If the subject weren't so completely brutal I might actually be enjoying this.
I am referring, of course, to watching the American establishment press as they twist themselves into knots over the Bush Administration's now infamous torture memos. As it stands for now I will just have to take what I can get.
This remains the single most notable and revealing fact of American political life: that (with some very important exceptions) those most devoted to maintaining and advocating government secrecy is our journalist class, of all people. It would be as if the leading proponents of cigarette smoking were physicians, or those most vocally touting the virtues of illiteracy were school teachers. Nothing proves the true function of these media stars as government spokespeople more than their eagerness to shield government actions from examination and demand that government criminality not be punished.
(3) The single most sacred Beltway belief is that elites are exempt from the rule of law. Amidst all the talk about how prosecutions would destroy post-partisan harmony and whether torture "works," it is virtually impossible to find any media star discussions about the fact that torture is illegal and that those who order, authorize or engage in torture are committing felonies. That is because -- other than for fun sex scandalsand other Blagojevich-like sensationalistic acts -- the overriding belief of the political class is that elites (such as themselves) have the right to break the law and not be held accountable.
Amazingly, when it comes to crimes by ordinary Americans, being "tough on crime" is a virtually nonnegotiable prerequisite to being Serious, but when it comes to political officials who commit crimes in the exercise of their power, absolute leniency is the mandated belief upon pain of being dismissed as "shrill" and extremist. Can anyone find an establishment media pundit anywhere -- just one -- who is advocating that Bush officials who broke the law be held accountable under our laws? That view seems actively excluded from establishment media discussions.
But for all the hedging and vacillating going on everywhere nobody has quite topped Peggy Noonan's appearance on ABC's This Week show last Sunday. It was an absolute classic that will certainly live on in infamy:
Sometimes in life you just want to keep on walkin'
Yup. That's what she said. About official torture conducted by the American Government.
"Its not that we torture. Its that we're the kind of people who don't torture.".
I suppose when you spend your entire career writing such insipid, treacly, disconnected dross for the oligarchy, as Peggy has, its inevitably going to come back and bite you in the ass at some point. But who would know that it would ultimately happen in such spectacular fashion. I'm sure Peggy didn't get up that morning and think up and plan these words she was going to say. They just kind of fell out of her brain - and as such are even more revealing. Watch it again. Even George Will looks uncomfortable.
I love the way you can literally watch her revert to her old Reagan speechwriting tricks. Dropping her 'g' on 'walkin' to make her sound, I don't know, all folksy-wise. But then after that bombs she tacks right and tries to cultivate that cheap sense of spiritual awe she loves so much. She hushes her voice, and then actually, unbelievably tries to interject that, you know, she thinks- 'some of life has to be mysterious.'. But by then she's deep in total panic - 'perhaps thats not the right word' - she pleads.
That is pretty much the full Reagan oratorical persona right there. It just doesn't work that same magic every time out I guess.
But perhaps I'm being too hard on Peggy, just because I don't love her so. The fact of the matter is that this approach is something that we all engage in all the time with regards to all kinds of things.
I just can't go there, right now. Its spring. Somebody ask me about baseball.
I mean take your pick.
Nonetheless, I do take some comfort that this ones going to follow Peggy around all viral in cyber space for the rest of her days. Just somethin' kinda karmic here. Its a greatest hit for sure. TV giveth and TV taketh away.
So this ones for you Peggy, and in honour of your greatest decade, may we leave you with this classic bit of early eighties righteousness from those classic Canadian rockers - Blue Peter:
Sorry. But I just can't get enough of this shit. And I'm sure there'll be more to come. As Obama said - 'Its probably going to get worse before it gets better.'.
Now if you have been paying attention you will know that I have already qualified myself a few times now as to the fact that I fully acknowledge - I am just beginning to learn about all of this stuff, and as such am far from an authority. But that said if you watched the last part of that last video you would have noticed the lecturer make the point that he felt that one of the reasons that the Credit Default Swap market grew to be so large was because there were many "investors" making these "swaps" because they clearly saw that so many of the original "assets" were in such obvious trouble, and in that trouble lay an incredible opportunity for them to make some serious money without ever having to own the original asset in the first place. Indeed, they did have to pay premiums, but much of the money that they ultimately used to pay these premiums was borrowed money in the first place.
A kind of informed gambling on the eve of destruction - no?
(If I'm wrong about any of this I would implore anyone who knows better to please explain to me how.)
When Lehman Bros filed bankruptcy, it had $155 bn in debt, but the notional value of the CDS related to its debt was $400 bn. Obviously, not everyone who bought protection against the failure of Lehman actually held its debt. They were speculating that it would fail.
Suppose I held a CDS from AIG that would pay off if Lehman failed. I would have a real incentive to see Lehman fail. I might even engage in short-selling in an effort to cause that failure. Of course, there is no evidence that anyone did that. But there are at least two things that might make a competent regulator/investigator ask questions. First, the regulations that restricted short-selling were substantially repealed. The last of these, the up-tick rule, was repealed in 2007 by the SEC. This rule was put in place in 1938, for the express purpose of preventing a bear raid, an attack on a company, designed to weaken or destroy it. Second, in the immediate aftermath of the collapse of Lehman Bros., the SEC imposed a ban on short-selling of financial stocks.
Taking all this together, it appears that by bailing out AIG, us taxpayers are making sure that a bunch of gamblers are going to get paid off on bets against the solvency of a whole lot of companies.
The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.
Fed Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn't require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.
Bloomberg News has requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure.
The Fed made the loans under terms of 11 programs, eight of them created in the past 15 months, in the midst of the biggest financial crisis since the Great Depression.
The Fed, of course, can argue that it has a good reason for keeping borrowers’ identities secret: It doesn’t want to risk another banking panic by giving stock traders and depositors a list of institutions that would immediately be seen as the weakest links in the financial chain. No regulator wants to force a failure if there's a decent chance an institution could survive, with time.
Especially if it would be possible to then in turn to purchase more CDS's on these "institutions" that are the "weakest links", if this in fact is what is really going on, so as to make more profits out of their imminent demise, profits that would now be coming directly out of the U.S. Treasury, which in turn would be borrowing the money.
I should reiterate once again that I am basically coming at all this stuff from the position of wondering about all the enormous opportunity costs now fading brutally into the proverbial sunset:
Opportunity cost or economic opportunity loss is the value of the next best alternative foregone as the result of making a decision.
Remember Obama's energy plan that called for a $150 billion dollar investment over ten years which was designed to "end America's dependance on Middle Eastern oil", "create 5 million new green jobs", and even possibly the creation of an entire new "green" electricity grid?. The environmental dividends that this action alone could pay for future generations are absolutely enormous. So it sounds like a good idea to me, unfortunately it seems that the first order of business is going to require paying off Buddy's Hedge Fund. Sorry, kids. Let Daddy try and explain ...
Unfortunately, as I pointed out in my last post on this subject the cost to the American taxpayer of this "Credit Crunch" bailout so far is presently - $7.8 trillion dollars. And all of that, borrowed money basically.
So thus my basic charge remains:
We have already seen in this time of the Administration of George W. Bush massive increases in money flowing out of the revenue column of the U.S Government for tax cuts for the most rich as well as to the full gamut of the Defense Industries (much of it to "private contractors", and much of it "classified") in all its assorted forms. And now in these twilight days we are now seeing these absolutely colossal, unprecedented cash outlays to the financial industry as well. And how much of that is going to effectively pay off somebody's bet?
