Today I am pleased to announce a new series at TBP, book reviews by Chris Whalen. Longtime readers of TBP are quite familiar with Chris Whalen. From his perch at Institutional Risk Analyst to his appearances on Bloomberg and CNBC, the former NY Fed and Bear Stearns analyst is an astute observer of banking foibles.

Chris and I partly disagree about how to assign fault for the collapse. But unlike Mayor Bloomberg or Mitt Romney, he is not a mere politico rationalizing an unsupportable position. We can have an intelligent discussion as to the factors that contributed to the collapse — and collegially disagree.

Here is Chris’ first review:


In his new book Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, Robert Stowe England provides some compelling data and analysis that adds to the collective understanding of the subprime crisis.  Leading analysts such as Barry Ritholtz, Josh Rosner, Gretchen Morgenson and Joe Nocera have been debating whether Washington or Wall Street owns the blame for “causation” in the subprime mess.  England approaches the crisis instead from a functional perspective that begins from the key central fact:  The housing GSEs and the Wall Street banks are one and the same.

One of the many reasons that I am grateful to my friend Alex Pollock at American Enterprise Institute is his reminders regarding the nature of reality when it comes to finance and analysis.  Accounting, he inveighs, is just one perspective on the elephant.  Where you stand determines your view of the pachyderm.

Instead of treating Washington & Wall Street as separate factors, England instead describes the interaction of Fannie Mae, Freddie Mac and the large Wall Street banks as part of a single market.  By focusing on the new bank capital standards put in place in 2001, the subsequent increase in subprime lending by Fannie Mae and Freddie Mac after 2004 and the amazing explosion of cash and derivative private label RMBS, Black Box Casino describes the affordable housing partnership as a true collaboration between the Wall Street banks, national realtors, home builders, politicians and community activists.

In Chapter 3, for example, appropriately entitled “Seeds of the Disaster,” England describes how the culture of affordable housing in Washington was enforced by federal bank regulators such as Boston Fed President Richard Syron.  Under his leadership, the Boston Fed published a series of scathing research reports detailing the “racist motives” behind bank lending patterns in New England – a message that was also being delivered by Fed examiners working in that region.

The point here is that a series of positive and negative incentives emanating from Washington and driven by politics did alter bank lending behavior during the past decade and more.  Badly underwritten loans were then sold to investors.  You know the rest of the story.  When it comes to credit availability, were we are today is closer to normal.

The role of the GSEs going back to Fannie Mae Chairman David Maxwell is likewise treated in detail, especially the symbiotic relationship between Maxwell and  the Lehman Brothers rain maker Jim Johnson, who eventually came to run Fannie Mae.  The author also reminds us how deep and far back in time go the roots of the subprime mess.

“What is forgotten today is that the purpose of the GSE legislation in 1992 was not to inaugurate an era of credit allocation and affordable lending,” England writes, “but to provide Fannie and Freddie from suffering the fate of the failed savings and loan industry.”  England rightly identifies the GSEs as the funding fall back to the S&Ls of the 1980s for the housing industrial complex in the 1990s and thereafter.

England goes on to explain that the capital standards set by Congress for the GSEs were so small that the effective leverage was over 200:1: “This Congress basically created the framework for what would become the world’s two largest hedge funds.”  And England describes very nicely how the politicians of that era, from Henry Cisneros to Bill Clinton and George W. Bush, all focused on access to affordable housing as a political cash cow.

When Barry said on Bloomberg Radio this past Thursday that Fannie and Freddie were just two more messed up banks, he really does them a great service.  In fact, the GSEs were the highly leverage guarantors of Wall Street’s total mortgage production, subprime and conforming.  The largest lenders of the time, from Countrywide to WaMu to Wells Fargo and Bank America, controlled the entire secondary mortgage market, as they do today. Bank America, Wells Fargo, Citigroup and JPM are today a cartel operating in the secondary market for home loans in concert with the GSEs and the private mortgage insurers, which are effectively appendages of the banks and GSEs.

