All the Devils Are Here

“Hell is empty and all the devils are here,” William Shakespeare wrote long ago.

Picking up on that, Bethany McLean and Joseph Nocera co-wrote a new book,

“All the Devils Are Here — The Hidden History of the Financial Crisis.”

It should be required reading for any registered voter in the U.S.A. It is particularly important reading for those who follow and participate in the auto industry.

In the late 1970s, consumption represented about 60% of the country's Gross Domestic Product (GDP). Thirty years later, consumption was up to about 70% of GDP, even though middle-class income levels had remained stagnant during that time span.

But there were SUVs, flat-screen TVs, video games and other goods that needed buying. The additional consumption came from credit funding provided primarily by “securitization.”

Auto loans, credit-card debt, student loans, dealer floor planning, commercial and capital loans and of course mortgages were bundled into securities and sold as bonds.

Wall Street's version of “securitization” was invented in 1979 and had grown to 40% of the total credit market by 2008. This expansion of credit fueled economic growth, for better or worse.

When the mortgage market collapsed, it took down the entire securitization market. Losing a major portion of available auto credit and funding for dealer floorplanning and working capital, pushed already fragile General Motors and Chrysler over the brink.

The auto industry particularly suffered. People hit hard by the economy were in no mood to buy cars. Other people that wanted to buy, couldn't get auto financing because it was hit by the ensuing credit freeze.

The irony is that the auto-loan industry had remained disciplined and was never part of the debacle that caused the crisis. But it sure was affected by it.

As auto sales slid, dealers dropped like flies. The wounded economy sank into recession. The Bush Admin.'s Troubled Asset Relief Program was all that stood between the world economy and a major depression.

First, Wall Street invented “tranching” to divide up the securities into segments, typically three, based on the inherent risk. This protected the highest-risk level by paying off defaults from the lower-rated tranches first.

The next step was to devise “derivative” contracts to “insure” the risk. Based on derivative “insurance,” such as credit default swaps, Wall Street was soon able to convince regulators it was not necessary to “reserve capital” as a hedge against default claims.

Soon, hybrid securities were devised that included a variety of different funding purposes bundled into the same financial instrument. At some point, Wall Street figured out it could profit by allowing bettors to bet on gambles already made.

Once the rating agencies, like Fitch and Moody, paid by the banks whose products they rated, attached the AAA rating to the securities, Wall Street nirvana could be achieved.

Now, junk could be sold around the world as high yield AAA-rated securities. Billions of dollars were made, huge bonuses paid, and many innocent people bilked and financially ruined. Profits were privatized while the risk was socialized.

The U.S. government's lack of oversight over the years let it happen.

Wall Street was allowed to create a “betting market” on almost anything. The problem was not so much deregulation, but a refusal to regulate at all.

Mortgage originators approved huge numbers of loans with little chance of them being paid back. They did this because they were never going to hold the paper anyway. It was all being sold to Wall Street because it could take the lousy paper, turn in into AAA-rated securities and sell it to anyone around the world.

I couldn't put this book down. It read like a riveting whodunit. Don't pass up the opportunity to learn what went wrong and why.

Auto consultant and former dealership general manager Dave Ruggles is at [email protected].