And if this borrowed public money is now going to some very rich, very smart, very well connected people who basically saw all this coming for a while now and in turn devised a way to enrich themselves even further because well, because basically they could - just how fucking cynical is that?
Dear reader?
And does this not then amount to basically one of the largest transfers of wealth ever?
And at any point - does this basically amount to theft? I'm pretty sure how I feel about it morally - but is there any question of criminality?
The financial meltdown has made it impossible to ignore the blatant irrationality of global capitalism. In the fight against Aids, hunger, lack of water or global warming, we may recognise the urgency of the problem, but there is always time to reflect, to postpone decisions. The main conclusion of the meeting of world leaders in Bali to talk about climate change, hailed as a success, was that they would meet again in two years to continue the talks. But with the financial meltdown, the urgency was unconditional; a sum beyond imagination was immediately found. Saving endangered species, saving the planet from global warming, finding a cure for Aids, saving the starving children . . . All that can wait a bit, but ‘Save the banks!’ is an unconditional imperative which demands and gets immediate action. The panic was absolute. A transnational and non-partisan unity was immediately established, all grudges among world leaders momentarily forgotten in order to avert the catastrophe. (Incidentally, what the much-praised ‘bi-partisanship’ effectively means is that democratic procedures were de facto suspended.) The sublimely enormous sum of money was spent not for some clear ‘real’ task, but in order to ‘restore confidence’ in the markets – i.e. for reasons of belief. Do we need any more proof that Capital is the Real of our lives, the Real whose demands are more absolute than even the most pressing demands of our social and natural reality?
Compare the $700 billion spent on stabilising the banking system by the US alone to the $22 billion pledged by richer nations to help poorer nations cope with the food crisis, of which only $2.2 billion has been made available. The blame for the food crisis cannot be put on the usual suspects of corruption, inefficiency or state interventionism. Even Bill Clinton has acknowledged that ‘we all blew it, including me,’ by treating food crops as commodities instead of a vital right of the world's poor. Clinton was very clear in blaming not individual states or governments, but the long-term Western policy imposed by the US and European Union and enacted by the World Bank, the IMF and other international institutions. African and Asian countries were pressured into dropping government subsidies for farmers, opening up the way for the best land to be used for more lucrative export crops. The result of such ‘structural adjustments’ was the integration of local agriculture into the global economy: crops were exported, farmers were thrown off their land and pushed into sweat-shops, and poorer countries had to rely more and more on imported food. In this way, they are kept in postcolonial dependence, vulnerable to market fluctuations – soaring grain prices (caused in part by the use of crops for biofuels) have meant starvation in countries from Haiti to Ethiopia.
And now, this morning, with the possible impending bankruptcy of General Motors, I had to ask myself the obvious question - who stands to make a lot of money shorting GM debt through Credit Defalut Swaps? I mean they have to be out there.
I Googled this question - and didn't find much but I did find the great masascio who was asking himself/herself the same question:
The Depository Trust & Clearing Corporation reports that there are over $65bn in credit default swaps naming GM as the reference credit. According to its most recent financial statements, GM has a total of $36 to 38bn in outstanding long-term debt, the kind associated with CDSs. Obviously not all of the protection buyers hold GM debt. There is a lot of money bet against GM’s survival, and the holders of that protection have a real reason to want GM to fail. I’d call that gambling, and I explain why in this diary. It’s important to note that the losses won’t affect GM. Only the protection sellers will have to pay off the bets.
So, if I am reading this right, that is probably over half of GM's "long term debt" wrapped up in Credit Default Swaps - "holders" of which have a direct financial stake in GM's failure. (Are we going to read about and see this as the narrative in the main stream media? I doubt it, as I see now that the problem apparently lies with the Unions) That's certainly more than twice the cost of what the actual bailout would have been. And as Michael Moore explained on CNN - at its present price the U.S. Government could just buy "the company" (GM) for three billion dollars, and then they would own it outright. But of course then you would also own all that "long term debt" as well, with just so much of it coming from pure speculation.
(m)asacio again:
Unfortunately, we have no idea who those gamblers are. The CDS market is private and hidden. The information provided by DTCC was the first public release of data about CDSs, which means there isn’t even any historical data from which we could figure out when all these gamblers bought their lottery tickets.
It's easy to think of people who might want GM to fail. One group might be those who want to buy the pieces cheap. That might include other car companies, or private equity funds. Another group might be hostile governments, who might like to see the US lose industries that can produce weapons and war-fighting machines. In either case, betting against GM provides a bunch of money to support whatever other goals those people might have.
Any other suggestions?
Update: I wonder if any holders of protection are lobbying against a bailout?
Apparently there has been some debate as to whether or not it is, I don't know, accurate to blame the present "economic crisis" on the so-called "financial elite". (See also the Columbia Journalism Review).
Well if you ask me the answer couldn't be more self evident. While, yes, our market economy will by definition have its ups and downs, our present crisis has been desperately exacerbated by the overwhelming greed, complete recklessness and a borderline sociopathic total irresponsibility from the "financial elites" in many countries of the Western world, but most notably the United States. A contagion that has now spread globally and implicated pretty much everyone.
Let me explain:
Here we are over two months (give or take a year) into what at some times is being called the "credit crisis" while other times often referred to as "the worst economic crisis" to hit the world since "The Great Depression". For myself its triggered its own private odyssey into trying to figure out not only how to respond but just what has happened here in the first place and just how this all came to be - specifically. For until two months ago I hadn't even heard of most of this financial arcana. And I had certainly never heard of Credit Default Swaps. I had heard of Derivatives, but had very little sense as to what they were.
So I begin this post with the above article The End by Michael Lewis, an article that is being widely read, linked and sent all over the internet(s). Lewis is a former investment banker himself who ended up leaving that world to write a famous book about it all - Liar's Poker - way back in the eighties. And in The End he revisits it all and tries to make sense. It has been a valuable read for me in that not only does Lewis attempt to explain all this for people like myself who might not know anything about it, but because he comes the closest I have yet read as to explaining why these Investment Banks, Banks, Hedge Funds, Money Managers, Bond Traders, Insurance companies etc. all engaged in the practice of Credit Default Swaps (for instance) in the first place, or why they were allowed to, beyond the given - because greed is great and that for a while at least they were making gobs and gobs of money.
Lewis does this in part by telling the story of Steve Eisman, a former lawyer who became a financial analyst before then becoming a hedge fund manager based in New York City. Eisman appeared to see before most the looming catastrophe that lay ahead for the U.S. subprime mortgage market and figured out a way to make money out of it. A lot of money. He did this by "selling short". By selling short Credit Default Swaps on Collateral Debt Obligations.
Now forgive me my ignorance dear readers (you always do) though I have already confessed to being very much a financial luddite and a stock market illiterate with regards to all of this (just ask my banker) but I had to at first look into just what "selling short" involved. So I googled it - and this is what I found:
Selling a stock not actually owned. If an investor thinks the price of a stock is going down, the investor could borrow the stock from a broker and sell it. Eventually, the investor must buy the stock back on the open market. For instance, you borrow 1000 shares of XYZ on July 1 and sell it for $8 per share. Then, on Aug. 1, you purchase 1000 shares of XYZ at $7 per share. You've made $1000 (less commissions and other fees) by selling short.
