Thursday, March 26, 2009

How Did the Losses Get So Big?

Many people still believe that this crisis was created by lenders making bad loans to subprime borrowers, and many people have trouble understanding how the losses to financial institutions can exceed the amount lost on the bad loans themselves. Matt Taibbi (via Rortybomb) makes it all clear:

Do you actually think that it was a few tiny homeowner defaults that sank gigantic companies like AIG and Lehman and Bear Stearns? …What we’re talking about here is the difference between one homeowner defaulting and forty, four hundred, four thousand traders betting back and forth on the viability of his loan. Which do you think has a bigger effect on the economy?

As I posted here, this crisis is a result of an alignment of errors on the part of borrowers, lenders, rating agencies, and securities investors. After reading Taibbi, we should add to that list the failure of the government to properly regulate the CDS market and internal risk controls at companies like AIG.