Imagine going to a casino with $100 dollars to gamble. As you enter, you notice a vending machine that sells gambling insurance policies. For a small price, the insurance policy will guarantee to replace any losses that you may incur while gambling. So being a prudent person, you buy one. Now you can’t lose anymore than the cost of the insurance.
But that was so easy, why not buy two (or more) insurance policies –then if you lose, you get back more than the amount you lost. There is nothing that stops you from buying multiple policies. Now you will be better off financially if you lose all of your money –the more you lose, the more you gain. At least to a lot of really, really smart people, it seemed that way… But you have just now lost any incentive to win, in fact, perversely, you want to lose, you need to lose. And even more perversely, there is no requirement that you have an 'insurable interest', so you buy an insurance policy (or two) against other folks losses. If they lose, you win. Maybe you even start betting against them, trying to help them lose, knowing full well that your own loses are insured. Sounds rather bizarre, doesn't it. That is how five trillion dollars of worldwide debt ballooned to 60 trillion dollars in contractual obgligations.
In conversations this week, and in a Twitter thread, I was reminded that the weekly program, 'This American Life', broadcast on National Public Radio, has presented a series of discussions/explanations about the underlying causes of the current global economic crisis. I know, that for me, it has been a struggle to understand how so many really 'smart' folks made such profoundly 'dumb' mistakes. I wanted to blame it all on avarice or greed, or illegal activities. Not discounting those factors, I now understand this is a problem of unintended consequences when folks attempt to remove 'risk' from financial life.
If you would like to get a better understanding, and perhaps learn what is a CDO, or CDS, or why your tax dollars are going to be used for decades to 'clean up' this debacle, I highly recommend these episodes. You can listen to them streaming online for free, or you can purchase the podcasts and download to your pod device.
The Giant Pool of Money (2008/05/09)
This American Life producer Alex Blumberg teams up with NPR's Adam Davidson for the entire hour to tell the story—the surprisingly entertaining story—of how the U.S. got itself into a housing crisis. They talk to people who were actually working in the housing, banking, finance and mortgage industries, about what they thought during the boom times, and why the bust happened. And they explain that a lot of it has to do with the giant global pool of money.
Another Frightening Show About the Economy (2008/10/03)
Alex Blumberg and Adam Davidson recount the 36-hour period, when the credit markets froze. Plus, what it’s like now for businesses to get short-term loans, and how the hardship is spreading to every sector of the economy. One more confusing financial product that’s bringing down the global economy. And one of way to think about this product is this: If bad mortgages got the financial system sick, this next thing you’re about to hear about, helped spread the sickness into an epidemic. These are "credit default swaps." Ira Glass talks with Michael Greenberger, a former commodities regulator, who tells the story of when it was decided not to regulate credit default swaps. And how that decision was emblematic of the way we didn’t regulate a lot of the toxic financial products we’re hearing about now.
Bad Bank (2009/02/27)
The collapse of the banking system explained, in just 59 minutes. Alex Blumberg and NPR’s Adam Davidson—are back to help all of us understand the news. For instance, when we talk about an insolvent bank, what does it actually mean, and why are we giving hundreds of billions of dollars to rich bankers who screwed up their own businesses?