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January 10, 2009

'Wall Street had built a doomsday machine'

By Jerome J. Schmitt

By chronicling at Portfolio.com the revelations of Steve Eisman as he began to understand the incompetence and self-dealing of Wall Street beginning in 2006, Michael Lewis, author of Liar's Poker,  records in in "The End of Wall Street's Boom"   an account of the man who correctly predicted the sub-prime mortgage debacle -- and who backed his singular prediction with his firm's capital by shorting bonds and other "mortgage-securitized" financial instruments such as "Credit Default Options" (CDOs).

Lewis's thesis is that the culture that enabled these excesses is traceable to the conversion in the 1980s of Wall Street Investment Banks from partnerships investing their own capital to corporations investing other people's (shareholders') money.  By leveraging their capital at unheard of rates (30:1), they built leveraged castles-in-the-sky out of piles-upon-piles of "securitized assets" with inflated values.  The role of CDOs in creating even more "sub-prime mortgage-backed bonds" without even troubling to bother with mortgages was a revelations to me. Eisman realized that many middleman took their "cut" as they passed these "securities" on to the greater fools, but not one expressed to him any concern or remorse over the flimsy nature of the transactions.  As we all know now, AIG, an insurer, has had to be bailed-out by the Federal Government with close to $1 trillion as a result of the CDO-debacle -- meaning that the taxpayer has now served unwillingly as the "greatest fool" in the chain of transactions.   

My impression, echoed here, is that Wall Street has been increasingly preoccupied with the "financial economy" and divorced from the "real economy" as evidenced by the dearth of news about such transactions as Mergers & Acquisitions (M&A) and Initial Public Offerings (IPOs) of industrial corporations  --  corporate finance activities that until quite recently were the life-blood of investment banking.  Perhaps the crash will force Wall Street financiers to return to the salutary, but recently-neglected, hard-work of financing America's industrial economy.
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