So "Selling Short" is gambling basically. Its making a calculated, even educated guess that a stock, or in this case a bond (essentially) is going to go down and then figuring out a way to capitalize on this. Though one is not actually manufacturing or contributing anything - the talent, the glory and the reward seems to come from one's prescience, foresight and willingness to assume and manage the risk involved. For if you gamble that a stock or a bond is going to go down and you decide that you might want to "sell it short" - you then go out and "borrow it", but then suppose it happens to start going up - well then I guess you're screwed and on the hook for what could potentially be a lot of money. And this is the stock and financial market for those looking to play the short game.
So what then is a Credit Default Swap?
A Credit Default Swap is on the face of it, in theory, a kind of insurance on all of this, I guess. If one made a bond purchase one could then buy a Credit Default Swap as insurance for the chance that the value of that stock, or in this case bond, happened to go down. And one would in turn pay premiums to the 'agency' who was selling you the 'swap', as with any insurance. Except in this case they don't call it "insurance" they call it "swaps" because to call it "insurance" would legally require that the market be regulated. And the Credit Default Swap (CDS) market is (was) totally unregulated. And the people who created and engaged in it certainly wanted it to remain that way.
And just because we are trying to be all definitive here for all the financial luddites like myself I might as well post the Wikipedia definition of Bond:
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity.
A bond is simply a loan in the form of a security with different terminology: The issuer is equivalent to the borrower, the bond holder to the lender, and the coupon to the interest. Bonds enable the issuer to finance long-term investments with external funds. Note that certificates of deposit (CDs) or commercial paper are considered to be money market instruments and not bonds.
Bonds and stocks are both securities, but the major difference between the two is that stock-holders are the owners of the company (i.e., they have an equity stake), whereas bond-holders are lenders to the issuing company. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is a perpetuity (i.e., bond with no maturity).
Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process of issuing bonds is through underwriting. In underwriting, one or more securities firms or banks, forming a syndicate, buy an entire issue of bonds from an issuer and re-sell them to investors. The security firm takes the risk of issue not being sold to investors. Government bonds are typically auctioned.
But the thing apparently about these Credit Default Swaps is that one can buy this insurance, one of these "swaps", without ever having to own the original bond or "asset" in the first place. So a Credit Default Swap then in this sense amounts to a kind of sidebet. It is a sidebet. All kinds of sidebets actually. An entire interconnected network of sidebets made largely with borrowed money. And as I find myself reading and researching on all this stuff this is always the question I inevitably arrive at: How this came to be and why this is allowed in the first place is a total mystery to me. And this certainly goes to the moral issue at the heart of all this, I feel. For if someone wants go and gamble all their money away in say Vegas, or even in Niagara Falls, I guess that's their perogative. But when you are a professional money manager dealing with shareholder and investor money - other people's money - and when all that money is all interconnected within the global financial system with everybody's else's money, and savings and pension funds and mortgages etc. it seems to me that it soon becomes everybody's problem. These arcane and exotic "financial instruments" were developed and designed after all, essentially - it seems to me, as a way to displace risk. To extend the risk. And that risk was absolutley massive. And it seems that the riskier it became the more arcane and complicated the entire enterprise became. And now it has certainly become the problem of the hundreds of millions of taxpayers who never engaged in any of this stuff, or who like myself, never knew anything about any of it in the first place, the instant the bankers and executives came looking for and graciously accepting their subsequent billions and even trillions of dollars of bail out money. (Yes, I'm Canadian - but our government has now gone and "purchased" $75 billion dollars worth of residential mortgages in order to "stabilize the industry". At a ratio of 10 to 1 in terms of population that would be the equivalent of the 750 billion U.S. bailout - no? What's the exposure of Canadian banks in the American subprime mess, and in the derivatives and CDS market?)
But lets try to get specific again. Many of the bonds that were at the heart of these Credit Default Swaps, for example, were bonds issued by these Mortgage Companies who were dealing largely in subprime mortages and were issuing many, many tranches of Collaterlized Debt Obligations.
Steve Eisman was managing a hedge fund called Frontpoint (I assume that's the right site) and he thought that whole subprime mortage market was a house of cards and thus he was making it his business to sell the stock in some of these companies 'short'. But he was frustrated because as Lewis writes: "Smart as these trades proved to be, they weren’t entirely satisfying. These companies paid high dividends, and their shares were often expensive to borrow; selling them short was a costly proposition.". So:
Enter Greg Lippman (now affectionately known as 'Shittman' to his many detractors), a mortgage-bond trader at Deutsche Bank. He arrived at FrontPoint bearing a 66-page presentation that described a better way for the fund to put its view of both Wall Street and the U.S. housing market into action. The smart trade, Lippman argued, was to sell short not New Century’s (a mortgage company) stock but its bonds that were backed by the subprime loans it had made. Eisman hadn’t known this was even possible—because until recently, it hadn’t been. But Lippman, along with traders at other Wall Street investment banks, had created a way to short the subprime bond market with precision.
Here’s where financial technology became suddenly, urgently relevant. The typical mortgage bond was still structured in much the same way it had been when I (Lewis) worked at Salomon Brothers. The loans went into a trust that was designed to pay off its investors not all at once but according to their rankings. The investors in the top tranche, rated AAA, received the first payment from the trust and, because their investment was the least risky, received the lowest interest rate on their money. The investors who held the trusts’ BBB tranche got the last payments—and bore the brunt of the first defaults. Because they were taking the most risk, they received the highest return. Eisman wanted to bet that some subprime borrowers would default, causing the trust to suffer losses. The way to express this view was to short the BBB tranche. The trouble was that the BBB tranche was only a tiny slice of the deal.
But the scarcity of truly crappy subprime-mortgage bonds no longer mattered. The big Wall Street firms had just made it possible to short even the tiniest and most obscure subprime-mortgage-backed bond by creating, in effect, a market of side bets. Instead of shorting the actual BBB bond, you could now enter into an agreement for a credit-default swap with Deutsche Bank or Goldman Sachs. It cost money to make this side bet, but nothing like what it cost to short the stocks, and the upside was far greater.
The arrangement bore the same relation to actual finance as fantasy football bears to the N.F.L. Eisman was perplexed in particular about why Wall Street firms would be coming to him and asking him to sell short. “What Lippman did, to his credit, was he came around several times to me and said, ‘Short this market,’ ” Eisman says. “In my entire life, I never saw a sell-side guy come in and say, ‘Short my market.’”
So what Eisman was doing was buying insurance on these lousy tranches of mortgages betting that they would go down and that the people who were selling him this insurance - in this case "Deutsche Bank or Goldman Sacks" - would have to in turn have to pay off. What really freaked him out was that the people he was buying these Credit Default Swaps from were actually encouraging him to do just that, something that this experienced hedge fund manager and short seller had never seen before. So - why?
I too cannot figure out how shorting the CDO market was, in effect, propping it up.
Its the same question I keep asking myself. Its the same question Kevin Drum asks himself - here:
I still won't pretend that I fully understand this. In fact, every time I read a story like this, it seems to get right up to the good stuff — "They were creating them out of whole cloth. One hundred times over!" — and then suddenly moves on. But I want more! I want an entire 10,000 word piece on how the combination of CDOs and CDS allowed Wall Street to magnify their underlying subprime losses so catastrophically. Instead, I just get a teaser and then the story meanders off in a more colorful direction.
