By Bob Dowling, Caijing editorial adviser

Americans are angry -- at least angry as they were after the 9/11 terrorist attacks on New York and Washington. But this time their anger is diffused. They are still not sure how many individuals or who to blame for the subprime crisis and the related destruction of US$ 45 trillion in global wealth – an amount four times the size of the American economy.

With each new disclosure, Americans fume at financial executives who walked away with multimillion-dollar fees and bonus payments. From those who profited by manufacturing and selling what are now nearly worthless investments, they want accountability. But that may never come.

Unlike the quickly identified 19 terrorists and the al-Qaida camps that trained them, the perpetrators of the subprime crisis were Americans working at many levels, from mortgage brokers in offices across the country who issued faulty loans, to chief executives at Wall Street firms that supplied capital and sales forces to repackage loans and sell them worldwide as triple-A rated debt securities. Meanwhile, Washington regulators were sleeping on the job, and leaders such former Federal Reserve Chairman Alan Greenspan, who did not want to burst the housing bubble, preached that subprime lending was a good thing because it spread risk globally.

Americans know the names of the leaders who ran the large Wall Street firms, from Citicorp and Bank of America, to Goldman Sachs and Morgan Stanley. They also know that, like Greenspan, they were promoting subprime securities and byproducts right up to the Great Collapse in the fall of 2008. They also know that many Washington politicians were cheering on the binge and that many, such as U.S. Sen. Christopher Dodd and U.S. Rep. Barney Frank – who are leading investigations of the crisis -- also benefited from large campaign contributions from the same firms they’re now bailing out and investigating. While this is not technically illegal in America, many in China will recognize these practices as the same kind of cronyism that American officials frequently complain about in China. Suddenly, the differences between the two countries are not so great.

All this means that investigations and bailouts to help save the United States and the global financial system are still at early stages. A positive signal was a rally for U.S. stocks the week of March 9-13, meaning that some investors think single-digit share prices for companies such as General Electric are just too good to pass up, and that the bailouts and rescues may be beginning to work. However, stock prices often begin moving up a year or more before an economic recovery gets under way because investors don’t want to miss the boat if an upswing starts.

Fixing the economy in America and making it healthy enough to pull up the global economy could take several years or more. The damage has been so great -- estimates are that US$ 45 trillion worth of world wealth vanished, and millions have been left bankrupt and unemployed – that many wonder how the crisis got so out of hand. That translates into questions over who first saw this crisis developing and why something wasn’t done earlier to slow it.

One of the earliest to see the danger ahead was New York author Charles R. Morris. In early 2007, he started work on a book called The $1 Trillion Meltdown. It was published in March 2008. Morris spelled out, using clear definitions, the seven kinds of securities that were dangerous. He also estimated the size of their threat. A former banker and lawyer, Morris guessed even then that his meltdown estimate was too low. Now an updated version called The $2 Trillion Meltdown is being released in China.

In a March 13 interview with Caijing, Morris explained why he was driven to write about the crisis before others. At the time, he was working with software that helped Wall Street firms package subprime debt. He noticed a huge increase in activity, then rushed to complete his book in just nine months. Today, the 70-year-old author remains deeply cautious about the future, believing it will be years before the mess is cleaned up. He thinks there is a 1 in 5 chance that the crisis will lead to a global depression. Unlike Greenspan, who has called the crisis a “once-in-100-years event,” Morris thinks it was a cyclical boom like many in the past that could have been stopped by regulators in 2004. He fully blames Greenspan for arguing that an increase in derivative securities would lower rather than raise risk. “It was crazy,” Morris said.

The performance of U.S. rating agencies that stamped the debt AAA “was a disgrace,” Morris adds. And he thinks the “little guys” who made bad loans will be prosecuted, but that the “big guys at the top of the firms” have already “rigged” the law to “get off” because they “are very careful about covering their tracks.”

Looking at possible lessons for China, Morris said he thinks open markets are still necessary, but that “strong regulation is also needed.” The interview follows:

Caijing: What prompted you to write The $1 Trillion Meltdown, and when did you begin?

Morris: I was president of a startup company that produced big-ticket deal processing software for banks and insurance companies. I could see the growth in demand for tools to assist in securitization, and the growing importance of all forms of credit derivatives, so it was a market I followed fairly closely. I’d also written a book (Money, Greed and Risk, 1999) that traced a number of financial crises.

Each time, there was a wonderful innovation that was pushed too far until there was a sizeable crash. The crash stage was an essential learning process for market participants and regulators before the innovation got incorporated into daily practice.

