Goldman Sachs and the Broken Windows Theory

In 1982, James Q. Wilson and George Kelling published an article in The Atlantic called “Broken Windows.” The article argued that failing to stop small crimes and acts of vandalism, such as broken windows, emboldened wrongdoers and led to bigger crimes and unlawful behavior. Criminals realized that if small crimes were ignored, larger ones were likely to be as well.

Wilson and Kelling argued that by acting to prevent the smaller crimes, enforcement agencies would help stem larger crime. A few years later, New York City, in consultation with Kelling, began to implement a crime enforcement approach based on this theory. The approach had many critics -- especially among liberal circles -- who argued that such enforcement was disruptive to communities and too discriminatory to minorities because it unfairly singled out individuals when “everybody was doing it.”

I moved to New York City 24 years ago, prior to the change in police tactics, when the city more closely resembled The Warriors or Escape from New York than Sex in the City. I was always on alert for the potential to be mugged, and amazed at the apparent lawlessness of the streets and subways. I had no doubts that stopping petty crime would have an immediate and positive impact on my life.

Eventually the new police enforcement techniques led to a tremendous reduction in crime, which many locals had considered unstoppable. All neighborhoods had an opportunity for revival and economic growth that had been unthinkable just a few years earlier.

The run-up to the financial crisis had its share of vandalism and broken windows.

A speculative real estate bubble grew rapidly, rating agencies appeared to be unable to distinguish between good or bad mortgage-backed securities or collateralized debt obligations, and certain investment banks seemed to treat the credit default swap market like the Wild West. Some of these issues were apparent prior to the crisis in 2008, and many more have been uncovered since that time. The previous administration seemed determined to deny the existence of any problems prior to the collapse of the markets -- and even as the crisis was unfolding.

In 2007 and 2008, Treasury Secretary Paulson and others asserted, on a number of occasions, that “the sub-prime problem was contained.” The current administration seems determined to “move on” and put the crisis behind us, despite many lingering questions about how the crisis happened and who was responsible. While many citizens in the country lacked a clear understanding of the details of the CDO or mortgage markets, they understood the unfairness of the bank bailouts and seethed at the billions in bonuses paid by the banks who had been saved by taxpayer money just a year earlier. But despite the occasional tough talk, the administration and Congress behaved indifferently.

I worked in the mortgage-backed security and CDO markets for twenty years. My prior company and job were blown up by CDOs, and I’ve felt a tremendous degree of guilt for my role in the crisis. In an effort to understand my mistakes, I devoted much of my newfound free time to researching and analyzing the CDO and mortgage markets. My goal was to expose practices that contributed to the crisis in the hopes of potentially identifying some wrongdoers and deterring future bad behavior.

Over the past several months, in posts at the financial website NakedCapitalism.com and in various meetings and consultations, I’ve questioned the government’s actions in bailing out AIG, Goldman’s apparent predatory behavior in the CDO market, and the questionable behavior of large institutions like TCW and BlackRock (links here, here, here, here, and here). But beyond a small group of like-minded journalists and bloggers, few people seemed to care or make the connection between CDOs and the financial crisis.