I'd like to read that piece too. But nonetheless, its the same question that Steve Eisner was apparently asking himself. Until he came to a kind of eureka moment while attending a subprime mortgage conference in Las Vegas of all places. Again, from the Lewis piece:
“You have to understand this,” he (Eisman) says. “This was the engine of doom.” Then he draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranche—the bonds Eisman had shorted. But Wall Street had used these BBB tranches—the worst of the worst—to build yet another tower of bonds: a “particularly egregious” C.D.O. The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities. “I cannot fucking believe this is allowed—I must have said that a thousand times in the past two years,” Eisman says.
Later on he was having dinner with a guy who was a CDO manager whose job it was the sell these lowest of the low tranches of mortgages - what Eisman had taken to calling dogshit - and he assumed that the guy would be having a hard time but instead he told Eisman that he was selling everything out.
“Then he said something that blew my mind,” Eisman tells me (Lewis). “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?”
Eisman was trying to find a way to bet that the housing market would crash. One of the ways he did this was by buying insurance on subprime mortgages, through something called a credit default swap.
Ok, selling insurance may seem like a strange way to place that bet. But imagine there is a house by the ocean and you want to bet that it's going to get hit by a hurricane. One way to do that would be to take out an insurance policy on the house, even though you don't own it. So every month you pay a small premium for the insurance, maybe $200. This goes on for a couple years. Then the house gets hit. And the insurance policy pays off, for say $1,000,000. You've lost a couple thousand, but made close to a million.
The reason the CDO expert was happy that Eisman was buying insurance, was that the expert had clients that were dying to sell that insurance. These were people who wanted to buy up mortgages, but there just weren't enough around. So they sold insurance instead. In a sense it was the same thing, owning mortgages and selling insurance. If you own someone's mortgage, then you get steady interest payments. If you sell insurance on someone's house, then you get paid steady insurance premiums. The two are similar on the downside also. In each case, if things go bad, you could lose an amount equal to the total value of the house.
There was a whole industry build up around this similarity. In a regular CDO (collateralized debt obligation) you actually own some mortgages in a pool. In a synthetic CDO you're selling insurance on a slice of mortgages in a pool. They're similar instruments, but constructed from different pieces. In one you own the mortgages. In another you're selling insurance on them.
Still confused? Me too. But I'm still doing my best. If you like, you could watch another video from Marketplace - this one specifically about Credit Default Swaps:
Few Americans have heard of credit default swaps, arcane financial instruments invented by Wall Street about a decade ago. But if the economy keeps slowing, credit default swaps, like subprime mortgages, may become a household term.
Credit default swaps form a large but obscure market that will be put to its first big test as a looming economic downturn strains companies’ finances. Like a homeowner’s policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts.
The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion — roughly twice the size of the entire United States stock market.
$45 trillion? That's so last year. I've been reading numbers as high as $72 trillion. To put this in perspective remember that the entire annual GDP of the United States itself, the largest economy in the world, is (according to the CIA) 13.3 trillion dollars. The GDP of the entire global economy (circa 2007) is thought to be just over 65 trillion dollars. That doesn't blow your mind? The entire Derivatives market itself - according to the NYT as of 2007: "is valued at $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago.".
Right. Lets not forget about "derivatives". Unsure as to what a "derivative" is? Me too. Johsua Holland tries to explain in this Alternet piece :
So just what is a derivative? A derivative is a piece of paper that can be bought and sold for real money but isn't attached to a real asset. Its value is simply derived from something tangible -- hence the name. You hear a lot of talk these days about the "real" nuts-and-bolts economy, and derivatives are in essence the exact opposite: They represent an unreal economy, created by financiers in mahogany-paneled office suites in New York and London, and it's this shadow economy that teeters on the edge of collapse today, threatening to bring down much of the real economy with it.
There are all sorts of derivatives. They are essentially bets -- you can bet that a market will go up, or down, or that a particular company will do well or poorly. You can bet on interest rates going up or down, or the value of a country's currency, or you can make more exotic bets about just about anything in the world -- even what the weather will be like at some point in the future.
(BUDDY: I'll bet a million dollars it snows this afternoon.
JOE SCHMOE: Oh yeah. You think you're so smart - what kind of flakes asshole? Maybe you should be in the "flakes derivative market". Because you know, the Inuit have over a hundred words for snow. Real men play the flakes. Just saying.
But then it doesn't snow, so BUDDY in a anxious panic, desperate about his financial future, incredulous as to the way things have turned out, calls his Congressman. He knows him. They went to Yale together.)
He links to this Andrew Leonard Salon piece - Panic on Wall Street - and Leonard also picks up on this useful NFL metaphor as a way of explanation:
A metaphor might be useful here. The real economy is like the Super Bowl. Real men on a real field push each other around and play with a real ball for a set period of time, and the team with the most points at the end wins. But while all this is going on, millions of outsiders who are not physically involved in the game bet on its outcome. Only they don't bet just on the outcome. They also bet on the spread -- how badly one team might beat the other. Or they can get more creative and bet on what the combined score of the teams might be, or which team's quarterback will be the first to be injured. There's absolutely no limit to the things that you can bet on, as long as you can find someone to take your bet.
The betting economy is the unreal economy. All those sports bets, no matter how kooky, are financial exercises whose value and meaning are derived from what happens on the field. Theoretically speaking, the betting economy exists in a separate dimension from the actual game, but we all know that's not true. There's so much money involved in gambling that the temptation to fix the results becomes irresistible. Players and referees, for instance, can be bribed.
We can call a bribed NBA official an example of "spillover" from the betting economy into the sports economy. The very same thing happens in the real and unreal economies. So much money is riding on all the derivative bets connected to the housing sector that Wall Street speculators essentially rigged the housing sector to make their bets pay off.
And then remember to take into account that the money (and I would guess most, certainly the majority of the money) that was used to engage in all of these practices was "leveraged". That is to say that it was borrowed money. Somebody else's money, if it ever even existed at all. As Joshua Holland explains:
This brings us to a key issue in the banking mess, one that has serious ramifications for how we move forward in the future. Obscured by the finger-pointing is a simple question: How could a drop in the value of the American housing market -- even a 20 percent drop in home prices -- threaten to bring down the entire global economy?
Part of the answer is "leveraging" -- using a limited amount of cash to buy a much larger position in an investment. Leveraging is a common investment tool, but there are rules in effect in regulated markets like the major stock and bond markets that limit the amount that an investor can leverage -- for example, the SEC says you have to put up at least 50 percent of the cost to buy a stock on American stock exchanges. But these fancy debt-backed investments are contracts between two gamblers and are not subject to those rules. They're traded "over the counter" -- in an opaque and largely unregulated exchange.
Today any wealthy individual can take $1 million and go to a prime broker and leverage this amount three times; then the resulting $4 million ($1 equity and $3 debt) can be invested in a fund of funds that will in turn leverage these $4 millions three or four times and invest them in a hedge fund; then the hedge fund will take these funds and leverage them three or four times and buy some very junior tranche of a CDO that is itself levered nine or ten times. At the end of this credit chain, the initial $1 million of equity becomes a $100 million investment out of which $99 million is debt (leverage) and only $1 million is equity. So we got an overall leverage ratio of 100 to 1. Then, even a small 1% fall in the price of the final investment (CDO) wipes out the initial capital and creates a chain of margin calls that unravel this debt house of cards. This unraveling of a Minskian Ponzi credit scheme is exactly what is happening right now in financial markets.
Indeed, as this NYT article - Agency's '04 Rule Let Banks Pile Up New Debt - explains in 2004 representatives of the major investment banks had demanded and received a meeting of the Securities and Exchange Commission where they asked for a change in the laws governing just how much they were legally bound to keep in capital reserve:
On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.
