John Steele Gordon on the Financial Mess: Greed, Stupidity, Delusion — and Some More Greed

John Steele Gordon, an author who specializes in financial and business history, has a helpful pedigree: both his grandfathers held seats on the New York Stock Exchange. His 2004 book An Empire of Wealth: The Epic History of American Economic Power is a remarkably vivid chronicle of every boom and bust that our economic history has absorbed.

Last week, we asked two University of Chicago finance professors, Doug Diamond and Anil Kashyap, to explain the Lehman and A.I.G. meltdowns (and more) in lay terms. Now we’ve asked Gordon to put the current mess in historical perspective and give some further insights into its origins.

Greed, Stupidity, Delusion — and Some More Greed

By John Steele Gordon

A Guest Post

Looking just at the Friday closes, it was one of those ho-hum weeks in the stock market. The Dow had ended the previous week at 11,421.99, and last Friday it closed at 11,388.44 — down 33.55 points — a measly 0.29 percent.

To be sure, in between the two closes things got a tad volatile: down 504 points on Monday, up 141 on Tuesday, down 449 on Wednesday, up 410 on Thursday, and up 368 on Friday — all on huge volume (with a record on Thursday of 10.2 billion shares). And in this remarkable week, the landscape of American capitalism changed profoundly. Great names like Merrill Lynch and Lehman Brothers will disappear, and government responsibility for backing up the financial system will increase considerably as the administration asks Congress for $700 billion in borrowing authority to handle the situation.

What happened? Simple: panic. Vast amounts of assets in the financial system became unsellable as no one knew what they were worth, and thus they were useless as collateral for loans. As a result, highly sophisticated bankers refused to lend to other highly sophisticated bankers overnight; Ma and Pa Mainstreet rushed to take their money out of uninsured money-market funds and put it in Treasury bills paying practically nothing, and in gold, which pays nothing at all (and indeed costs money for storage or insurance).

The world’s financial system came perilously close to seizing up — like an engine without oil. Had that happened, the consequences would have been very nasty indeed. Let us hope that the market’s bets on Thursday and Friday are a sign that the government is getting a handle on things.

But the first thing to do in a panic is … don’t panic! “If you can keep your head when all about you are losing theirs,” you’ll be fine.

There have been headlines that this is the worst economic crisis since the Great Depression. No. It is a financial crisis.

The underlying American economy is not in bad shape. Unemployment is at 6 percent; that’s a little high by the standards of the last decade or so, but not by longer-term standards (unemployment reached 10.8 percent as recently as 1982). In 1933, it was over 25 percent (and actually far higher, with many working part time). In 1933, G.D.P. was little more than half of what it had been in 1929.

G.D.P. has grown smartly in the last five years, even in 2008. Farm mortgages were being foreclosed at the rate of 20,000 a month in 1933. The nation’s farmers have never been so prosperous as they are today. When F.D.R. was inaugurated on March 4, 1933, banks were entirely closed in 38 states and restricted in the other 10. Over 5,000 banks had already failed by then, and had taken the savings of millions with them. Today, millions of families have substantial savings, retirement funds, and equity in real estate. In 1933, exports were one-fifth of what they had been in 1929. American exports are booming today.

In 1933, we were a country of haves and have-nots; today, we are largely a country of haves and have-mores. The poverty of the sort seen in the immortal photographs of Walker Evans simply does not exist today.

How we will get out of this mess is becoming clearer, and Congress will have to act very quickly. But the members of Congress stared into the abyss along with the rest of us last week, so my guess is that even they will act responsibly for once.

But there is no doubt at all about how we got into this mess.

To be sure, there is plenty of blame to go around. Greed, as it periodically does when traders and bankers forget the lessons of the past, clouded judgments. Some very smart people talked themselves into believing in the repeal of one of the fundamental laws of economics: risk will always equal potential reward. The idea that risk can be eliminated and high yields guaranteed is as idiotic as the idea that gravity can be suspended. Remember Long-Term Capital Management? Ten years ago it figured out how to eliminate risk using highly sophisticated computer programs and rolled up annual returns averaging 40 percent — until it collapsed in a heap.

