Down below, off the left hand side of the aircraft, you can see Main Street

I’m still trying to figure out the intellectual delusion which infected Wall Street and convinced banks that subprime mortgages were AAA.  I understand the concept of pooled risk – it’s why we should have universal health insurance – and can accept that collateralized debt obligations can serve useful ends.  What I don’t understand, however, is how anyone with common sense believed that families with low-paying jobs or individuals who did not report their income or individuals with poor credit scores could represent safe investments.

In fact, it was clear to a lot of people for a long time that the gee-wizardry was intellectually bankrupt.  This article in the Washington Monthly does a great job explaining derivatives (tangential to mortgage backed securities but deriving from the same high-finance-is-God mindset) and their potentially devastating effect on anything they touch.  I say potentially because Byron Dorgan wrote it in 1994.  New York Magazine has just published an article written by Michael Osinski, the smart father of the computer programs which facilitated this binge.  (I don’t blame Osinski at all for the current crisis: Do we blame Einstein for nuclear weapons?)  I can’t remember where, but I recently read an article about two men and their investment groups who made a killing off of the turmoil.  Their secret?  Common sense coupled with actually visiting some of the exurban developments fueling the mortgage backed securities.  (Goldman Sachs, at the end of 2007, and Nassim Taleb also profited from common sense.)  In other words, the two investors, whose names I cannot remember, actually went out and tried to understand the concrete nature of their product – what a revelation!

The way I conceptualize it – and I could be completely wrong since I have no experience with Wall Street – is that the investment banks and the men (and some women) who work there form a large echo chamber with little exposure to the concrete world.  (Cable news fits this description too.)  Analysts work 100-hr weeks and therefore have no free time and barely any to eat, sleep, poop, or take stimulants.  The hours get more tolerable as the burn outs leave, but you’re still talking easily 60-hour weeks.  And of course, the free time those at the top do have is most likely spent on a golf course, vacationing at a resort, or at a retreat in Vermont, all places where they will find themselves surrounded by their peers (or similarly wealthy lawyers, doctors, executives, and celebrities).  So in that world, you either don’t have the time to read about the rest of the world and get a holistic understanding of your investments, or you surround yourself by people whose ideas hardly deviate from yours.

Of course, this broad stroke does not describe everyone on Wall Street.  But it describes enough, and definitely those with decision making power, to be important.  When you walk around in suits more expensive than most monthly mortgage payments and your airplane tickets cost as much as many people’s car, it becomes cognitively difficult to pull back and understand life from a normal person’s perspective.  Worse, if you summer in Southhampton, you probably think “normal” is wintering in Florida (instead of no vacation at all).  Of course, I admit I may be completely wrong, but I do believe it is very difficult to understand a financial product if one cannot picture and grasp the asset(s) behind it.  For our financial system, financial products became meaningless numbers on a sheet creating more numbers and lost sight of their origin in real product.