They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.
The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.
And they got what they wanted:
After 55 minutes of discussion, which can now be heard on the Web sites of the agency and The Times, the chairman, William H. Donaldson, a veteran Wall Street executive, called for a vote. It was unanimous. The decision, changing what was known as the net capital rule, was completed and published in The Federal Register a few months later.
With that, the five big independent investment firms were unleashed.
In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the agency also decided to rely on the firms’ own computer models for determining the riskiness of investments, essentially outsourcing the job of monitoring risk to the banks themselves.
Over the following months and years, each of the firms would take advantage of the looser rules. At Bear Stearns, the leverage ratio — a measurement of how much the firm was borrowing compared to its total assets — rose sharply, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt. The ratios at the other firms also rose significantly.
(This article is one of many in the recent NYT series on the 'financial crisis': The Reckoning.)
Indeed, the lobbying arm of this industry, the International Swaps and Derivatives Association had always fought hard against any kind of regulation or government oversight and in 2000, in the last vote of the then lame-duck Congress they achieved what has been described "the final nail in the regulatory coffin" with the passage of the Commodity Futures Modernization Act. After the collapse of Enron, which up until all this recent crisis had been the largest corporate failure in the history of the United States, the Act was famous for what came to be known as its Enron loophole which exempted over the counter energy trades from government regulation. The Act was championed by then Senator Phil Gramm of Texas, who has subsequently became famous for the following remarks made while he was an advisor on economics with the McCain/Palin campaign:
But if all of this still isn't enough for you could still read about Credit Default Swaps in TIME from last March, or in Newsweek from last September.
I plead guilty. I'm not an expert on any of this. Anyone who is, is welcome to write to me and fill me in. And obviously it wasn't just CDOs and CDS and MBS that caused this crash. Everything points to a confluence of many different bad or unsound practices. There are plenty of people out there who actually know what they're talking about who are describing these issues – the predatory lending, those crazy subprime mortgages in which the low teaser rates were like the free drinks that brought borrowers to the blackjack table (hoping they would hit 21 via continually rising real estate prices), the ramping back of one Roosevelt-era regulation after another (culminating in the repeal of the Glass-Steagall Act), the generally high level of speculative home-buying, etc.
But the root cause of all of this is the same thing that has caused every speculative bubble since the tulip craze. It's a bunch of assholes who think that because they spent a few days scribbling some equation on a napkin, the laws of nature have been repealed. You can't turn a Kingston charcoal briquette into a diamond no matter how hard you squeeze and you can't conquer the problem of "risk" in investing by slicing a bunch of mortgages up into itty bitty pieces and then mixing the good ones up with the bad ones (so that it all looks kosher from a distance, if you squint).
The reason I thought it necessary to even write about this at all is that I haven't anywhere seen anyone say what absolutely needs to be said about this crash. You see finance/media people on TV just kind of moping around, with this hangdog look on their face that says, aw, man, this blows, what shitty luck. Like this downturn in housing prices was some terrible accident, like a hurricane or a flood.
Bullshit! These people on Wall Street – who are often the cream of our educational crop, the products of our most advantaged families – exist in society for exactly one reason. Yes they're supposed to create wealth (and it's great if they can figure out a way to do more with a dollar than you or I would). But the number one thing they're supposed to do is not fucking lose wealth. That is the number one justification for their enormous salaries and astonishingly privileged existences. These people are not writing Huck Finn, they're not painting Still Life With Apples, they're not inventing the Atlas rocket, they're not designing timeless buildings or making inspiring speeches.
They do exactly one thing, and that is guard our money. Their first, second, third, fourth, fifth, sixth, seventh, eighth and ninth moves of every day have to be utterly conservative. They are the people we trust with the keys to the car. That's why they get to sleep in the grownups' room. That's why they get to live in palaces and work in eighty-story obelisks. Because if you just give some dude at a bar nineteen billion dollars, he's going to spend half of it on beer and the rest betting on the Phillies. Right? That's why you have to give it to the guy with two degrees from Yale, the guy who's studied every great book on economics since The Wealth of Nations, the guy who spent eight years in the best schools in the world learning the difference between a calculated risk and a seat-of-the-pants gamble.
Well, apparently not. What we're finding out about this crisis is that you basically couldn't have found a weather-beaten crack hound on the streets of the worst ghetto in America who would have taken worse care of our nation's treasure than this community of risk-addicted craps-playing blowhards.
Sports fans out there, you know who Travis Henry is? That guy who played running back for the Bills, Titans and Broncos? Travis Henry made many millions of dollars playing football over the years, but we found out this fall that he's broke and deep in debt because a) he fathered at least ten children by ten different women b) he's got an apparently incurable drug problem and c) he tried to get out of his financial problems by dealing coke and ended up getting arrested doing it. Now those ten kids are really in trouble for about the next 18-25 years.
Well, Travis Henry would have done a better job of things than Wall Street did with the world's wealth. These guys didn't just bet the house on their investments. They bet fifty times the house! They bet a thousand times the house! They were absolute fucking madmen. All those brilliant ways they thought up to make four hundred different bets with the same dollar made them infinitely more dangerous to society than some coke-freak running back pumping his jism into two cookies on every road date. Think about that. If Travis Henry had been in charge of all that money, we'd be FINE now! Even Travis Henry couldn't even imagine the scale of desperate irresponsible greed we're talking about with these guys. They were like a bunch of rabbits on strychnine. You don't get to an almost mathematically inexpressible financial collapse through merely ordinary greed and irresponsibility of the type you might encounter in your home life, or even on the Buffalo Bills. You need an advanced education to dig this big a hole.
Things like the CDO and the CDS are just the tools these idiots used to dig that hole. There were plenty more. But the basic concept is the same across the board. They were supposed to safeguard our money and instead they gambled with it like a bunch of coke addicts. You know how a coke addict goes from having money to buy his own coke, to selling the shit in his house to buy coke, to stealing items from his mother's place to buy coke, and then finally ends up in Jayson Blair/Maureen McCormick territory, sucking cocks to get the money to buy the coke? Well, these guys in Wall Street were about fifty stages past that. They were promising to promise to suck a cock to get the money to buy the coke. This crash happened when the dealer finally decided they weren't good for it.
Just don't let anyone tell you this was all bad luck. If they'd been doing their jobs, the possibility of bad luck would have been figured into the equation.
The moral code of these Wall Street executives corresponds to stage one of Lawrence Kohlberg’s famous stages of morality: “The concern is with what authorities permit and punish.” Morally, they are very young children. The Swiss bankers are closer to stage four, most common among late teens, where a concern for maintaining the good functioning of society takes hold. Stage six, an elaboration of universal moral principles based on an idea of the good society, is a distant dream for the titans of global finance.
In private life, extreme indebtedness, bankruptcy, the ruin of those close to you, and dependence on the government dole are generally thought to be causes for anguish, self-denial, and a degree of shame. But if you’re a financial executive with an exalted title, a big enough salary, a deep enough debt, and a vast enough handout, these same disasters entitle you to go on living and feeling about yourself much as you did before. You even have a right to think that the taxpayers owe it to you—that it’s for their own good, not yours. You don’t have to explain yourself; you certainly don’t have to apologize.
I would like to see these malefactors of great wealth apologize to the country. I would like to see them organize their own press conference in a lineup on Wall Street and, in the manner of disgraced Japanese officials, bow low to the pavement, express contrition, and beg their countrymen’s forgiveness. Such a scene would go some way toward cleansing the smell of the financial crisis.