Credit ratings agencies such as Moody’s and Standard and Poor’s gave good credit ratings to securities they didn’t understand.

But at the heart of the problem is Congress and its deeply corrupt relationship with Fannie Mae and Freddie Mac. Congress was equally at the heart of the savings and loan disaster 20 years ago and, obviously, learned nothing from it. (For a history of what led to the savings and loan collapse, see here.)

Fannie and Freddie, two of the largest publicly traded financial institutions on earth, are headquartered in Washington, D.C., where the next-largest non-governmental financial institution is probably a local credit union. Big financial companies are headquartered in New York and other cities where capitalism is practiced. That should tell you a lot about Freddie and Fannie: they were political to their fingertips.

Being “government sponsored entities,” they were able to borrow at lower interest rates than other profit-seeking companies, had less regulation, had lower capital requirements, and had an “implied” guarantee on their huge debts. This was supposed to translate into more money available for mortgages, but was used instead to roll up big profits and, not so incidentally, big bonuses for their top management — which came not from the financial world but from the political one.

Franklin Raines, Fannie C.E.O. from 1999 to 2004, had been budget director in the Clinton White House. He cooked the books at Fannie to increase his compensation (more than $50 million). Jamie Gorelick, vice C.E.O., was number two at the Clinton Justice Department before going to Fannie Mae. She made $26 million. Jim Johnson, a perennial Washington big-foot, was chairman from 1991 to 1998. He too, according to an official government report, cooked the books to increase his compensation and failed to publicly reveal how much he received.

The Wall Street Journal editorial page has been giving chapter and verse for years on why this was a disaster waiting to happen (Pulitzer Prize judges, please note). The Bush administration tried way back in 2003 to change the system. It got nowhere. Alan Greenspan, then the chairman of the Federal Reserve, frequently noted the danger of Fannie and Freddie’s weak capitalization. He was ignored. Congressman Mike Oxley, then chairman of the House Financial Services Committee, introduced a bill in 2005 to correct the situation. Lobbyists from Fannie and Freddie succeeded in gutting it to the point that Rep. Oxley pulled the bill.

Why were Fannie and Freddie so successful at maintaining the status quo? Check it out.

Senator Chris Dodd — formerly ranking member and now chairman of the Senate Banking Committee, with oversight over Freddie and Fannie — recently said on Bloomberg Television: “I have a lot of questions about where was the administration over the last eight years.”

Excuse me? Just where the hell were you, Senator? Oh, right. You were standing in line at the bank in order to deposit the political contributions Fannie and Freddie were lavishing upon you. At least they got their money’s worth — until the party ended and the American people got the bill.

Members of Congress — aided and abetted by their many waterbearers in the media — wonder why their collective approval rating is about on par with colon cancer’s. The reason is simple enough: Congress is the sick man of Washington; a textbook example of the truism that institutions tend to evolve in ways that benefit their elites, at the expense of the people they were created to serve.


Who are we kidding?  If you want to point fingers it should be at the american consumer who over-extended himself.  Predatory lending? seriously?  Just because someone offers your a loan for $500,000 when you can only afford a loan for $250,00 doesn't mean you have to take it.  If you don't understand the document you are signing for an ARM, baloon mortgage, etc. don't sign. Just because you can, doesn't mean you should.  Its called self-restraint. 

Julie Johnson

This is a good summary of what is going on.



A little basic education about Mortgage Brokers. Firstly, every state is different. Some states such as Calif. Mortgage Brokers are heavily monitored and regulated and they have to be licensed. Loan officers that work for Banks do not have to be licensed. To understand it better if you can only get that banks products then you have a loan officer. Many people make the mistake of referring to Mortgage Brokers that are really loan officers. Mortgage Brokers only originate loans. Several licensed salespersons work under a Broker whom has broker agreements with several banks. BoA, WAMU, CHASE, Wells, First Franklin...etc. To become a Premier Broker you have to do a lot of volume. My broker that I work for has an MBA from USC and every Mortgage Broker in our office is not only licensed but we all have college degrees.