The fact that most of the insurance exposure taken by the GSEs was conforming, as Barry and many others rightly argue, misses the point.  Wall Street banks were using the underpriced GSE insurance to move supposedly “prime” loan production that would otherwise have never been done.  The supposedly high quality conforming, 80% debt, 20% cash down loans now are starting to go bad in growing proportions due to the fact that one third of all mortgages are now under water.

The gaming of the GSE guarantees for collateral in RMBS trusts created by Countrywide, WaMu and other lenders is well documented.  This short-changing on RMBS investors in conforming deals was a direct factor in the decision to force a merger with Bank America, which was Angelo Mozilo’s conduit lender.

The GSEs and private MIs, whose pricing was forced down by the GSE’s artificially low risk pricing,  were equally enablers in the sense that the pricing of their guarantees was an order of magnitude too low to cover the true economic risk.  The fact of Washington’s subsidy of the prime mortgage market and the political protection offered to Fannie and Freddie by politicos like former CT Senator Christopher Dodd is described nicely in Black Box Casino, particularly the refusal of Dodd, Rep Barney Frank (D-MA) and other key Democrats to move on GSE reform.

England recalls Frank telling the Washington Post that the reason for the collapse of the GSEs was market psychology, not “fundamentals.”  But the fundamental fact is that the government sponsorship for the US housing market going back to WWII has run its course, tracking demographic and social trends perfectly.  We should recall that it was only after WWII that Wall Street began creating structured securities following the financial boom of the Roaring Twenties.  The landmark Supreme Court decision by Luis Brandeis in Benedict v. Ratner in 1925, which created the standard for collateralized borrowing, also shut down the Wall Street sausage machine and arguably caused the Great Crash of 1929.  With the subprime crisis we now have come full circle.

Barney Frank, Chris Dodd and many other politicians of both parties leveraged the housing market with the full faith and credit of the US Treasury.  The tab for Fannie, Freddie and FHA is north of $170 billion and climbing.  After the 2012 election, we’ll get the bad news on embedded losses inside the GSEs from defaults on those supposedly “prime” conforming loans that were guaranteed by the US taxpayer for scant consideration.  Black Box Casino tells this story in a well written and sourced perspective on our shared misery.

Category: Bailouts, Books, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

22 Responses to “Review: Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance”

  1. EMichael says:

    “particularly the refusal of Dodd, Rep Barney Frank (D-MA) and other key Democrats to move on GSE reform.”

    All I need to know about Mr. Whalen, “collegial discussions” or not.

    Why have a discussion about government’s role in the crisis with a man who shows a total ignorance of how the government operates?

  2. flocktard says:

    Great, ANOTHER book on the crisis I will probably read, but from this summation, more than likely even more deeply flawed than Morgenson and Rosner’s asinine piece.

    Look folks- some of you people read too deeply into this, and many don’t look hard enough.

    People keep making this a credit issue- there is an element of that in it, BUT THAT IS NOT THE PROBLEM.


    If I am shaky borrower, and I’ve “bought too much house” as the meme goes, believe me, the house is only one of my problems- I can’t handle my car payments, I can’t handle my credit cards, and taking the family to the IHOP now becomes a matter of serious internal confliction. The mortgage is the last thing to go, and most people are not going to sit there with their fingers up their ass waiting for a sherriff to pile the borrower’s furniture on the curbside, if they can help it. So the borrower sells, IF he can get his equity out. Up until about 2006, he could.

    When subprime literally took over the market, as evidenced by the GSEs massive shrinkage in market share by the time 2003 rolled around, this created massive distortions in home pricing, and you can see this in Case Schiller as plain as the nose on your face. You don’t have to be Myron Scholes to figure this one out, folks.

