The following is excerpted from a Q&A with former Citigroup risk executive and current finance professor Clifford Rossi: “Living Through the Big Short”
Insider’s View To ‘The Big Short’
SMITH BRAIN TRUST – Feb. 25, 2016 — With roles at Countrywide Bank, Washington Mutual, and Citigroup’s consumer lending group, Clifford Rossi had a front-row seat at the housing-bubble implosion depicted in “The Big Short,” up for Best Picture on Sunday’s Oscars telecast. A finance professor at the University of Maryland’s Robert H. Smith School of Business, Rossi says — quibbles aside — the film captured many aspects of the 2008 market meltdown accurately.
Lulled by good times: “The Big Short” focuses on a few renegade financiers who spotted rot in the housing-finance system (with celebrities like Selena Gomez popping up to explain arcane Wall Street instruments like Collateralized Debt Obligations). How could more people have failed to see the looming danger? “The short answer,” Rossi says, “is that in the years leading up to the crisis we had been coming through a very extraordinary period, a period marked by very low inflation, very low interest rates, very rapid home price appreciation and a very benign economic environment.”
Psychology of the crash: He’s come to see the importance of insights from behavioral economics in explaining the crisis — such as the idea that people irrationally and stubbornly assume that recent patterns will continue indefinitely. Rossi didn’t foresee a crash himself, but when he presented executives with newly modest forecasts for housing values (in the zero-to-two-percent range), they scoffed, pointing to charts showing steep climbs in recent past quarters.
Harsher penalties? During the bubble, highly risky securities were rated as safe because banks would threaten to take their business to a rival ratings service if they weren’t given a thumbs up. Ratings companies now “err on the side of conservativism,” Rossi says, but the structural problem of raters getting paid by the people they rate persists. Should bankers have gone to jail after the crisis, as “The Big Short” implies? Rossi saw lots of “bad behavior” and stupidity. “But overt criminal intent? I didn’t see that.”
The president of the Federal Reserve Bank of Minneapolis, Neal Kashkari, who played a role in the bailout at Treasury, recently said that “too big to fail” remains a problem, and that banks should be broken up. Is he right?
Yes and no. There are certainly banks that have come together over time that I would almost characterize as Frankenstein banks: They are so large, so complex that it is so hard for any individual at the CEO level or the chairman level to really know what is going on at that institution. Should they be broken up? It’s very possible that in some very isolated cases the institution might be better off if it were put into smaller pieces that were more understandable, more manageable. I guess I’d say, by and large, the idea of too big to fail will continue to be with us for a long time, with no ready solution.