Mortgage Brokers have absolutely NOTHING to do with the programs that a lender offers. A Mortgage Broker has absolutely nothing to do with the underwriting standards a lender uses. I can only send in a prospective borrowers loan application for a program that exists. Contrary to many of things I have read on this blog, nearly every person has an idea of what kind of loan they want. The majority are very certain. If good MB will give them a couple of options and some suggestions for their particular situation. A loan package just to get the whole thing started is 26 pages of required disclosures including the application. Then the borrowers get’s disclosures from Escrow and then the Lender sends their disclosures out. And all this is before you even get to the loan doc’s. You know what your signing and if fraud is committed there has always been recourse for those circumstances. That is not what has produced this mess.

Fannie/Freddie: As I stated early a Mortgage Broker has nothing to do with each lenders underwriting standards but I will tell you that nearly all lenders in the past 10 years have been taking all Fannie/Freddie approvals. What do I mean: A Mortgage Broker will do a DU , Desktop Underwriting which is Fannie Mae on the lender your are using, web-site to get an approval. What was happening until this past year was that nearly every lender took Fannie/ or LP Loan Prospectors (Freddie’s,) findings or approval. So I’m sorry the analyzes of the original author is correct. Personally as a very conscientious and conservative Mortgage Broker I have always felt that Fannie and Freddie’s Underwriting Standards were much to lax. Yes, it was ultimately the lenders responsibility whether they were going to completely accept those findings, but they got greedy and it was a wild ride the past 8 years. Then you had the packaging of the loans to sell on Wall St. and well you know the rest of the story.

Defaults: Please be aware that 73% of all defaults today are of loans that were 100% financing. So why is Congress in such a rush to bail out people that didn’t LOSE ANYTHING! NO money down folks, why would you bail them out. From what….I would tell every client I had that wanted a 100% loan that it was a form of gambling. I told them that when they went to refinance that if the values went down they would still owe what was on the note. I will tell you that in all the years that there have been 100% loans I only had 2 people (out of 100’s) that opted to get fixed loans fully amortized. If more people that qualified did this and you would be surprised how many did qualify and just wanted the couple hundred dollars cheaper monthly payment. Those 2 clients that got 100% fully amortized have lost the value just like everyone else, but they both have 30 year fixed loans and won’t lose their homes and they have the chance for the market to come back. Millions of other people got 100% financing and a couple of years later refi’d and got fixed rates and their not losing their houses either. Anyone with half a brain knows real estate always goes up and down and that 100% financing on adjustables was stupid. I think we should keep the 100% financing but make the borrowers qualify with a fully amortized fixed loan. Here in expensive California homes are still very expensive.

I think the corrections that Bush recommended back in 03 and then again in 05 should have been adopted. In 03 when the Republicans were the majority 10 Republicans voted nay so that is why it did not pass. I think there is a mix up on all the different legislation that was introduced. Surprisingly, all the regulation was requested from 01 till 06 by Republicans. Check out all the bills that never made it out of committee and/or the bills that did not pass. It’s a shame because this all could have been prevented with common sense.

Keep the faith folks...

it's hell out here.

M Anne


Eric Zhou

"the truism that institutions tend to evolve in ways that benefit their elites, at the expense of the people they were created to serve. "

On this, I have some disagreement. I'm thinking of this from the perspective of China. For this old and seemingly booming nation's long-term welfare, there should be a genuine shift from a society (in both economic and political sense) based on "relations and connections" to "institutions and rules".

And back to the topic of this article, I think Mr Gordon's writing is great! I've read one of his books about Wall Street history.

george harter


George C. Harter


george harter

In my neighborhood in Queens and at my workplace in Manhattan, it is almost unanimous: without REAL supervision, Paulson will likely blow $2-3 trillions, under the cover of darkness.

