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March 09, 2011
Film Review: Inside Job
    by Robert Kropp

Writer-director Charles Ferguson's Oscar-winning documentary explores the roots of the financial crisis and the global recession that followed.


I started writing journalism for SocialFunds.com in 2008, just as the financial crisis was leading to the implosion of global capital markets. As members of the mainstream media subjected themselves to crash courses in credit default swaps and the effects of 30 years of deregulation of the financial industry, I learned through the example of Community Financial Development Institutions (CDFIs) that subprime mortgage lending can be conducted responsibly, and need not be predatory.

I learned also that sustainable investors at the Interfaith Center on Corporate Responsibility (ICCR) and elsewhere had been pressuring financial institutions for years on issues such as executive compensation and the securitization of mortgage loans; issues that, as the Oscar-winning documentary Inside Job repeatedly points out, were significant factors in the financial crisis and the global recession that followed.

Written and directed by Charles Ferguson, Inside Job was released on DVD this week. Unlike Capitalism: A Love Story, Michael Moore's equally effective but more boisterously irreverent film, the outrage expressed in Inside Job is delivered in measured tones. Nevertheless, as the film quickly points out, "This crisis was not an accident. It was caused by an out-of-control industry." Viewers with knowledge of the years of advocacy for reform by corporate governance experts and sustainable investors may well be entitled to an additional helping of outrage.

Inside Job guides the viewer through the effects of 30 years of financial industry deregulation, beginning with the Reagan administration. Almost immediately, deregulation resulted in a series of economic crises, each one more severe that the last. In the late eighties, as the economist Nouriel Roubini points out in the film, a comparatively minor drop in housing prices led to a relatively severe recession. The Savings & Loan crisis cost US taxpayers well over $100 billion and led to criminal charges against S&L executives and investigations into the actions of five US Senators known as the Keating Five.

In the early years of the new century, the collapse of the Internet bubble, which according to Inside Job was fueled at least in part by traders selling the stocks of companies that they knew were worthless, led to an even more severe recession.

However, the successful efforts of lobbyists for the financial industry to keep increasingly profitable complex derivatives unregulated would set the stage for the greatest economic collapse since the Great Depression. Derivatives permit the risk associated with underlying assets to be transferred from one party to another. In the case of mortgage loans, the lender, now free of any liability should the loan go unpaid, focuses on high-interest predatory loans to unqualified home buyers. The lender then sells the loans to investment banks, who then package them with other loans in collateral debt obligations (CDOs), which it then sells to investors.

Not content with simply selling investment products that, as the film points out, they should have known would collapse, investment banks then began investing in credit default swaps. In effect, credit default swaps allowed banks to bet against the very investment products that they were selling to unwitting investors as solid investments. As it became clear during Congressional hearings into the marketing by Goldman Sachs of the Timberwolf CDO, products continued to be sold long after executives knew they were bound to fail.

To add insult to injury, Goldman then allowed hedge fund manager John Paulsen to choose securities to include in the CDO. Paulsen then proceeded to bet via credit default swaps against the very investment product that he and Goldman created.

The arrangement retains an illusion of liquidity as long as housing prices continue to rise; and as Ben Bernanke, now Chairman of the US Federal Reserve, told an interviewer in the course of the film, there was no precedent for expecting that housing prices would do anything other than continue to rise. (Bernanke's perspective was roundly criticized by some of those interviewed in the film, who correctly foresaw that the doubling of housing prices over the course of very few years was indeed unsustainable.)

If a film in which all the principal actors escaped any accountability at all could be said to have villains, Bernanke would be one. Others were Alan Greenspan, Bernanke's predecessor at the Fed; Henry Paulson, who moved from CEO of Goldman Sachs to Treasury Secretary in the second Bush administration; and Larry Summers, the former President of Harvard University and until late 2010 the chief economic adviser to President Obama.

In order to fan the flames of unsustainable growth, Paulson successfully lobbied for allowing investment banks to increase their leverage to as much as 33:1. As a result, even a minor downturn would leave institutions with no money with which to continue operations.

The massive influx of short-term profits allowed firms to dole out huge cash bonuses as soon as contracts were signed, without regard for the risks associated with the products. As early as 2005, the economist Raghuram Rajan was warning of the effect of compensation based on short-term performance with no penalties for losses incurred later, and argued for compensation based on risk-adjusted performance instead.

According to Rajan, Summers took issue with what he perceived as a call for increased regulation, effectively describing Rajan as a "luddite."

Other factors contributing to the financial crisis, according to the film, were the repeal of the Glass-Steagall Act of 1933, which allowed for mergers in the financial industry that led a consolidation in which the major banks became too big to fail. Also, the number of AAA ratings for investment products skyrocketed, as rating agencies such as Moody's and Standard & Poor were paid by investment banks and contracted no liability when their ratings turned out to be disastrously incorrect. As one ratings agency executive after another told Congress, the ratings represent nothing more than "opinions."

The crisis and its aftermath have been, of course, well-documented. Lehman Brothers went into bankruptcy, the securities insurer AIG had to be bailed out by the government, and taxpayers funded a $700 billion bailout of the handful to too-big-to-fail banks. The recession that followed led to record numbers of foreclosures and high unemployment; as many as 15 million people may have slipped below the poverty level as a result, the film observes.

As an executive with the International Monetary Fund (IMF) stated in the film, "At the end of the day, the poorest, as always, pay the most."

"This crisis was not an accident," the film states. One wonders if the crisis could have been avoided, or at least made much less severe, if calls for reform by sustainable investors had been heeded. ICCR members have been calling for transparency in securitizations since the 1990s and in 2010 introduced shareowner proposals at several of the largest banks, requesting that the companies "ensure that the collateral is maintained in segregated accounts and is not rehypothecated."

This year, the Securities and Exchange Commission (SEC) mandated regular advisory voted by shareowners on executive compensation, an issue that corporate governance experts and sustainable investors have been addressing for years.

Yet, in describing the advances in corporate governance reform accomplished since the financial crisis, Anthony Miller, the Economic Affairs Officer for the Investment and Enterprise Division of the United Nations Conference on Trade and Development (UNCTAD), told SocialFunds.com recently, "Especially in the United States, a lot of the reforms we talk about are still ongoing and have not gone through. The biggest risks right now are no reform or watered-down reform."

As Christine Lagarde, the Finance Minister of France, said in the film, "I'm concerned that a lot of people want to go back to the old way, the way they were operating before the crisis."

 

 
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