Money, Greed, and Risk: Why Financial Crises and Crashes Happen

1. Collaterized Mortgage Obligations grew to $1 trillion by 1993, 500 times the size of the Junk Bond melt down, valued at $22 billion and in 1994-96, the CMO market crashed. 2. The second most important financial instrument over the past half century has been the residential mortgage. In 1996, the outstanding value of residential mortgage was about $3.8 trillion. If fund manager fear getting stuck with illiquid investments, they will demand higher interest return. In the case of mortgages, these returns are passed on, as higher financing costs for home buyers, fewer sales, and less construction activity. 3. Freddie Mac and Fannie Mae are private corporations supervised by government. They are authorized to buy high-quality conventional (non-federally insured) mortgages with principle amounts geared at middle-income buyers. They raise money for financing on the private market. Only Ginnie Mae has obligations guaranteed by the government. 4. Saving and Loan falter as higher interest rates in the 1970s cause mortgage values to devaluate. Because of S & L accounting practices, losses did not have to be recognized on the book until the mortgages were sold. So S & L stopped selling, which meant they had no cash to lend, and no new mortgages for Salomon Brothers to trade. St. Germain S & L legislation allow S & L to spread their losses over forty years. 5. A mortgage backed security is a long-term security, and its value is affected by changes in interest rates. About half of the thirty-year mortgages are prepaid by about the twelfth year, and after fifteen years or so, prepayments drop off sharply. When rates rise mortgage backed fall. When rates fall, homeowners prepay, so the fund managers find themselves holding an unexpected slug of cash that has to be reinvested in low return environment. 6. In the 1970s, Freddie Mac introduced the Guaranteed Mortgage Certificate (motorcycles) which guaranteed interest and principal and the timing of cash flow which made the risk of prepayment moot. The problem with motorcycles was the more risk Freddie Mac removed from investors, the more it was taking on itself. Loss of expected cash flows might make it impossible to service the Motorcycles cash flow guarantees. The solution was to break the device into three tranche types: slow, medium, and fast pay. The affect, Wall street could get paper with maturity and payment predictability like short term treasury notes. Interest rates on each tranche type was based on the risk of prepayment; the medium-pay tranche would have more prepayment risk than the fast-pay. The birth of the CMO. By the 1990s, about two-thirds of all mortgages were securitized and resold, about half were CMOs. By 1987, the average mortgage spread over comparable maturity treasuries was 1 percent. The annual savings to home owners was an estimated $17 billion a year. 7. S & L usually retained most of the mortgages they issued, but whenever mortgage growth outran i

Mr. Morris book provides a very readable survey of financial crisis which occured during the last 150 years. The real value of this book lies Mr. Morris's commentary which draws into focus the fundamental similarities between seemingly unrelated financial disasters. It is banal to observe that the future is likely to include some as-yet unforseen financial meltdown. Armegeddon-peddlers, chicken-littlers, and perpetual bears have been saying this for centuries. It it brilliance on the part of Mr. Morris to explain exactly why this is the case.Mr. Morris debunks the garden varieties of conventional wisdom, which variously held that financial crisis are "caused" by currency speculators, Michael Milken, junk bonds traders, Jews, computer trading programs, etc. Mr. Morris demonstrates that all crisis run a predictable course: economic innovation and growth, corresponding financial innovation provide capital to fuel the growth, over-shoot of valuations of the new financial mechanisms by financial markets chasing high yields, and the invevitable crash and ensuing chaos.The USA Savings and Loan debacle, Asian currency crisis, British investments in post Civil War USA railroads are all shown as variations on this theme.I did not award 5 stars because the book often delves into complex financial mechanisms which could have been explained in a more layman friendly manner.

An excellent book for the serious investor who wants historical perspective on the market changes happening today. It's added gift is that it will imbue its reader with the knowledge to preserve wealth and actually profit whenever the next financial crisis comes, since the author proves that there is not much new in modern crises, and their prescriptions, that couldn't be found in crises a hundred years ago. The author serves the reader well by constantly pointing out the irresponsibility of the nation's bankers and financial institutions especially when motivated by greed- "the opportunity to fleece the greedy proved irresistible," The author possesses the rare skill of being able to see the wood for the trees and of relating that to his readers. The foreword is right on.

I found myself continuously amazed at the insights that Morris shows in his analysis of US financial markets and in their basic similarity over 150 years -- similar but more complex. I have been a student of financial markets for over forty years and I confess that I found insights being expanded consistently. As I read I kept thinking "What a great critical summary!"