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Oh. My. God. How the econopocalypse happened - Elf M. Sternberg
Oh. My. God. How the econopocalypse happened
Porfolio.com has a long article that explains, in excruiating, on-the-ground detail, how the econopocalypse came upon us: The End of Wall Street's Boom.

If you read nothing else about the stock market, read this. It helps to make sense of it all. It helps to understand how the movement of money through Wall Street, with each layer taking its cut, encouraged the submerged and "shadow" layers to create money on the books out of nothing at all, creating asset futures that they knew would never come due.

It's told from the point of view of Steve Eisman, a manager at hedge fund FrontPoint. Eisman was famous for being a doomsayer, for harassing people looking to deal with the question, "How are you going to screw me?" If the answer satisfied him enough he'd go ahead with the deal anyway. Eisman's company was heavily leveraged into credit default swaps, cheap-shorting the expectation that CDOs would fail. The thing was, Eisman admitted that for the two years his hedge fund rode this wave, he didn't understand where the money was coming from. After laying into a particularly loathesome example of a CDO dealer, the dealer replies:
"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 [the lowest-rated, highest-risk/reward band of a bond investment vehicle - Elf] 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?"

Current Mood: furious

8 comments or Leave a comment
shunra From: shunra Date: November 26th, 2008 08:41 pm (UTC) (Link)
"There weren't enough Americans with shitty credit taking out loans to satisfy investors' appetite for the end product."

That's the hallmark of a pyramid scheme the ones at the top need every-growing masses of people (marks?) to sign on and pay their pennies.

The bailout? Bails out the schemers.
moofinator From: moofinator Date: November 26th, 2008 10:03 pm (UTC) (Link)

Not just bailing out the Schemers...

Remember, the schemers have already gotten paid. They were making hundreds of thousands of dollars a year during the boom. They successfully transferred the risk onto Main Street, onto Fixed Income, retirement investors, pension funds.

Now the people at the bottom are stuck with all the fool's gold. That's the point of the end:

“We felt insulated from the whole market reality. It was an out-of-body experience. We just sat and watched the people pass and talked about what might happen next. How many of these people were going to lose their jobs. Who was going to rent these buildings after all the Wall Street firms collapsed.” Eisman was appalled. “Look,” he said. “I’m short. I don’t want the country to go into a depression. I just want it to fucking deleverage.”

So that's why the bailout.
en_ki From: en_ki Date: December 1st, 2008 05:08 pm (UTC) (Link)
The pyramid had a bunch of suckers at the bottom. The bailout turns those people from suckers into happy crooks and makes the rest of us into the last layer of suckers.

The fewer layers there are, the fewer victims there are and the fewer happy crooks.

The right outcome for this is that those of us who stayed out, and therefore aren't under water on our mortgages or failing to make our margin calls, can buy real estate at reasonable prices and clean up by picking the good securities out of the fire sale. The bailout is serving to prevent that.
ideaphile From: ideaphile Date: November 27th, 2008 04:13 am (UTC) (Link)

Yeah, that's why the patient died.

Unfortunately, this piece doesn't explain why the patient got sick in the first place. That makes it pretty much impossible to prevent the disease next time.

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From: (Anonymous) Date: November 29th, 2008 03:58 am (UTC) (Link)

Re: Yeah, that's why the patient died.

uhm.... don't do that ?
ideaphile From: ideaphile Date: November 29th, 2008 04:23 am (UTC) (Link)

Re: Yeah, that's why the patient died.

Don't do what? Don't let people be greedy and stupid? Good luck with that.

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ewhac From: ewhac Date: November 27th, 2008 08:45 am (UTC) (Link)
This piece has been going around, and it's an excellent piece. But everyone highlights this one paragraph. Even after reading it for the fourth time, I still don't get it. Is he talking about a genuinely non-existent loan, fraudulently created to sell a CDS against? Or is he using the concept of a loan as a rhetorical stand-in for another CDS, in an attempt to describe swaps insuring swaps insuring swaps? He flips between heavily overloaded terminology too quickly...
shunra From: shunra Date: November 27th, 2008 08:40 pm (UTC) (Link)
The bonds were created by using an income stream - and as far as the finance companies and rating companies any stream would do. Subprime mortgages were fine, they created an initial stream. But short selling of the bonds *also* created a stream (since someone - a broker, usually - has to buy the bonds for you to be able to short them).

As far as the financiers are concerned, *any* income stream can be collaterlized and turned into tranches, which are then "sorted" into categories rated "likely to continue long term" (which would be rated AAA or "really good") down to "this income is going to stop really soon" (which would be rated BBB or "don't buy it, it's not worthwhile").

The scam is in the rating of the tranches: there is no particular reason to assume that a certain part of an income stream based on (say) shorting CDOs would continue or not, because they never existed before. There's no historical data that can tell the rating companies what they'd do. An honest rating would have been "I don't know". But they couldn't give that. Which is why all the Wall Street types responded with a smirk to the question of why the ratings were as they were.
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