Many nasties of ALL kinds will then disappear in the greatest theft ever engineered. Many corporations will emerge looking Bright Eyed and Bushy Tailed into a world flooded with worthless US fiat currency.

Where is the Supreme Court? This measure is unconstitutional. Have we finally destroyed the only document that has made us great??

Once abrogated, this is no longer the US of A.

Without our consitution we are like the Emperor with out Clothes.

George C. Harter

PS I had respect for this column. HAD.


It is shocking to read an economic column written on the financial meltdown that presents little other than a lopsided partisan bias. It looks like you already reached a conclusion even before you started your analysis, so it's a matter of piecing together a few facts from the history to justify your conclusion.

klaus bothmer

I see a whole new problem that could evolve from this financial crisis. The strength of the Dollar and trust in our institutions.

If I am not mistaken, the US Dollar is not backed by Gold or other hard tangible assets. It is backed by the belief that the US Economy, it's financial institutions and businesses are above board and transparent. These rules/regulations/oversights created a friendly and safe haven for investments in businesses by our own citizens and foreign entities alike.

If this "faith in a system" standard diminishes, the investments from within and abroad will certainly have second thoughts. Our standards of accountability have fallen and so will the Nation if this continues to spiral out of control.

The bail out money being discussed in this discussion are only the hard numbers we presume we know. What effect this could have on future investments, domestic and from abroad will certainly add to the already dire situation.

Posted by: Klaus


Steve J.

Mr. Steele is just parroting the latest wingnut line. The problems at Fannie and Freddie are miniscule compared to the investment banks, mortage brokers and ratings agencies.

klaus bothmer

I see a whole new problem that could evolve from this financial crisis. The strength of the Dollar and trust in our institutions.

If I am not mistaken, the US Dollar is not backed by Gold or other hard tangible assets. It is backed by the belief that the US Economy, it's financial institutions and businesses are above board and transparent. These rules/regulations/oversights created a friendly and safe haven for investments in businesses by our own citizens and foreign entities alike.

If this "faith in a system" standard diminishes, the investments from within and abroad will certainly have second thoughts. Our standards of accountability have fallen and so will the Nation if this continues to spiral out of control.



I refer to post #157 very last paragraph, by Clifford decker.

"""The entire system of OligarchicAmerica should be thrown out by the people instead of requiring the people to fund the same. Capitalism and the free market are sick and near-dead. """"

I say Let the system crash and burn, so we may rise out of the ashes of this antiquated system,of criminal,fradulant,corrupt elite rich control, give the country back to the american, the other 300 million of us.

Rohit Pillai

Why is everybody surprised at this turn of events? Does nobody read John Kenneth Galbraith's 'A Brief History of Financial Euphoria' any more? The sort of thinking that leads to such crashes is clearly explained in it.

Perhaps the question should be "Does anybody read at all?"

Tom Altman

To argue that the current crisis was caused by having a Republican in the White House (with a philosophy of deregulation), or that it would have been avoided by having a Democrat there (with a philosophy of greater regulation), is to pick up the worst of the over-simplified noise from the current political campaign. It's not accurate and it's not helpful. The problems didn't come from rolling back any regulations and no one has yet shown how any new or stronger regulation would have helped.

Everything I can find suggests that the fundamental issue wasn't too much or too little regulation, but bad legislation and bad regulations, which set up inappropriate incentives and thereby triggered unanticipated responses.

John Steele Gordon is clearly on the right track, though perhaps a bit overfocused on one key element. The fundamental issue can't be "Wall Street greed" -- as long as we are human, greed is always with us, and it certainly isn't confined to Wall Street. Rational human beings, even greedy ones, don't loan money they don't expect to recover. So something more fundamental initially triggered the excess.

Think of it like a fire. Something started the fire, other things kept us from seeing it at first, then still other things helped it spread into a conflagration.