Of course, nothing like this is going to happen. So instead, like the parents of two-year-olds, the next Congress should summon them to Washington and publicly punish these executives who, in Kohlberg’s terms, “see morality as something external to themselves, as that which the big people say they must do.”
But we will give Steve Eisman the last word:
"It was like feeding the monster," Eisman says of the market for subprime bonds. "We fed the monster until it blew up."
So there it is. I rest my case.
The monster blew up. So bring on The Monster.
But as I've already come this far - let me see if I've actually got this straight:
Our annual spending on "national security" -- meaning the defense budget plus all military expenditures hidden in the budgets for the departments of Energy, State, Treasury, Veterans Affairs, the CIA, and numerous other places in the executive branch -- already exceeds a trillion dollars, an amount larger than that of all other national defense budgets combined.
And the U.S. budget deficit itself might soon reach a trillion dollars, with the debt now on its way to $11 trillion dollars.
But meanwhile, back on Wall Street,
while all this other stuff has been going on apparently the "financial elites" (forgive me, I can't come up with a better term) of the United States have been engaging in the financial practices of "exotic" and "arcane" instruments like Credit Default Swaps and Derivatives - trading in what has been termed a "shadow economy", completely unregulated (and maintained as such through deliberate political pressure and design), extremely opaque to the general tax paying public at best, totally and completely unknown at worst. Practices that essentially gamed
the real economy - creating an unreal economy to a market value of hundreds of trillions of dollars. An unreal economy that began in the late eighties but really, really took off after the year 2000.
And (as the author goes on to state) - this is more than the entire cash outlay for the entire American commitment to World War II:
The $4.6165 trillion dollars committed so far is about a trillion dollars ($979 billion dollars) greater than the entire cost of World War II borne by the United States: $3.6 trillion, adjusted for inflation (original cost was $288 billion).
In the last year, the government has assumed about $7.8 trillion in direct and indirect financial obligations. That is equal to about half the size of the nation’s entire economy and far eclipses the $700 billion that Congress authorized for the Treasury’s financial rescue plan.
Those obligations include about $1.4 trillion that has already been committed to loans, capital infusions to banks and the rescues of firms like Bear Stearns and the American International Group, the troubled insurance conglomerate. But they also include additional trillions in government guarantees on mortgages, bank deposits, commercial loans and money market funds.
So there you have it.
And for some reason, dear reader (if you've made it this far) I just can't think of all of this stuff without remembering the fact that, you know, people in Haiti are eating mud in order to force off imminent starvation.
And yet trillions of dollars are presently flowing out of government coffers (most of it borrowed - from whom and for how long?) in order to help prop up the financial industry, and some of the richest people on the planet, and ultimately save the entire global economic system, as they say.
Because if we don't, and they didn't get that money ...
The Bush administration on Saturday formally proposed to Congress what could become the largest financial bailout in United States history, requesting unfettered authority for the Treasury Department to buy up to $700 billion in mortgage-related assets.
The proposal, not quite three pages long, was stunning for its stark simplicity. It would raise the national debt ceiling to $11.3 trillion. And it would place no restrictions on the administration other than requiring semiannual reports to Congress, granting the Treasury secretary unprecedented power to buy and resell mortgage debt.
Maybe the removal of these bad assets would allow the firms to raise the capital. But maybe not — meaning one or more could conceivably have to file for bankruptcy, creating yet another spasm of financial turmoil. It’s a huge roll of the dice by the government.
Finally, there is the question of how much it will ultimately cost. “Institutions so far have written down $550 billion globally of bad debt,” said Daniel Alpert, managing director of Westwood Capital. “We think that when you add up all the problems in the residential housing market still to come — further erosion of housing prices, mortgage foreclosures and so on — we are going to need another $1 trillion of write-downs.”
In other words, for all the toxic securities that Wall Street has acknowledged holding, there will be yet more mortgage-backed paper that will go bad as the housing market continues to fall. As much as we all hope the worst is over, it’s probably not.
And as much as we might hope that the government finally has the answer, it probably doesn’t.
The administration is requesting “unfettered authority” to buy whatever with the $700 billion worth of bailout money they’re asking for. And of course that’s what they want. If you were to give me authority to do something, I’d prefer to get the unfettered kind. But you almost certainly wouldn’t give it to me. And you especially wouldn’t give it to me if the problem the authority was meant to resolve had occurred under my watch. If this scale of funds is going to be spent. Here’s Ed Paisley for CAP on what a reasonable package could look like:
Thanks to the leadership of Federal Deposit Insurance Corporation Chair Sheila Bair, Congress has a model to work with. The FDIC is doing just this at failed California-based IndyMac Bank. By engaging in systematic loan restructuring, rather than foreclosing on the failed bank’s mortgages, the FDIC will likely end up preserving more value and reducing taxpayer exposure. Whatever agency Congress assigns to this broader task should do the same, restructuring troubled loans in the portfolio of mortgages they purchase in a systematic manner, rather than through piecemeal modifications. The result of refinancing more loans than private holders have been able or willing to do will be fewer defaults and foreclosures.
The financial markets are but one of the economic problems we face. The last eight years brought stagnant wages and weak job creation—with the situation getting even worse over the course of this year. Restoring our economy requires a plan to address the financial crisis and the underlying weakness in our economy. We need to make job-creating, growth-producing investments in our infrastructure and transform to a low-carbon economy. The legislative package that moves rapidly through Congress to implement Paulson’s new plan should also include expanded unemployment benefits and heating assistance for low-income families, increased food stamps, and assistance for states in providing health coverage to families in need during these difficult times. The folly of Wall Street and the negligence of the Bush administration has produced today’s pain on main street. It would not be right if the rescue only rescues firms and not families.
To give the regulatory authorities who failed to prevent this crisis carte blanche to hand out money to the financial institutions who caused the crisis while doing nothing for ordinary people would be outrageous.
WASHINGTON — The next president will take office in January with little hope of getting his pet programs enacted quickly, if at all, because of already-massive budget deficits likely to balloon even further from the hundreds of billions expected to be used to bail out Wall Street.
"The next president is just not going to have the money to meet his promises," said Maya MacGuineas, the president of the Committee for a Responsible Federal Budget, a nonpartisan budget-research group.
In August 2007, the SCLC formed a partnership with CompuCredit, a subprime credit card issuer and payday lending company. (The Post later updated its story to reflect this.) The deal included plans for an affinity card that would put the famous civil rights group's name on CompuCredit Visa cards and joint "economic empowerment" workshops around the country to help educate minorities about credit. When Steele announced the deal last year, he said, "Consistent with SCLC's historic commitment to civil rights and economic justice, this partnership represents a critical part of our campaign for economic empowerment."
While the civil rights group has been lauding its corporate partner, the federal government has taken a slightly different view of CompuCredit's contributions to economic empowerment. Last month, the Federal Trade Commission sued the company for unfair and deceptive trade practices, as well as violating the Fair Debt Collection Practices Act. The FTC alleged that CompuCredit bilked consumers out of at least $217 million through a scheme in which consumers paid so much in fees that they rarely had any credit available on the company's Visa cards. The CompuCredit cards are better known as "fee harvesting" cards—that is, credit cards sold to people in dire financial straits that have high interest rates, low credit balances, and lots and lots of fees for people who generally can't afford them. The practice is enormously lucrative. The National Consumer Law Center reports that in 2006, CompuCredit made $400 million in fees on such cards, simultaneously saddling consumers with more than $1 billion in debt.
