It’s not too soon to start highlighting the lessons of the Bush Depression as they pertain to us. If nothing else, we must cease advancing flawed ideas and reject gross incompetence to lessen our own pain. So this article is part of a series exploring what’s happened and how we can use it.
The first domino to fall in the current debacle was the under-regulated mortgage market. In a nutshell, mortgages were being wrapped up in big, mass bundles and sold as commodities via networks. The underlying rationale: If you aggregate hundreds or thousands of individual mortgages into a single pool, the failures of any individual loan cannot sink the entire pool. To some extent this makes sense, as a tool to mitigate risk across a large pool of common, known loans. The problem is that the individual loans, and their securing assets (homes) were neither common nor known. Instead these instruments spawned a “mortgage brokering” industry that shopped these products to any and all comers, without ever-fewer checks and balances. By last year appraisers were in on the scam, over-valuing homes to sell loan instruments with far greater risks than claimed. In the end, no one could trust that brokers and banks originating the loans were performing with due diligence. As it became apparent that the problem was widespread, our economy collapsed. We lost certainty in the value of real estate broadly, and lost faith in the profession responsible for it’s valuation. Loans immediately ground to a halt, and the economy collapsed around us.
The take home message is not that networks are bad, but that transparency is essential in networks and reputations matter. The opacity of these mortgage backed securities created the problem, and remain an obstacle to it’s resolution. Transparency is what makes Ebay and Amazon work so well; mechanisms are built in to ensure buyers know what they’re getting beforehand, and compare it’s value to similar goods. A sellers reputation is part of the transaction – no one buys from poorly rated sellers, and Ebay actively works to prevent bad actors from signing up under new names. Even when they come back, there is safety in numbers: a seller with a single 5 star rating is less likely to get a bid or sale than one with thousands of 4 stars and a few rants. Experience counts when it comes to building a reputation.
In the music industry, there’s a long history of opacity. Some of this is a necessary evil in an entertainment business: there’s always a mythical element to stardom, and fans really don’t want to know exactly how the sausage is made. But once the curtain drops, there’s no valid reason for labels to offer opaque contracts with overly broad and vague terms in contracts. There’s no benefit for reviewers to call turds “tootsie rolls” when it damages their reputation. And there’s certainly no benefit to force-feeding faux-products to any human network. In short, the collapse of the mortgage-backed security market has many parallels to the collapse of the music industry.
One other thing important parallel is found in the perils of complexity. In the music business one of the biggest failures has been our ability to make it easy for people to pay us for our work. Licensing is problematic for end-users – it’s often hard to know who to pay what! Some rates are negotiated, others compulsory. We’re lashed to an archaic system that evolved around mutual distrust between parties in a zero sum game.
The music industry has taken big hits based on people’s perception of greed, based not on their direct experiences with musicians, but rather myths spun around stars and star-makers. Not terribly different from the Wall Street crowd in that respect. The majority of local bankers making loans at your local branch didn’t create this crisis. It was Wall Street swingdicks bundling their solid products on the same basis as garbage loans from companies like Countrywide, and individual “mortgage brokers” (kind of like “indie promoters” in radio, eh?) who wrote loans for the closing costs and a quick buck. The weak link becomes the broker who closes every loan with a few thousand bucks in his pocket, regardless of the buyers ability to pay it off.
More to follow!
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