The starter was described nicely by personal finance columnist Scott Burns: "The current crisis can be traced to a government policy of the early '90s: Expand access to homeownership by reducing lending standards. It seemed, as they say, like a good idea at the time. The idea was embraced by Democrats, Republicans and Alan Greenspan. It was also embraced with great enthusiasm by everyone who could make a buck on it — Wall Street, mortgage lenders, mortgage brokers, rating agencies and home buyers. So it went way too far."

Among the starters we had the Community Reinvestment Act, compelling banks to lend to borrowers who wouldn't otherwise have qualified and often couldn't repay them. We had Fannie May and Freddie Mac, quasi-governmental quasi-private entities that were explicitly incented to take outsized risks: any gains went to the shareholders, any losses would be backstopped by the government and taxpayers. With the Federal Reserve holding interest rates so low for so long, credit was widely available and Fannie and Freddie amplified that by being able to borrow at rates even lower than market. That combination of incentives lead naturally to the housing bubble.

Unfortunate regulations also delayed our detecting the fire. Wall Street firms had only half the financial analysts they did in 2000, largely attributable to Eliot Spitzer's heavy-handed "restructuring" of the industry. My understanding is that many of those people went to hedge funds and other places where their analysis wasn't made public, and we didn't hear them when they tried to blow the whistle on the excess; note that hedge funds, which did have the benefit of their insight, have had either smaller problems or have unwound them more uneventfully than the big firms.

In the name of "helping," regulators also limited short-selling, another classic mechanism for helping detect and deflate bubbles.

The accelerants spreading the fire certainly included greed, as those seeing an opportunity to profit from the badly aimed incentives creatively took advantage of them and carried subprime mortgages, etc. well beyond what anyone initially envisioned. As long as the housing market rose, it looked good.

A second accelerant kicked in once the housing bubble burst: so-called "mark to market" accounting, added among the regulatory over-reactions after the Enron scandal, which required financial institutions to downgrade loans on their books below their likely actual value. As one analyst noted, a 20% drop in the value of housing is clearly significant, and loan defaults clearly rose, but to have to mark those assets down nearly 100% as a result was clearly an over-reaction, which speeded the downward cycle.

So it seems to me there is a lot of "Freakonomics" involved here and we need to take those lessons seriously, rather than simply shouting about more or less regulation. Incentives matter -- a lot! Attempting to set/control incentives effectively is very difficult. Good regulation can help markets run better -- most agree we are less likely to have a true crash today than in 1929 due to some good measures now in place -- but bad regulation can have disastrous, unanticipated consequences, so we need to be very careful about propagating those regulations.

On Fannie and Freddie: why we would ever have wanted them incented to take oversized risks is beyond me. That was clearly an invitation to disaster! No one ever expected it would get this large, or be this bad. But that's the point: setting up such cockamamie incentives in the first place was a fatally bad idea.

So it wasn't just Fannie and Freddie, but they absolutely _were_ key players in this, and truly classic examples of how bad law and bad regulation can cause problems. (And of how political and economic incentives can work at cross purposes.) Wall Street over-reaction certainly played a role in this, but the crisis as we are experiencing it wouldn't have happened -- or would certainly have been far less impactful -- if not for badly designed incentives inevitably leading Wall Streeters astray.



Its a total disbelief what has been allowed to occur in this market place causing this "crisis" , funny how every other week we end up uncovering another crisis,mortgage,energy,jobs,deficeits,wars,terrorism. so far the 2000's have been the years of crisises. it blows me away at the fact such a large number of people ,investors,brokers, moved such large amounts of money out of money markets, all in a couple of days.

Major message in that move in itself. figure it out.

i gather that this move seems to be the trigger for this latest 'bailout'. Major money movement from a stable area. Where did they move it to? hmm oil?

we have two options, first some form of 'bailout' or second we let the market run its natural economic dynamic course. and if its destine to crash , let it do so. Figure out what to do and reform it. unfortuately the latter is the most destructive to the country and even to parts of the world.

as of today. i do not have any money in the money markets. where is it safe?



I have a question:

Are the links posted here at all vetted for correctness and bias? The link to the website seems extremely questionable to me; as the comments there indicate the methodology is flawed, the data is partial, and I for one do not understand how employees' personal contributions measure influence of the company.