A credit derivative crash should have happened about 2003 or so.  Instead, it kept growing and growing to ever-more alarming levels.  I started researching for a possible book in January of ’07, found it was even more alarming than I thought, and did a handshake deal with the publisher in March ’07.  It was finished in late November ’07 and shipped by the end of January.

Caijing: You now have a sequel, The $2 Trillion Meltdown. Was that written mainly because your first estimate of the cost was too low, or did your thinking about the crisis change as well?

Morris: It was the scheduled paperback version, a year after the hard cover. I made a number of updates throughout the text, and it was clear that we needed to update the title as well.

Caijing: Why were so many within regulatory authorities and in the markets so unaware of what was happening?

Morris: Alan Greenspan, for one, saw clearly what was happening and thought it was for the best. The Chicago (University of Chicago) schoolboys describe an ideal “complete market” where every risk has a “contingent claim,” or what’s called a financial derivative.

The idea is that, in a perfect market, all risk will migrate to the most suitable holder. And in heaven, that’s true. So he saw the huge buildup in derivative exposures not as a cataclysmic increase in leverage, but as a diminution of risk. It was crazy. He gave speeches in that vein and argued expressly that regulating these things would only increase risk by interfering with markets.

Caijing: How far along do you think the U.S. and other governments are now in repairing the damage?

Morris: They’ve hardly started. Throwing money at the wall is actually sensible for the time being, to prevent a total freeze-up.  But that’s just temporizing. There is at least another US$ 1 trillion in toxic assets on bank balance sheets, and huge overhangs of misallocated resources. The damage cleanup will take years.

Caijing: Is there still a risk of global depression?

Morris: Yes. I’d say the risk is 1 in 5.

Caijing: How do you think the Obama administration has handled the crisis so far?

Morris: It’s too soon to tell. Certainly, Wall Street’s complaints that he hasn’t “fixed” it yet ring pretty hollow. They’ve blown up the entire world economy, most of them still collecting excessive pay and complaining that the firemen are taking too long and leaving a mess.

Caijing: Some say the subprime crisis can’t really be explained to the public because things like SIVs (structured investment vehicles) and their uses are too arcane. Your comment?

Morris: A lot of people, including the press, aren’t willing to spend the time, because it’s less work to spin sound bites.

Caijing: The American rating agencies -- Standard & Poor’s, Moody’s and Fitch -- assigned their highest AAA rating to the subprime securities. They are now downgrading these same securities to junk bond levels. What is your view of the value of the downgradings and the future role of ratings agencies in the global financial system?

Morris: The rating agency performance was a disgrace. The ratings systems themselves make little sense once you look behind the curtain. There is little correlation between the rating of different classes of financial instruments and their risk of default – like marking on a curve. Investors shouldn’t buy things that they can’t make a judgment on themselves. Individual investors who can’t do that – which is most of us -- should stick with index funds.

Caijing: Most Asian nations and China did not load up on subprime securities such as collateralized debt obligations but are now suffering from the collapse of the U.S. economy. Is there a way for them to be more insulated from future shocks, or are they destined to live and die by Wall Street?

Morris: I thought China might move even faster than it now seems to be doing, to decouple from its export dependence. It needs to modernize its banking system to the point where it has its own consumer economy. Using the U.S. current account deficit as an economic crutch is dangerous. As a transition, fine. But make it fast.

Caijing: Many have urged China to develop open securities markets like those in the U.S. Yet China was as blindsided by this crisis as most other countries. What advice, if any, would you have for China’s leaders?

Morris: China needs open markets, (but) not necessarily like ours. Above all, it needs regulation of markets.

Caijing: Some officials such as former Federal Reserve Chairman Alan Greenspan and current Chairman Ben Bernanke have cited a “global savings glut,” in part driven by China, as the culprit for the crisis, meaning too much cheap money flooded into the U.S. Were there alternatives to this condition?

Morris: Global savings were roughly flat in the 2000s. China was not the culprit.

Caijing: Was this, as Greenspan argues, a “once-in-100-years event,” or should individual blame be assigned?

Morris: He may have helped make it one, but a lot of people saw it coming.

Caijing: Americans who built their retirement and personal savings with Wall Street investments appear outraged by the wealth losses they have suffered and want individuals who created and marketed the subprime securities identified and prosecuted. Do you think that would be helpful, and do you think it is possible?

Morris: Many bad actors made this happen. Most of the bad things don’t fall within criminal law. Some of the little guys will get prosecuted, but the big guys at the top of the firms are smart. They have rigged the process to keep it from being illegal.