    When you add the SEC’s boneheaded to decision to allow leverage to 40 to 1, by eliminating the NetCap rule, the petitioning brokers used ALL of that leverage on real estate, INCLUDING COMMERCIAL, which has no inputs from the GSEs to factor in. That turbocharged an already robust market, by adding MORE subprime funding.

    Take a look at some of the commercial deals that were done. GE Capital makes New Century look like a f*cking credit union run by Carmelite nuns. Its why GE doesn’t pay any taxes, because the loss carryforwards from this swill are immense. But of course, lets hang this on ACORN!

    Again, look at Case Schiller and look at the Moody’s Commercial Property Price Index and look at the 2005-2007 price spike- THERE’S the formation of your crisis. And as anyone who trades CMBS or private label RMBS paper knows, this is where the toxic stuff lies, REGARDLESS OF THE INITIAL QUALITY of the credit when the loan was originated. Paper issued before and after this bucket have very few issues. If you’re in the market, you see this every day.

    The book is more than likely garbage, especially since the AEI has its paws on it, while they fund Ed Pinto’s disinformation tour, but from this brief summation, people are straining at all costs to hang this on the GSEs, even as their business became overshadowed. Same flaw as Morgenson’s book- hanging the disaster on James Johnson, who left Fannie in 1998, before Glass Steagall was even repealed.

    Keep trying, guys. I’ll be looking right over your shoulder.

  3. EMichael says:

    Kudos, flocktard.

    For everything except reading this book down the road. I would reconsider that choice.

  4. Sophocles says:

    Let’s see. EMichael finds one phrase he disputes and it’s off to the races with a diatribe accusing the reviewer of being a know-nothing. GSE reform legislation was constantly introduced in Congress for many years by Rep. Richard Baker of Louisiana. It was fought tooth and nail by the Democrats on every occasion. These are simple facts.

    Then flocktard takes up the baton and runs with it, knowing absolutely nothing about what’s in the book, leaping to conclusions left and right, condemning the book and author by a thin assumed association with a think tank he/she despises. I have read the book and know for a fact that it also exposes the insanity around subprime CDOs and all the excesses that Wall Street embraced. It also exposes the failures of enforcement at the SEC and the many excesses in compensation and other ills the marked the bubble.

    I like the idea of a reasoned discourse and respectful discussions. EMichael and flocktard seem incapable of anything but rhetoric and invective. People who have to rely entirely on personal attacks and overblown rhetoric usually have no strong argument based on facts or logic or argument.

  5. baldski says:

    If Chris Whalen depends on the AEI, then he is suspect. AEI has an agenda and it is: Corporations = godliness, Government = evil.

  6. wngoju says:

    So, lots of passion in comments, but I’m trying to figure out what Whalen is actually saying. Eg:

    “What is forgotten today is that the purpose of the GSE legislation in 1992 was not to inaugurate an era of credit allocation and affordable lending,” England writes, “but to provide Fannie and Freddie from suffering the fate of the failed savings and loan industry.” England rightly identifies the GSEs as the funding fall back to the S&Ls of the 1980s for the housing industrial complex in the 1990s and thereafter.

    I think “provide” should be “protect”. But, anyway, ab0ve, what does the last sentence mean? No can parse. And that goes for several places in the text.

    I think there might be a cogent point in the article – that per Whalen and England the GSE’s (manipulated behind the scenes by the evil Dodd and Frank) wound up very highly leveraged even before the repeal of Glass-Steagall or the SEC action re the big 5. And although they were only securitizing conforming loans, they somehow served insurance to securitization in the shadow banking system, and -that- was where the taxpayer got hosed.

    Well, it is true that the GSE’s are the only game in town these days for getting RE loans, and they certainly are backed by the Gument. But I don’t see any understandable explanation of above process. Is there one? Or can’t I read…

  7. flocktard says:

    @ Sophocles:

    Spare me the horsecrap about Congress trying to “reign in” Fannie Mae. I’ve read Senator McCain’s S.190 100 times over. Read it yourself, and you tell me what’s in the bill that would have changed the outcome we’re living with now. Nothing Congress would have done or proposed would have changed the outcome, because it did nothing about the two factors I mentioned:

    1) the rise of subprime volume
    2) the repeal of the NetCap rules

    We can throw in interest rate policy, but whose counting?

