“Whoever makes a loan has responsibility if it goes wrong afterwards.” This Copybook Heading principle of traditional banking was flouted by the securitization market, in which loan originators were able to escape responsibility for poor credit decisions. The result was an orgy of poor housing lending, involving not simply poor credit decisions but outright fraud, connived in by loan originators who collected their fees and passed the fraudulent paper on to Wall Street and international investors. In this disaster, Wall Street was self-deluded, drunk with excessive money supply; the real crooks were the mortgage brokers, mostly a bunch of used-car salesmen who had never been closer to Wall Street than a day trip to the Statue of Liberty. The securitization market will only survive under careful limitations which ensure that, at least to some degree, this God is obeyed1.
“Don’t take risks that you don’t understand.” Flouted openly in most bubbles, this God was drugged during this one by perverted science, the “Value–at-Risk” Risk Management technique, which controlled risk just fine provided that the markets involved were not in fact risky. In Wall Street’s defense, the proof that VAR was a load of codswallop required fairly sophisticated mathematics and so was available to only a few noisy skeptics like myself and Benoit Mandelbrot2, whose previous invention, fractal geometry, was unknown to the intellectually uncurious workaholics of Wall Street.
1Hutchinson is careful here to not blame securitization per se. Securitization makes sense if done properly, e.g., if mortgage originators use rational underwriting standards, if only loans of homogeneous credit quality and terms are packaged together, and if mortgage originators and borrowers both have some skin in the game if a loan goes bad.
2Brooklyn-based musician/geek/Internet phenom Jonathan Coulton wrote a song about Benoit Mandelbrot, "Mandelbrot Set". For more on Coulton, see Clive Thompson's New York Times article on him, "Sex, Drugs, and Updating Your Blog"