One of the themes of my talk was that it wasn’t an excess of greed and speculation which led to the financial crisis, but rather an excess of overcaution, with an attendant surge in demand for triple-A-rated bonds. Investors didn’t want risk, and investment banks made billions of dollars, during the boom, by waving their magic securitization wands and seemingly making that risk disappear. In Islam, high religious authorities are tasked with looking at complex structures designed to circumvent the prohibition on paying interest; in western finance, the ratings agencies played a similar role, blessing highly complex structures (CPDOs, anyone?) which otherwise investors would never have touched.
Like Noah, I am not an expert in this area. And while I think this is an interesting viewpoint, my gut tells me it downplays the role that risk-acceptance played in the story.
Let’s grant Salmon the fact that there was an increased demand for AAA-rated bonds. I don’t doubt this (in fact, it seems quite logical), in fact I would be surprised if it wasn’t the case given how market volatility has seemingly increased over the past few decades and investors are always looking to balance their portfolios with low-risk investments.
However, this analysis completely ignores two factors: 1) that someone, somewhere was in fact taking (and, frankly, creating) tremendous risks (i.e. the investment banks that were creating these securities and the agencies that provided the gold-seal ratings) and 2) an over reliance on faith and trust in the ratings agencies and a subsequent lack of due diligence by investors and their brokers.
The fact that these products garnered such a low-level of skepticism and caution is itself proof that risk-aversion was not ruling the decision calculus of all parties. (The term willful blindness comes to mind). Blindly trusting the ratings agencies despite the fact that these offerings where impenetrable for most tells me that people where taking on increased risks and rationalizing it by hanging their investment decisions on a third-party such as Moody’s or S&P.
An increase in demand for low-risk products alone would not cause the financial meltdown we’ve witnessed. You had to combine demand with a supply of flawed products and a large group of (at best) unsophisticated and/or (at worst) willfully blind buyers.