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The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him. —Leo Tolstoy, 1897
If mere scandal could have destroyed the big Wall Street investment banks, they would have vanished long ago.
The big fear of the 1980s mortgage bond investor was that he would be repaid too quickly, not that he would fail to be repaid at all.
“Any business where you can sell a product and make money without having to worry how the product performs is going to attract sleazy people.
Sy Jacobs
How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans.
All these subprime lending companies were growing so rapidly, and using such goofy accounting, that they could mask the fact that they had no real earnings, just illusory, accounting-driven, ones. They had the essential feature of a Ponzi scheme: To maintain the fiction that they were profitable enterprises, they needed more and more capital to create more and more subprime loans.
“If you are going to start a regulatory regime from scratch, you’d design it to protect middle-and lower-middle-income people, because the opportunity for them to get ripped off was so high. Instead what we had was a regime where those were the people who were protected the least.”
Steve Eisman
“When you’re a conservative Republican, you never think people are making money by ripping other people off,” he said. His mind was now fully open to the possibility. “I now realized there was an entire industry, called consumer finance, that basically existed to rip people off.”
Steve Eisman
The market might have learned a simple lesson: Don’t make loans to people who can’t repay them. Instead it learned a complicated one: You can keep on making these loans, just don’t keep them on your books. Make the loans, then sell them off to the fixed income departments of big Wall Street investment banks, which will in turn package them into bonds and sell them to investors.
In the bond market it was still possible to make huge sums of money from the fear, and the ignorance, of customers.
The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street it was a machine that turned lead into gold.
Mike Burry didn’t own any triple-B-rated subprime mortgage bonds, or anything like them. He had no property to “insure” it was as if he had bought fire insurance on some slum with a history of burning down. To him, as to Steve Eisman, a credit default swap wasn’t insurance at all but an outright speculative bet against the market—and this was the second way to think about it.
If it’s such a great trade, why are you offering it to me?
The closer you were to the market, the harder it was to perceive its folly.
They hired a PhD student from the statistics department at the University of California at Berkeley to help them, but he quit after they asked him to study the market for pork belly futures. “It turned out that he was a vegetarian,” said Jamie. “He had a problem with capitalism in general, but the pork bellies pushed him over the edge.”
What struck them powerfully was how cheaply the models allowed a person to speculate on situations that were likely to end in one of two dramatic ways. If, in the next year, a stock was going to be worth nothing or $100 a share, it was silly for anyone to sell a year-long option to buy the stock at $50 a share for $3. Yet the market often did something just like that. The model used by Wall Street to price trillions of dollars’ worth of derivatives thought of the financial world as an orderly, continuous process. But the world was not continuous; it changed discontinuously, and often by
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Financial options were systematically mispriced. The market often underestimated the likelihood of extreme moves in prices. The options market also tended to presuppose that the distant future would look more like the present than it usually did. Finally, the price of an option was a function of the volatility of the underlying stock or currency or commodity, and the options market tended to rely on the recent past to determine how volatile a stock or currency or commodity might be.
As a rule, any loan that had been turned into an acronym or abbreviation could more clearly be called a “subprime loan,” but the bond market didn’t want to be clear. “Midprime” was a kind of triumph of language over truth.
“Leverage means to magnify the effect. You have a crowbar, you take a little bit of pressure, you turn it into a lot of pressure. We were looking to get ourselves into a position where small changes in states of the world created huge changes in values.”
They needed fools; only fools would take the other side of their trades. And they wanted to do more trades.
The triple-A ratings gave everyone an excuse to ignore the risks they were running.
The fraud was so obvious that it seemed to us it had implications for democracy. We actually got scared.” They both knew reporters who worked at the New York Times and the Wall Street Journal—but the reporters they knew had no interest in their story. A friend at the Journal hooked them up with the enforcement division of the SEC, but the enforcement division of the SEC had no interest either.
Goldman Sachs was the big kid who ran the games in this neighborhood. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things.
Complicated financial stuff was being dreamed up for the sole purpose of lending money to people who could never repay it.
For more than twenty years, the bond market’s complexity had helped the Wall Street bond trader to deceive the Wall Street customer.
“In 2008 it was the entire financial system that was at risk. We were still short. But you don’t want the system to crash. It’s sort of like the flood’s about to happen and you’re Noah. You’re on the ark. Yeah, you’re okay. But you are not happy looking out at the flood. That’s not a happy moment for Noah.”
Steve Eisman
The big Wall Street firms, seemingly so shrewd and self-interested, had somehow become the dumb money. The people who ran them did not understand their own businesses, and their regulators obviously knew even less.
The stimulus would lead inevitably to inflation, he thought, but also to a boom in stock prices.
The CEOs of every major Wall Street firm were also on the wrong end of the gamble. All of them, without exception, either ran their public corporations into bankruptcy or were saved from bankruptcy by the United States government. They all got rich, too.
What are the odds that people will make smart decisions about money if they don’t need to make smart decisions—if they can get rich making dumb decisions? The incentives on Wall Street were all wrong; they’re still all wrong.
the U.S. Federal Reserve took the shocking and unprecedented step of buying bad subprime mortgage bonds directly from the banks. By early 2009 the risks and losses associated with more than a trillion dollars’ worth of bad investments were transferred from big Wall Street firms to the U.S. taxpayer.
The world’s most powerful and most highly paid financiers had been entirely discredited; without government intervention every single one of them would have lost his job; and yet those same financiers were using the government to enrich themselves.
The main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders.
It’s too much to expect the people who run big Wall Street firms to speak plain English, since so much of their livelihood depends on people believing that what they do cannot be translated into plain English.