Besides, this article makes no sense to me. Starting with an attempt to explain the financial crisis, the writer jumps into why Freddie and Fannie are corrupt and greedy. Did I miss a point where it was explained how that caused Lehman and Merril Lynch and AIG into trouble? If I remember right, the cost of rescuing Fannie and Freddie was about a tenth of what the current rescue plan for the Wall Street in NY is supposed to cost.

I'd come to expect some standard of quality from this blog. I guess I was wrong.

wolf snout

With all due respect I feel I must challenge the notion poverty and homelessness notion of non existent. I have returned from spending the last five years in the great state of Calif.

In the north (S.F) all of the rest stops there are filled not with weary travelers seeking a short rest, there are countless numbers of homeless individuals that actually do have jobs but can't afford the high first&last month rent and deposit requirements to move in. I know they are there because I was one of them for over three weeks.

The same was true in L.A. when I went south to seek work. Again the rest stops had the same feel of familiar over night parking. One starts to keep an eye on one's surrounding in situations such as these. Cars became identifiable as people tended to park in their "usual" spots. Sleeping in a car for an extended period of two or three weeks is extremely humbling indeed.

People are not concerned whether ATM's continue to work or not, they have no money left to take out or put in. Jobs are hard to come buy and without an address, what are you going to do?

I have a B.S. from a Calif. Univ., but even with the degree it is difficult to get hired. I am starting to look like that "gray haired, wrinkly dude" and people don't want to hire you. Sad.

I now live in a small community in the bible belt. I do volunteer work with the "older" people and survive with the senior nutrition program. I still have hopes of finding another job, and I hope it is soon, winter is starting to move into the plains....

Who cares about a $700 billion dollar bail out,I could use $1,000.00 bail out, but nooooooo!



Mr. Gordon may have his way with lots of financial figures, but he seems to have lost his view of the forest.

First, Donna and others are right. We actually have increasing poverty in this country. A family with a TV and even a car may still be starving; our material wealth, and the fact that children are not reared on consistently starvation diets, hides this poverty from the rest of us. This is no less true in the 2000s than it was in the 1960s, when The Other America became popular -- and the number of poor and even starving people is growing.

Second, pinning this whole debacle on FNMA and FDMC is simplistic and, in many ways, dishonest. About 20 years ago, folks in commercial and investment banks decided that plain and simple hedges were separate products of their own. And thus -- without any fundamental economic benefit to the market -- they created a mammoth global commerce in the hodgepodge of largely unregulated and unreported things loosely called "derivativates."

Securitized mortgages are only one part of this shady market, but their shakiness has exposed the fundamentally unsound basis for the entire set of Emperor's clothes.

Mr. Gordon not only ignores this ball of jello, he pretends as if Congress and the White House hadn't actively sought to shelter it from any exposure or regulation.



Really?...Fannie and Freddie at the heart of this? I only read the first 50 comments or so, and i know I'm reiterating a lot of points, but just add my 2 cents...bull-***t. The author fails to connect Fannie and Freddie to the insolvency of major financial institutions. He fails to address the complicity of commission driven professionals like Realtors and mortgage brokers and investment managers. He fails to address inflated appraisals, a corrupt ratings systems, a culture of easy credit, a false-premise of ever-increasing house prices, doe-eyed home-buyers leveraging their assets at the same 30-1 ratios as the Lehmans of the world. Not to mention a zealous de-regulatory culture that has been stewing alongside the zealous neo-con foreign policy of the past 30 years.

In the spirit of Comic-Book Guy...


Paul Habib

Regarding # 84: "I believe this is all deliberate." Indeed.


Ummm...why are you comparing 2008 unemployment with 1933? The more likely scenario is that this crash may precipitate 1933-level unemployment--in 4 years. Pre-crash unemployment in 1929 was also around 5%.

We may be at 1929, not 1933 as the author suggests. By most standards, the pre-crash 1929 economy was also sound.