Fascinating and informative article by Michael Lewis about the ultimate collapse of Wall Street, brought about (at last) by the insane financial models created by the mortgage industry. I'll quote from the opening, since it sets the tone very well, but the whole article is an A+, and more than worth reading. It's interesting, and it gives a lot of insight into the what's and why's that went into creating the current financial crisis.
To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital -- to decide who should get it and who should not. Believe me when I tell you that I hadn't the first clue.
I'd never taken an accounting course, never run a business, never even had savings of my own to manage. I stumbled into a job at Salomon Brothers in 1985 and stumbled out much richer three years later, and even though I wrote a book about the experience, the whole thing still strikes me as preposterous -- which is one of the reasons the money was so easy to walk away from. I figured the situation was unsustainable. Sooner rather than later, someone was going to identify me, along with a lot of people more or less like me, as a fraud. Sooner rather than later, there would come a Great Reckoning when Wall Street would wake up and hundreds if not thousands of young people like me, who had no business making huge bets with other people's money, would be expelled from finance.
...In the two decades since then, I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility.
The article goes on to weave together a tale of incompetence, greed, group-think, jaw-droppingly lax regulation, Ponzi-esque pyramid schemes marketed as AAA-rated investments, and much more.
On a local level, every bank was basically throwing mortgage loans at anyone who asked, while knowing the only way those loans could ever be paid back was if the lendees were able to flip their bubble-priced houses to some other other would-be flipper. Which is fine, in theory, but who was the 2nd (or 3rd, or 11th) flipper getting their ever-increasing mortgage loan from? At some point prices had to flatten out, or decrease, and what then, when the people getting the loans were clearly not able to afford the actual monthly payments? It's easy to see why individuals didn't think about that, or chose not to think about it, but financial institutions are supposed to be staffed by economists and people trained in finance. They're not supposed to play the housing bubble casino and hope for the best. (This is an easy question to answer; just look at the opening of Lewis' article and consider that he got a job with a large and prestigious investment firm. Then imagine the sorts of clueless fools your local bank had on the staff, or the boiler room home loan companies you used to see ads for on late night TV?)
Those (inevitable) losses were enough to ruin the credit ratings of countless now-houseless buyers, and to severely impact the profit margins of the stupid banks who gave them the loans. None of that would have brought down Lehman Brothers and the rest, though, nor would it have precipitated the stock market crash that has cost most investors 30-50% of their net worth over the past few months. That doom required the enthusiastic madness of Wall Street firms inventing new ways to profit by, and multiply the effect of, the reckless mortgage lending practices. Lewis spends much of his article examining that issue, through a profile of Steve Eisman, one of the very few investors who saw the crash coming well in advance.
Whatever rising anger Eisman felt was offset by the man's genial disposition. Not only did he not mind that Eisman took a dim view of his CDOs; he saw it as a basis for friendship. "Then he said something that blew my mind," Eisman tells me. "He says, 'I love guys like you who short my market. Without you, I don't have anything to buy.'"
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. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. "They weren't satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn't afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That's why the losses are so much greater than the loans. But that's when I realized they needed us to keep the machine running. I was like, This is allowed?"
This particular dinner was hosted by Deutsche Bank, whose head trader, Greg Lippman, was the fellow who had introduced Eisman to the subprime bond market. Eisman went and found Lippman, pointed back to his own dinner companion, and said, "I want to short him." Lippman thought he was joking; he wasn't. "Greg, I want to short his paper," Eisman repeated. "Sight unseen."
The whole issue remains impenetrably complicated (especially what needs to be done to fix it), but this article helped me understand. More. Better yet,
this post by Kevin Drum was where I saw the link initially, and in the comments some clever financial types do what they can to explain things in semi-laymen's terms.
Labels: business
