The devils are in the details

December 09, 2010  

The latest crisis book puts it all together.

By Leah Spiro

All the Devils Are Here: The Hidden History of the Financial Crisis 
By Bethany McLean and Joe Nocera

"All the Devils Are Here" tells the story of an ambitious cast of characters who took the lowly American home mortgage and turned it into a lethal financial instrument of mind-boggling complexity. The tale is engagingly told through interwoven profiles of the "devils" who destroyed the mortgage-backed securities market with their "immoral, unjust, craven, delusional behavior." The losers? Ordinary people who just needed a roof over their head. "It’s what Goldman forgot that caused all its problems. It wasn’t dealing with a financial product. It was dealing with people’s homes," say authors Bethany McLean and Joe Nocera.

Goldman and its chief executive, Lloyd Blankfein, is only one of about a dozen culprits who are blamed for the financial crisis. There’s also Countrywide’s Angelo Mozilo, Ameriquest’s Roland Arnall, Merrill Lynch’s Stan O’Neal, Moody’s Investors Service’s Brian Clarkson, Fannie Mae’s Franklin Raines and AIG’s Hank Greenberg. (Hedge fund manager John Paulson is only a minor actor.)

With each culprit’s transgressions explained in detail, the larger, interrelated story of the financial crisis unfolds. For Hank Greenberg, his downfall is his arrogance in running a sprawling empire like a corner grocery store where everyone is beholden to him, with one exception: Howard Sosin, the ex-Drexel quant who built AIG Financial Products outside of Greenberg’s clutches. Then there is Stan O’Neal, who was so out of touch with his firm that he let his mortgage-backed guys build a colossal CDO-manufacturing machine that generated huge bonuses but also huge risks for Merrill. Regulators of all types are excoriated for their frightening naïveté and inertia.

Where do hedge funds fit into this ugly morass? A few are portrayed positively as skeptics who were savvy enough to short the mortgage market, such as Andrew Redleaf, head of Minneapolis, Minn.-based hedge fund Whitebox Advisors. But the authors reserve some of their harshest language for Paulson when they describe his notorious deal with Goldman:

"In renting the Abacus platform and helping to select the referenced securities, Paulson was doing something that may have been perfectly legal, but was awfully sleazy," they argue.

The conflicts for a broker/dealer owning a hedge fund are apparent in the chapter on Ralph Cioffi, who ran two doomed hedge funds at Bear Stearns. Their collapse, after all, started the whole thing unraveling. And when Merrill’s O’Neal fired Osman Semerci, the former head of fixed income, Semerci promptly started a hedge fund in London. No matter that Merrill wrote down $42 billion out of the $45 billion that Semerci and a colleague had added to Merrill’s book in just one year.

Although most accounts of the financial crisis have largely given hedge funds a pass, McLean and Nocera show them as an integral part of the mortgage machine, with a boundless appetite for socially worthless financial esoterica.

While Merrill created billions of dollars’ worth of CDOs and synthetic CDOs, it was hedge funds that kept buying the increasingly arcane pieces. The authors suspect hedge funds magnified and prolonged the bubble for two to three years by buying the equity in CDOs and shorting the triple-A’s in popular "correlation trades," as illustrated by Magnetar Capital.

By now, there are a ton of books on the financial crisis. While this one is not the first on the scene, hedge fund managers will be living with the bigger issues identified here for the rest of their careers. Don’t miss this definitive, eye-opening book on the lessons of the financial crisis.

Leah Spiro is president of Riverside Creative Management, a literary agency specializing in business books.

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