Grab a coffee. Or a strong drink.
This is your “must read” for 2008.
Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.
But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.
As an investor, Eisman was allowed on the quarterly conference calls held by Moody’s but not allowed to ask questions. The people at Moody’s were polite about their brush-off, however. The C.E.O. even invited Eisman and his team to his office for a visit in June 2007. By then, Eisman was so certain that the world had been turned upside down that he just assumed this guy must know it too. “But we’re sitting there,” Daniel recalls, “and he says to us, like he actually means it, ‘I truly believe that our rating will prove accurate.’ And Steve shoots up in his chair and asks, ‘What did you just say?’ as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him.”
“With all due respect, sir,” Daniel told the C.E.O. deferentially as they left the meeting, “you’re delusional.”
This wasn’t Fitch or even S&P. This was Moody’s, the aristocrats of the rating business, 20 percent owned by Warren Buffett. And the company’s C.E.O. was being told he was either a fool or a crook by one Vincent Daniel, from Queens.
A full nine months earlier, Daniel and Moses had flown to Orlando for an industry conference. It had a grand title—the American Securitization Forum—but it was essentially a trade show for the subprime-mortgage business: the people who originated subprime mortgages, the Wall Street firms that packaged and sold subprime mortgages, the fund managers who invested in nothing but subprime-mortgage-backed bonds, the agencies that rated subprime-mortgage bonds, the lawyers who did whatever the lawyers did. Daniel and Moses thought they were paying a courtesy call on a cottage industry, but the cottage had become a castle. “There were like 6,000 people there,” Daniel says. “There were so many people being fed by this industry. The entire fixed-income department of each brokerage firm is built on this. Everyone there was the long side of the trade. The wrong side of the trade. And then there was us. That’s when the picture really started to become clearer, and we started to get more cynical, if that was possible. We went back home and said to Steve, ‘You gotta see this.’ ”
Eisman, Daniel, and Moses then flew out to Las Vegas for an even bigger subprime conference. By now, Eisman knew everything he needed to know about the quality of the loans being made. He still didn’t fully understand how the apparatus worked, but he knew that Wall Street had built a doomsday machine.”
[…]
That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower.
h/t to Bernie.
Update – Lots of excellent commentary in the comments, plus this via email from the Captain –
“Wall Street was an inefficient market (economics term for a market that does not accurately reflect true information, and thus true prices/values). Wall Street, for all it’s glamour and glory was basically an elitist’s club where blue bloods and Ivy Leaguers who never really worked a day in their lives all of the sudden got six figure jobs because of their daddy (Chelsea Clinton is a perfect example, how does a 26 year old child get a hedge fund manager position?)
Do these people know how to allocate capital? Do they know what they best investments are? Of course not.
Which is why it should be no surprise the markets are off 45% and none of the “Bulge Bracket” elites remain in their previous form.
If anything, it is proof positive that the “best” and the “elite” are nothing more than spoiled brat nepotists who achieved their “elite” status through inheritance or no feat of their own and is why the system ultimately is crashing in that they have no inherent value or wealth production abilities.
The scarier part is that more or less the entire $35 trillion world economy place their faith in these frauds and is why we’re all in for a world of hurt.”
That was the most fascinating article I’ve read in some time. I was particularly gobsmacked by these two bits:
In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000.
Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism.
What worries me now though are the repeated calls for America (and the West generally) to turn its back on capitalism and change to a much more socialist society. That would be a tragic mistake.
What has gone off the rails is not Capitalism, but Capitalism WITHOUT ETHICS. The solution is not to move away from Capitalism altogether but simply to severely penalize those who choose to operate without ethics – including and perhaps especially the ratings agencies like Standard & Poor’s and Moody’s.
Many of us in the general public are shocked that anyone has been able to legally act so unethically in the first place but such is the case. Greed has corrupted a great many. Now it’s time for them to pay the price … that is if they haven’t bought off too many of those who will be judging them. So I hold out little hope that the guilty will ever suffer anything more than a slap on the wrist.
amazing. creat paper, assign a value and call it an investment. fraud??????
No Robert, it’s capitalism with personal consequences that has gone off the rails. Bailouts and buyouts are only exacerbating the problem. What we need to see is some jail time, and some people spending the next few years paying back what they owe – from the Mexican strawberry picker to the CEO.
Its a good thing that in a money supply driven financial crisis we don’t have a Liberal demagogue with Totalitarian Guevarist admirers in the White House.
Or, as we say in the online donation business:
Hail to the Thief.
This financial crisis hilites the problem with a fiat currency.
With a fiat currency, ie the unlimited ability to print more and more dollars just gives the politicians and friends more reasons not to make hard choices or make good value judgements.
With a limited money supply, everyone is required to make the best use of the available dollars in their situation. And hard workers are rewarded with quality money that can buy goods.
A gold standard/fixed basis for currency forces people, and governments in particular, to make better decisions.
Anybody for smaller govt?
Vote for a gold standard money system, or some suitable substitute.
Ron Paul has it right.
Robert W said-
“What has gone off the rails is not Capitalism, but Capitalism WITHOUT ETHICS.”
Not actually. What went off the rails was the Dems, (with help from the RINOs), skewed the market by forcing lenders to create continually more sub-prime loans, BY REGULATION! At the peak, Fannie and Freddie were REQUIRED to have 42% of loan volume to sub-prime lenders. To meet this sheer volume of funding, a $40,000 trailer just didn’t cut it. Hence the $720,000 sized loans with vicious ARM’s attached.
Given that REGULATION also required that these loans be sold off, (to generate the cashflow to be able to sell MORE sub-prime loans), regulators effectively FORCED banks and near banks to accept this doggy doo.
Just as you would do if forced to keep a couple of hundred pounds of doggie doo in your house, instead of putting it in the hottub so your neighbours could smell it, they put it in the freezer instead, and tried to sell it to someone else.
The market ALWAYS works, if left alone. The problem is, people that like big government don’t like the workings, OR the results.
No Robert, it’s capitalism with personal consequences that has gone off the rails.
That’s exactly right Kate. However, we also need to address the “fatal conceit” of central banking as practiced by former wizard, now clown, Alan Greenspan, and explore some form of “free banking”.
Central banks skew the incentive structure and cause malinvestments when interest rates are artifically low, as they were in 2003 when Greenspan pushed the Fed rate down to 1%, well below inflation.
This disaster has much to do with a politicized Fed fighting a recession “tooth and nail” for it’s political masters. Sadly, the delayed but inevitale recession is much, much worse.
Once upon a time you dressed so fine
You threw the bums a dime in your prime, didn’t you?
People’d call, say, “Beware doll, you’re bound to fall”
You thought they were all kiddin’ you
You used to laugh about
Everybody that was hangin’ out
Now you don’t talk so loud
Now you don’t seem so proud
About having to be scrounging for your next meal.
Let’s see if you can accept the truth. Who controls wallstreet? Jewish bankers? People control the stockmarket. Not anyone of you on this blog.
Granny! Take that money from your mattress an oblige Mr.Drysdale.
That’s the best commentary yet on this entire fiasco. The real failure is the $700 billion bailout. I plan to send the article to my representatives. The horse has bolted the barn but it’s not too late to break out the shotgun.
The gov’t should gurantee all pensions. They guarantee their own. Do you think Harper will give up his cushy gov’t pension? Not in this life. Niether will any MP or MLA. Their’s are guranteed.
You fools on here still think a totally free market works? You guys are the worst need of a BJ than any white guys I know.