The FTC also alleged that CompuCredit was working in tandem with its debt-collection arm, Jefferson Capital, in a complex scheme that used the credit cards as a way of duping consumers into paying off old debts that had been discharged by other lenders. Far from lifting consumers upward, CompuCredit was leaving its customers mired in debt, from which they would have a tough time escaping.
I keep hearing how "complicated" this present financial crisis is, and while formulaically that may be true - and certainly the implications as well any potential responses will be very complicated - at its heart it doesn't seem all that complicated to me. It was just a bunch of people who went looking for free money and when the time came to pay up, they tried to hide it, and when that didn't work they tried to hide it some more. It was a chain and a system of denial where when the shit finally hit the fan this week everybody went scurrying for the protection of the government.
So I went looking for people who could explain the present global financial crisis to me this week and this is some of what I found:
The documentary does very good job of tracing the entire process; beginning with people like former homeowner Clarence Nathan:
It’s a no-income verification loan. They don't do
that. It's almost like you pass a guy in the street and say: lend me 540,000
dollars? He says, what do you do? Hey, I got a job. OK. It seems that casual
even though there are a lot of papers that get filled out and stuff flies all over
with the faxed and emails. Essentially, that's ... that the process.
I wouldn't have loaned me the money. And nobody that I
know would have loaned me the money. I know guys who are criminals who
wouldn't loan me that and they break your knee-caps. I don’t know why the
bank did it. I’m serious ... 540 thousand dollars to a person w/bad credit.
And then without ever meeting him face to face Clarence is eventually hooked up with a guy like Mike Francis - former Executive Director at Morgan Stanley on the residential trading desk. Adam Davidson explains:
Mike was one link in a chain that connected the global pool of
money to its new favorite investment, these residential mortgages, the US housing
market, and guys like Clarence Nathan.
Think how attractive a mortgage loan is to that 70 trillion dollar pool of money.
Remember, they're desperate to get any kind of interest return. They want to beat
that miserable 1 percent interest Greenspan is offering them.
And here are these homeowners, they're paying 5, 7, 9 percent to borrow money
from some bank. So what if the global pool could get in on that action?
There are problems. Individual mortgages are too big a hassle for the global pool of
money. They don't wanna get mixed up with actual people and their catastrophic
health problems or debilitating divorces, and all the reasons which might stop them
from paying their mortgages.
So what Mike and his peers on Wall Street did, was to figure out how to give the
global pool of money all the benefits of a mortgage – basically higher yield - without
the hassle or the risk.
So picture the whole chain. You have Clarence. He gets a mortgage from a broker.
The broker sells the mortgage to a small bank, the small bank sells the mortgage to
a guy like Mike at a big investment firm on Wall Street.
Then Mike takes a few thousand mortgages he’s bought this way, he puts them in
one big pile. Now he’s got thousands of mortgage checks coming to him every
month. It’s a huge monthly stream of money, which is expected to come in for the
next thirty years, the life of a mortgage.
And he then sells shares of that monthly income to investors. Those shares are
called mortgage backed securities. And the 70 trillion dollar global pool of money
loved them.
Mike Francis: it was unbelievable. We almost couldn’t produce enough to
keep the appetite of the investors happy. More people wanted bonds than we
could actually produce. That was our difficult task, was trying to produce
enough. They would call and ask “Do you have any more fixed rate? What
have you got? What’s coming?” From our standpoint it's like, there's a guy
out there with a lot of money. We gotta find a way to be his sole provider of
bonds to fill his appetite. And his appetite’s massive.
Alex Blumberg: To be fair, they knew there were risks. But investors have a system
to assess those risks. They’re these special companies. Credit rating agencies.
Moody’s, Standard & Poor’s, Fitch. Their job, their main job, is to assess risk for Wall
Street and the global pool of money. They rate every kind of bond according to its
risk. Triple A is the safest, then there’s double A, single A, all the way down to single
B and below.
And that’s all most investors look at - the letter grade. They trust the credit rating
agencies. And these agencies blessed most of these mortgage-backed securities.
Gave them AAA ratings - which means they were considered as safe as a US
government bond.
This was the magic of this whole system. You could take a pool of thousands of risky
mortgages, and create a security that was called money-good, as safe as any
investment out there. At least that's what people thought.
But now we know those agencies relied on the wrong data. That same historic data
that had nothing to do with these new kinds of mortgages.
Adam Davidson: And then things got even worse. The thing that took this problem
and turned it into a crisis was something else that was new, something called a
Collateralized Debt Obligation. A CDO. And that brings us back to the guy we met at
the awards dinner in the beginning, Jim Finkel.
Adam Davidson: Jim Finkel runs this CDO shop, Dynamic Credit. It takes up three
modified apartments on the upper East Side of Manhattan. The trading room is like a
factory floor for CDOs, it’s where they make the things.
Adam Davidson: Maybe factory is the wrong term. But this is where he makes
CDOs. But what is a CDO? He shows us on a computer screen.
Jim Finkel: Here’s our deal Monterey...
Adam Davidson: To start with, every CDO has its own name. Finkel loves his
country house in the Berkshires, so he always names his CDOs after towns in
western Mass. Like Monterey.
Jim Finkel: Monterey CDO limited. 189 assets...189 tranches of different MB
pools
Alex Blumberg: Let’s translate some of that. A mortgage-backed security, you
remember, is a pool of thousands of different mortgages. These are all put together
and divided into different slices. Jim used the word tranche. Tranche is just French
for slice - some of these slices are risky, some are not. OK, a CDO is a pool of those
tranches. A pool of pools.
And Jim and most companies like his weren’t buying the top-rated tranches - the
safest ones, the AAAs. They were buying the lower-rated stuff. The high-risk stuff.
Jim’s company was buying tranches that came from Glen Pizzolorusso’s company.
The guy who hung out at nightclubs with B-list celebrities. The guy who said he was
selling mortgages to people who didn’t have a pot to piss in.
Adam Davidson: There's another term the industry uses, no joke, they call these
lower-rated tranches toxic waste. They're so high-risk, they're toxic.
Alex Blumberg: So, a CDO is sort of a financial alchemy. Jim takes that toxic stuff,
these low-rated, high-risk tranches, puts them all together. Re-tranches them, and
presto: he has a CDO whose top tranche is rated AAA, rock-solid, good as money.
If this seems too good to be true to you, you're in good company. Guys like
billionaire investor Warren Buffet said the very logic was ridiculous. But back in
2005, 2006, the global pool of money couldn't get enough of these things.
And the CDO industry was facing the same pressures everyone else was at every
other step of this chain. To loosen their standards. To make CDOs out of lower and
lower rated pools.
And then those "toxic" though triple A rated "tranches" of CDO's" were disseminated out into the markets of the international financial system in many forms and at many levels, instantaneously and electronically, implicating and involving pretty much everybody- wait a couple of years and voila: biggest financial crisis since The Great Depression.
Money ain't for nothing, as Dire Straits used to sing. If you have the time its very well done, very revealing and illuminating and well worth your time.
This was the week the world changed. It started with the US authorities trying to rescue Lehman Brothers. It ended with the US taxpayer preparing to pick up the tab for the mistakes of Wall Street's elite. It started with the prime minister sipping cocktails with financiers in Canary Wharf.