    Since Barry has eloquently exposed the fraud of The “Big Lie” about the GSEs being to blame, what is your rationale behind dragging up this stupid chestnut about “reforming” them?


    Since you read the book, it is apparently stricken with the same cynical motive as Morgenson and Rosner: Let’s blame the GSEs, while we studiously catalog every major contributing factor to the crisis that was none of their making, and draw up some silly pieties.

    This is rubbish. As far as my “not liking” the AEI, I also don’t like the John Birch Society. Morally and intellectually, they’re about even, even as the AEI maintains its veneer about “research.”

  8. Sophocles says:


    So if leftists build a world construct based on Karl Marx and Saul Alinsky, then can we say they are suspect and they come with an agenda? Capitalism = Evil, Government = God? The end justifies the means = totalitarianism?

    I say that not to ridicule people for opposing Wall Street to be give the logical opposite of your assertion.

    There are, in fact, people in Occupy Wall Street who are genuinely concerned about the excesses on Wall Street and Wall Street needs to be vilified and its excesses exposed. Yet, the people who came up with Occupy Wall Street are mostly a bunch of crazy Communists and anarchists. So people of goodwill without agendas can be associated with a group that wants to destroy Wall Street and capitalism, and yet have a distinct opinion that one should evaluate on its own merit.

    Can Chris Whalen not have a respect for Alex Pollock, who has a life above and beyond AEI — he has years experience in banking, including the Federal Home Loan Bank of Chicago — and not be characterized as worshipping corporations and considering government inherently evil?

    I know for a fact that your silly syllogism does not represent Alex Pollock’s thinking. Nor does it represent Chris Whalen’s thinking.

  9. flocktard says:

    Oh, the Saul Alinsky meme.

    Someone send this guy off the Yahoo boards. We’re supposed to be better than that here.

    As far as the AEI being a “think tank”, let me tell you what a think tank is:

    Its a place where people think up ways to distort or discard facts that get in the way of their political prejudices.

    The AEI is no better than the John Birch Society, but with an assumed pedigree.

  10. Sophocles says:


    So are you saying the crisis can not have multiple contributing causes?

    Are you saying that the GSEs played no role? Or are you saying the entire crisis cannot be blamed entirely on the GSEs?

    Are you also saying that anyone who puts together a list of the causes and any of those causes, however remotely, is tied to the GSEs, then the entire construct is false?

    Are you not, in fact, defending the GSEs from having any role at all, even a remote one?

    Is your mission then to attack any and everyone who even raises the specter that the GSEs contributed to the crisis in any way whatsoever?

    If so are you not, in short, fanatically defending the GSEs and rejecting all arguments and evidence to the contrary without seriously considering them?

  11. flocktard says:

    To answer your questions:

    I already indicated in my responses that the crisis had multiple causes and BR has already done a good job of identifying them in his WaPo Op-Ed.

    The GSEs, as far as I can tell, played no role in the crisis, as far as CAUSALITY. There is a difference between being a hub and a spoke.

    If anyone was capable of locating a CAUSAL factor that the GSEs contributed to the crisis, I’m all ears. Morgenson and Rosner tried, but their own book defeats their own thesis. Johnson may have voted himself bonuses, rewarded his fellow board members, cooked the books, drank red wine with fish, and beat his wife, but NONE of those things sends the US economy into the toilet- and that is all that matters. In fact, he acted like any one of 1000 CEOs of a large corporation. Think Paul Ottelini can hand out ethics lessons?

    If you can name any CAUSAL factor the GSEs committed to the crisis- I dont want to hear how good they were at lobbying Congress- go right ahead.

