Sunday, May 22, 2011
The Big Short: Inside the Doomsday Machine
by Michael Lewis
Where to start?
In late 2008 when the TARP bill was being debated I was thoroughly confused. What the heck was a credit crisis anyway? I wasn't the only one who was confused to be sure, in fact, I would wager that 98% of Congress - the people voting on the bill - were too. The financial system had cracked and was spilling out all over the place. Wall Street, Main Street and every street from Berlin to Tokyo was affected. In retrospect it's entirely possible that TARP saved the world from complete disaster although we will never really know because we can't go back and replay what might have happened had TARP never passed. It's also entirely possible, even probable that it was the greatest fraud ever perpetrated.
What actually happened is not easy to explain and even harder to understand technically, but in simple terms greed and mass psychosis cast a pall over Wall Street that prompted a fairy-tale like reaction among the few peripheral players that had tossed their blinders aside. As light began to shine on the inner workings of a handful of massive Wall Street firms at different times and in different ways these players realized that the Emperor actually had no clothes.
With The Big Short Michael Lewis, a former Wall Streeter himself spins a tale of the few men who saw the whole thing coming. Even while they were setting themselves up to make a profit by throwing rocks at glass houses they were for all intents and purposes shouting at the top of their lungs that something terrible was about to happen. But nobody would listen...
Mike Burry, a doctor turned investment adviser, Steve Eisman, a cranky, tell-it-like-it-is analyst, a tiny California firm called Cornwall Capital and an employee of Deutsche Bank, Gregg Lippmann stood at the center of the financial storm of the century. These guys were not men in white shining armor, but neither were they responsible for the pain we are all suffering to this day as our home values continue to fall and our economy struggles to keep it's head above the water.
The scoundrels in this story are plenty...
As the subprime market evolved the complexity of the financial vehicles and game playing by firms like Goldman Sachs, Bear Stearns, Merrill Lynch, Lehman Brothers, Bank of America and Citigroup became so mysterious that the under-manned, under-trained Federal regulators stood no chance. When you learn the final authority, namely the two ratings agencies of Moody's and Standard and Poor's were no better trained and no better paid than the Feds - no one stood a chance.
Nothing was on the level. Not to overlook the people who took loans they knew they could never pay back, but it was the mortgage originators pushing booby-trapped loans on the lower middle class that were particularly slimy. Add the pure greed of the Wall Street bond market, their complicated schemes for packaging and selling junk to unwary traders and the delusion that the housing market would go up in value forever and the perfect storm was brewing.
This is where Mike Burry came in. His knack was in seeing things clearly. This was because he did his homework - actually reading "the prospectus" and pouring over the boring details in the fine print. From day one he knew something was terribly wrong with the subprime mortgage business. The big firms on Wall Street were packaging mortgages in investment vehicles called mortgage-backed securities and selling them without the buyers knowing what was actually in them. This got Burry's attention. The more he looked the more convinced he was that these things were a time bomb for the investor. He wanted to bet against them in a big way. He approached different firms looking to buy "insurance" against the possibility of these mortgages defaulting. For a small premium Burry would buy what became known as a Credit Default Swap and the middlemen at Goldman Sachs and other brokers would take a small fee. For Goldman Sachs it was like taking candy from a baby and then getting the baby to pay them for stealing it. Burry would be paid when a certain percentage of the mortgages in any one of the mortgage backed bonds went into default.
Soon every big Wall Street firm and most the super large banks worldwide got in the game. CDO's or Collateralized Debt Obligations were bundles of these mortgage backed securities that the big firms put together and then sent up to the ratings agency for a bond rating. Neither Moody's nor Standard and Poor's had any better idea what was in the CDO's than next guy, so in a sense the ratings were meaningless - except that the higher the rating the more confidence the investor had that it would never go bad. The dirty secret was that regardless of what was in the CDO's they were getting AAA ratings.
Eventually Gregg Lippmann of Deutsche Bank caught on to what Mike Burry was doing and he began a campaign to get investors interested in credit default swaps. Mostly people thought he was crazy for betting that the subprime market was a fraud and would eventually collapse. There were a few for whom the light-bulb flickered. I say flicker because even as they bought into Lippmann's ideas they were still mostly in the dark convinced that what Lippmann said and what Burry knew was just too good to be true. All they had to do was hold the line for a few years with these insurance policies in their hands and their payday would come in spades. The trigger would be falling housing values, the bet was that they couldn't go up forever.
Steve Eisman, skeptical of Wall Street and Lippmann from the start could find no evidence that the whole subprime market was anything but a fantasy. His style was to challenge everyone for details and justification for the seemingly ridiculous level of confidence in the housing and mortgage markets. In California the operators of Cornwall Capital, a firm so small no one on Wall Street would even talk to them, scratched an clawed their way into Lippmann's world having no idea what they were doing - convinced that they had to be missing something. It couldn't be this easy, could it?
When it happened - housing values started to fall - nothing much happened. The world went on. Wall Street went on. Subprime mortgage fraud went on. It was still a year or so away from when a majority on the teaser rate mortgages would start to fail in large numbers. For the next 18 months the people betting short on the subprime market were either questioning themselves or being questioned by their investors convinced they were either fools or thieves. With just a few months left in 2007 the calls came pouring in. The big Wall Street players who had treated the short sellers like chumps suddenly wanted in and were willing to pay big for credit default swaps.
The rest is history, we all lived through it. Burry, Eisman, Cornwall Capital and the rest made at lot of money. Wall Street firms one by one crashed and burned. Eventually the whole credit system went belly up. But none of them felt vindicated, no one was happy with the way it went down. Burry quit the business, Eisman became a kind a caring man for the first time in his life. These men were who had been right all along and tried telling the world were changed. Oddly, sadly, Wall Street wasn't changed.
Michael Lewis doesn't even get into the government and regulatory villains until the epilogue, but this book wasn't about the headlines it was a story about being there in the midst of it all. To that end Lewis succeeds brilliantly. It was a nonfiction book that was hard to put down - and that's rare. Sadly, Lewis concludes that what is strange and complicated about the whole affair is that all the important people on both sides of the subprime gamble left the table rich. The rest of us unimportant schleps got screwed and we are still paying the price to this day.
The biggest slap in the face was that the TARP money was paid to make everyone's bad bets good. No one lost their jobs, no one was sent to jail for fraud. AIG, Goldman Sachs, Citigroup and Bank of America were given billions with nothing asked in return, nothing. Bonuses were paid with TARP funds. Government stimulus money paid off the outrageous 40:1 bets made by AIG and the worst part of it all is that nothing has been structurally changed. On Wall Street it's business as usual, looking for the next scam to screw us with.
We continue to struggle with joblessness, lack of investment, and diminished outlooks for the next generation. Governments face crushing deficits and the middle class is squeezed. I repeat: on Wall Street it's business as usual - busy looking for the next scam to screw us all with.
I used to think what went on with regards to Wall Street, as mysterious as it was , was necessary for our system and our way of life. It's not. The legitimate functions of equities trading and bond trading have been superseded by those who have only self interested greed in their hearts. Maybe it's always been that way, who am I kidding, but these pricks in DC shouldn't be feeding this pricks on Wall Street.