It ended with the government slapping a ban on short-selling and Gordon Brown pledging to clean up the City. Britain's biggest lender was rescued and the Chinese government lined up to take a 49% stake in Morgan Stanley, one of the last US investment banks left after a week of carnage. Ben Bernanke, the chairman of the Federal Reserve and Hank Paulson, the Goldman Sachs tycoon who became US Treasury secretary, have done more for socialism in the past seven days than anybody since Marx and Engels.
Over and above the extraordinary individual events, there was the capitulation of the prevailing economic model. History will show that the great experiment with financial deregulation lasted from the first post-war oil shock in 1973 to the third oil shock in 2008.
Sin Two: Allowing Unregulated Bond Rating Agencies to Decide What was Safe. Sub-prime is only the best known of a widespread fad known as "securitization." The idea is to turn loans into bonds. Bonds are given ratings by private companies that have official government recognition, such as Moody's and Standard and Poors, but no government regulation. These rating agencies have become thoroughly corrupted by conflicts of interest. If you want to package and sell bonds backed by risky loans, you go to a bond-rating agency and pay it a hefty fee. In return, the agency helps you manipulate the bond so that it qualifies for a triple-A rating, even if the underlying loans include many that are high-risk. Without the collusion of the bond-rating agencies, sub-prime lending never would have gotten off the ground, because it would not have found a mass market. Had regulators looked inside this black box, they would have shut it down. They might have needed new legislation, but they never asked for it. And public-minded regulators might have done a lot under existing law, since banks (which are regulated) were heavily implicated in the financing of sub-prime.
When I taught a journalism course at Princeton a couple of years ago, I was captivated by the bright, curious minds in my class. But when I asked students what they wanted to do, the overwhelming answer was: “Oh, I guess I’ll end up in i-banking.”
It was not that they loved investment banking, or thought their purring brains would be best deployed on Wall Street poring over a balance sheet, it was the money and the fact everyone else was doing it.
I called one of my former students, Bianca Bosker, who graduated this summer and has taken a job with The Monitor Group, a management consultancy firm (she’s also writing a book). I asked her about the mood among her peers.
“Well, I have several friends who took summer internships at Lehman that they expected to lead to full-time job, so this is a huge issue,” she said. “You can’t believe how intensely companies like Merrill would recruit at Ivy League schools. I mean, when I was a sophomore, if you could spell your name, you were guaranteed a job.”
But why do freshmen bursting to change the world morph into investment bankers?
“I guess the bottom line is the money. You could be going to grad school and paying for it, or earning six figures. And knowing nothing about money, you get to move hundreds of millions around! No wonder we’re in this mess: turns out the best and the brightest make the biggest and the worst.”
According to the Harvard Crimson, 39 percent of work-force-bound Harvard seniors this year are heading for consulting firms and financial sector companies (or were in June). That’s down from 47 percent — almost half the job-bound class — in 2007.
Institutions and products are graded by various credit-rating firms so as to supposedly give an objective view of the risks and of the possibilities of default. Can anyone say, while keeping a straight face, that the current system of having the institutions themselves pay for this service is a good idea? The moral hazard is so obvious you can almost taste it.
I spend a great deal of time speaking to people in banks about their mathematical models. I know which are using good models (a very few banks) and which are using bad models (most banks). I know of the dangers present, from a quantitative-finance and risk-management perspective. And for many years I have explained these dangers to anyone who would listen, and I will continue to do so. So it is incredible to think that ratings agencies, which must also have detailed knowledge of the nature and, more important, size of the toxic transactions, will happily give out their multiple A grades without any feeling of shame.
And then the word “theoretically” becomes very important. I have attended many conferences on quantitative finance, at which professors and practitioners describe their latest models for derivative instruments and the like. All the time I’m sitting in the audience thinking that these models are far too simplistic and based on countless unrealistic assumptions. I tell people that these instruments are dangerous, that no one understands the risks. But no one cares.
As long as people are compensated hugely for taking risks with other people’s money, and do not suffer equally on the downside, then those risks will inevitably become outrageous. Whether markets are efficient or not I don’t know for sure, but I do know that if there’s a way for someone to make money at another’s expense, he will. In spades. I want out.
Thus the current system of compensation at financial companies does not lead to anything good at all. If you give $10 million to random people on the street and tell them that they’ll get 20 percent of any profit they make, without any consequences if they lose it, then many of them will go into the nearest casino and bet it all on red. (The really clever ones will find a way to leverage it up first — after all, a $2 million bonus is nothing; you can’t seriously expect people to live in New York or London on less than eight figures, can you?)
If Wall Street gets away with this, it will represent an historic swindle of the American public--all sugar for the villains, lasting pain and damage for the victims. My advice to Washington politicians: Stop, take a deep breath and examine what you are being told to do by so-called "responsible opinion." If this deal succeeds, I predict it will become a transforming event in American politics--exposing the deep deformities in our democracy and launching a tidal wave of righteous anger and popular rebellion. As I have been saying for several months, this crisis has the potential to bring down one or both political parties, take your choice.
And as a bonus have some fun watching cheerleader Larry Kramer try to blame it all on the "guilty liberal consciences" of the U.S. Congress
I think it's the duty of the comedian to find out where the line is drawn and cross it deliberately. -- George Carlin
Lots of obits to George Carlin today, of course. But this one by John Nichols at The Nation - George Carlin: American Radical is pretty good.
Carlin explained himself best in one of his last interviews. "There is a certain amount of righteous indignation I hold for this culture, because to get back to the real root of it, to get broader about it, my opinion that is my species--and my culture in America specifically--have let me down and betrayed me. I think this species had great, great promise, with this great upper brain that we have, and I think we squandered it on God and Mammon. And I think this culture of ours has such promise, with the promise of real, true freedom, and then everyone has been shackled by ownership and possessions and acquisition and status and power," he said. "And perhaps it's just a human weakness and an inevitable human story that these things happen. But there's disillusionment and some discontent in me about it. I don't consider myself a cynic. I think of myself as a skeptic and a realist. But I understand the word 'cynic' has more than one meaning, and I see how I could be seen as cynical. 'George, you're cynical.' Well, you know, they say if you scratch a cynic you find a disappointed idealist. And perhaps the flame still flickers a little, you know?"
Always kind of did make me feel uncomfortable. Just doing his job.
FURTHERMORE:
And just for the sake of a mild rebuttal to the above video some might want to check out this story from yesterday's 60 Minutes on the disappearance of the west coast salmon - The Fuss over Fish, which I think both confirms and challenges what George has to say.
Not so long ago, the phone rang in my office. It was Barack Obama. For more than a decade, Obama was my colleague at the University of Chicago Law School.
He is also a friend. But since his election to the Senate, he does not exactly call every day. On this occasion, he had an important topic to discuss: the controversy over President George W. Bush's warrantless surveillance of international telephone calls between Americans and suspected terrorists. I had written a short essay suggesting that the surveillance might be lawful. Before taking a public position, Obama wanted to talk the problem through. In the space of about 20 minutes, he and I investigated the legal details. He asked me to explore all sorts of issues: the President's power as commander-in-chief, the Constitution's protection against unreasonable searches and seizures, the Foreign Intelligence Surveillance Act, the Authorization for Use of Military Force and more.
Obama wanted to consider the best possible defense of what Bush had done. To every argument I made, he listened carefully and offered a specific counter-argument. After the issue had been exhausted, Obama said that he thought the program was illegal, but now had a better understanding of both sides. He thanked me for my time.