    But I’ve read thousands of pages on this subject- books, articles, opinions,etc. and I can tell you one thing:

    If someone had checked the rampant growth of subprime lenders like Fremont, New Century and Long Beach, and the SEC had not stripped away the NetCap rule, you have no crisis, and this man has no book to write.

    I can’t put it any plainer than that. The GSEs did not turn the housing market into a giant pump and dump- the two factors I mentioned did.

  12. Sophocles says:


    Thanks for your explanation. That was helpful.

    I think the your are right about the subprime lenders identified and the NetCap rule.

  13. flocktard says:

    Always happy to assist those in the theatre.

  14. Asymptosis says:

    Private mortgage insurance “pricing was forced down by the GSE’s artificially low risk pricing.”

    This is the crux of the argument here. Would love to hear more/details on the mechanisms whereby that occurred, and how it was significant in fomenting the crisis.

    Really not questioning this, am open to knowing. But would appreciate expansion/clarification.

  15. EMichael says:

    “Let’s see. EMichael finds one phrase he disputes and it’s off to the races with a diatribe accusing the reviewer of being a know-nothing. GSE reform legislation was constantly introduced in Congress for many years by Rep. Richard Baker of Louisiana. It was fought tooth and nail by the Democrats on every occasion. These are simple facts. “–Sophocles–

    Explain to me how the Dems fought this reform “tooth and nail”? And we will leave out the fact that McCain’s reform package was totally worthless as pointed out by Flocktard.

    Did I miss a filibuster in the Senate when this reform bill was presented? Did I miss a Senate or a House vote on GSE reform? Did Barney Frank somehow stop this reform bill while a member of the minority member of the House?

    No one I know of thinks the government was blameless in this affair. But an author bringing up Dodd(who at least could have organized a filibuster to stop a vote) and Frank shows ignorance of the system, history and facts.

    Neither one of these two affected GSE reform in any way I know of, but if you know something to say this is false let me know(and spare me comments from these two on the health of the GSEs, they mena nothing).

    The first time these two had any power at all it was January of 2007. Elvis had left the building.

  16. Sophocles says:


    The efforts at GSE reform began in the mid-1990s and continued right up until July 2008, when GSE reform was finally passed.

    Richard Baker led the battle for GSE reform in Congress — the only member of Congress who would even try. He would write up a bill every Congress and introduce it. When he became chairman of the relevant subcommittee, he was eventually able to get in through that subcommittee.

    However, rock solid Democrat opposition, plus the refusal of a sufficient number of GOP supporters to fall in line, prevented him from getting it passed in the House. No Democrat during this time every sign on as a co-sponsor of Baker’s reform legislation.

    Those in the GOP who dared to speak for reform were branded as racists by the Democrats and the subjected of severe attacks.

    Fannie and Freddie lobbied with every fiber in their body to stop reform. They were prepared to punish anyone who stepped out line. They were able to intimidate enough GOP to keep reform from getting passed in the House for many years.

    Beginning in 2003, Baker held hearings on the accounting scandal at Freddie Mac, at which time Democrats vilified him and Armando Falcon, the man who regulated Fannie and Freddie, for making much ado about nothing. Frank was especially heated in his opposition to any change that would require Fannie and Freddie to increase their capital base, which was set at a tiny amount by statute. He said he would prefer to “roll the dice for subsidized housing” rather than give the regulator the power to raise capital standards.

    Then in 2004 there were hearings held by Baker on the accounting scandals at Fannie Mae. Slowly, Baker was building support.

    It was not until 2005 that Baker was able to get reform through the House of Representatives, without Frank’s support and with Democrats fighting every step of the way. The GOP-controlled Senate sat on the reform and did nothing.

    To his credit, Frank after the 2006 selections, decided to switch from opposition to support for GSE reform with only a couple of Democratic supporters. It had become a political liability for the Democrats in the wake of the accounting scandals and Baker’s relentless campaign for reform.

