The United States experienced a meltdown in its financial system that devastated much of the economy in the years 2007 to 2008. In Gambling with Borrowed Chips, author Christopher C. Faille reexamines what is becoming settled wisdom about that financial crisis and the economic troubles that have plagued the country ever since. In his analysis, Faille challenges what he calls the common misdiagnosis that speculation—especially on the short side—combined with indebtedness, leverage, deregulation, and greed, produced mayhem. In Gambling with Borrowed Chips, Faille contends that speculation, or “gambling,” serves valuable functions in an economy. It steers money and other resources to where they can be most of use; it punishes profligacy and rewards foresight; and it disturbs overly cozy arrangements such as those of entrenched corporate managements. Gambling with Borrowed Chips argues that it is acceptable to gamble, even with borrowed chips. Faille helps us understand the real problem: gambling in a casino that hands out the chips too readily or one that is always eager to manufacture new chips in order to stimulate activity.
ONEThe Old Stigma: Speculators as ParasitesOver the weekend of September 13-14, 2008, Merrill Lynch sold itself to Bank of America at a once-unimaginably cheap price. In the early morning of Monday, September 15, came news more shocking still: Lehman Brothers had filed for bankruptcy. That day the DJIA opened at 11,416 and headed straight down, ending at 10,917. On Tuesday, the central bank of the United States, the Federal Reserve, lent $14 billion to the huge insurance company AIG. That achieved its desired effect, producing a bit of an upward blip in the Dow, allowing very uncalm policy makers to declare that they had calmed the markets. There were wild zigzags through the rest of the month as the market absorbed ever-changing news of money-market repercussions, government and Fed reactions, and overseas echoes of all of it. At the end of September, though, the good news – if one can call it that – was that the Dow was still only a little lower than the bottom of that mid-month vertical line.If September had been startling, October was devastating, bringing the Dow into the 8,000s. On October 11, the head of the International Monetary Fund (IMF), Dominique Strauss-Kahn, spoke for many, saying: “Intensifying solvency concerns about a number of the largest US-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.” We need not continue the chronology. Subsequent events, both on and off Wall Street, proved satisfactorily that finance has a critical role to play in the broader economy, for better and for worse. For richer and for poorer. Private sector residential loans disappeared (for the next two years only Fannie and Freddie, now themselves overtly wards of Uncle Sam, financed home buying at all). Commercial loans, too, virtually disappeared. States, municipalities, and a variety of quasi-public entities intertwined with them both felt severe budgetary pressures, and the unemployment rate stayed consistently above 9 percent quarter after quarter. One sometimes amusing variant of the blame-the-speculators impulse that has come to the fore in the wake of these events is “let’s blame it all on Goldman Sachs,” in the manner of Matt Taibbi in his July 2009 article for Rolling Stone, who started things off with his “vampire squid” analogy. The article begins: “The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” He almost makes it sound like that’s a bad trait. The Senate Permanent Subcommittee on Investigations was only slightly more subtle in those not-especially-enlightening hearings on Goldman that the Senators staged in April 2010. The Senators were exercised in particular over the ABACUS special purpose vehicle. Without getting into the jargon involved, we need only say now that ABACUS was a series of transactions in which Goldman offered to serve as the bookie and allow people to take bets for or against the credit worthiness of homeowners. The first ABACUS deal came about in 2004, when the housing boom still had some way to run. A German bank, IKB, wanted exposure to a specific collection of mortgage-backed securities, because it thought these securities were sound. In other words, IKB wanted to bet that the securities were sound without having to actually own any interest in the mortgages. For IKB to get the kind of deal that it wanted, Goldman like any other bookie had to find somebody else to take the other side of the bet. It had to find a “short,” somebody willing to bet that a lot of those underlying mortgages would default. In 2004, it was tough to find anybody willing to short, because optimism about the housing market was very widespread. Prices and credit worthiness are closely related issues. As long as prices kept going up, it did little harm for people who were not especially credit worthy to buy homes with no money down. After all, they’d just have to last a couple of months, then flip the house to another buyer at the higher price, pocket their profit, pay off their lenders … and everyone would be happy. It was only when the upward trajectory of housing prices changed that flipping ceased to be an option and credit worthiness became a critical issue. Over the next three years, Goldman used ABACUS as a brand name. It became a “market maker,” setting the table where optimists and pessimists met. Fabrice Tourre, a mid-level trader at Goldman, wrote some entertainingly expressed emails about the ABACUS trades, which have helped keep them in the limelight -- in one, the most oft quoted, he refers to himself as the “Fabulous Fab” who didn’t understand “all of the implications of those monstrosities.”
Christopher C. Faille, a member of the Connecticut bar since 1982, has written on a variety of financial and legal issues. He was an early reporter with HedgeWorld and is also the coauthor, with David O’Connor, of Basic Economic Principles. He lives in Enfield, Connecticut.