going was good. Even middle managers could take in a million bucks a year. So what if the whole thing went belly up – you still had millions stashed away and could crawl out from under your stone in a few years when the storm clouds had passed. Just like happened with the mountebanks who hustled the dotcom bust, in the full knowledge of what they were doing.
So that’s what happened Angela. And it means that the people fixing the problem are know-nothing politicians working with the Wall St. crooks who caused the problem initially. I think it’s officially time to panic.
Now where did I leave my brown trousers?