    Senator Dodd, however, kept reform proposals from votes in the Senate Banking committee in 2007 after Frank got a measure out of the House. He fought reform right up until the summer of 2008, as Fannie and Freddie’s share prices were plummeting and investors were increasingly reluctant to invest in their securities.

    It was only after Fannie and Freddie were on the verge of collapse that Congress was willing to pass reform. Senator Dodd was dragged kicking and screaming into supporting the reform in late July 2008. By early September, he was screaming he was tricked by Paulson into supporting reform after Fannie and Freddie had to be taken over by the government. Dodd felt believed it was unnecessary.

    That is the story in brief.

  17. flocktard says:

    Again, the word “reform” is being kicked around, but REFORM WHAT? What is the substance of this “reform” we keep hearing about?

    To complain about the GSEs’ capital cushion in the wake of the NetCap rule repeal has me rolling on the floor. And how about a few hundred billion of Trust Preferred Securities issuance by the banks? Oh and don’t forget the derivatives business at firms like AIG- hundreds of billions in exposure and not ONE DOLLAR in collateral.
    This is another phony issue.

    But what was ever really “reformed” at the GSEs?

    I also agree with Dodd that the takeover (or conservatorship) by the government was an act of fiscal terrorism performed by Paulson. I will go to my grave believing it.

    Let me tell you something about the banking industry- they viscerally hated the GSEs for a number of reasons, including their practical monopoly on the conventional/conforming loan’s underwriting template, which shrunk their margins by commoditizing the product. There are plenty of “Representatives” like that creep Jeb Hensarling, who is a reliable sodomite of the bankers, who will vilify the agencies while his paymasters were the ones who caused the crisis.

    You really have to drill down into this issue, and again, the CAUSALITY is all that matters. Everything else is noise.

  18. Sophocles says:

    I was asked about GSE reform and I answered the question.

    I’m beginning to realize you know practically nothing about mortgage banking. If the GSE reform had not passed in the summer of ’08, Fannie and Freddie would have failed and the government would have had no other alternative than to put them into receivership. They did not have authority to put them into conservatorship until it was granted in GSE reform. At least with conservatorship, they could continue to write business. If the GSEs had stopped writing business, the mortgage market would have collapsed to 10 percent of its prior capacity. The housing market would have collapsed and we would be in the Great Depression.

    And that’s my last comment. Carry on without me.

  19. flocktard says:

    You’re obviously avoiding being called out, but let’s try this one more time before you go:

    WHAT “REFORM?” Be specific. What specific piece of legislation had any effect on how F&F do business? How is it germane to the crisis? Again: BE SPECIFIC.

    Lastly, I regret to inform you that this comment : “I’m beginning to realize you know practically nothing about mortgage banking. ” is most unfortunate. I was a mortgage broker for eight years and had correspondent lending relationships with over 30 lenders of every stripe. If you think you know more than I do on this subject, have at it. You’ll be proven wrong.

  20. EMichael says:

    I truly do not know what is worse, the neverending avoidance of mentioning actual legislation that somehow the minority stopped from implementing or the mention of the accounting scandals.

    Like talking to a kitchen table.

  21. EMichael says:

    “Frank was especially heated in his opposition to any change that would require Fannie and Freddie to increase their capital base, which was set at a tiny amount by statute. He said he would prefer to “roll the dice for subsidized housing” rather than give the regulator the power to raise capital standards.”

    I wonder why Frank’s “especially heated” opposition to the Iraq War from the beginning had no effect?

  22. flocktard says:

    More to the point, as empty as the prior attempts to “reign in” the GSEs were, what would “reform” passed in 2008 do for us?

    We were already dead.

    By the way, folks, don’t get sucked into that “Fannie and Freddie need another 12 billion, and what did I tell ya” rant. The extra money isn’t for GSE loans that went sour- its for the loans Paulson simply shoved onto the GSEs ‘ books after he staged his putsch.