“When people stumble onto the truth they usually pick themselves up and hurry about their business.”—attributed to Winston Churchill
It’s the question everyone wants answered: Why did so many smart people miss the signs of the collapse of the subprime market? As early as 2001, there were many danger signals about the impending housing bubble and the rampant use of derivatives. Yet these signals were largely ignored by such financial players as Northern Rock, Countrywide, Bear Stearns, Lehman Brothers and Merrill Lynch until they all had to face the music harshly and abruptly. Some players were more prescient, however, and sensed as well as acted on the early warning signals. In 2003, investment guru Warren Buffett foresaw that complex derivatives would multiply and mutate until “some event makes their toxicity clear.” In 2002, he derided derivatives as financial weapons of mass destruction. Likewise, Edward Gramlich, a governor of the Federal Reserve, warned in 2001 about a new breed of lenders luring buyers with poor credit records into mortgages they could not afford.1
Some business leaders also noticed. Hedge-fund honcho John Paulson spotted “overvalued” credit markets in 2006 and made $15 billion in 2007 by shorting subprime. In July 2006, the chief U.S. economist... To read the complete article, login or sign-up using the form below.
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