January 10, 2016

People Believed It Would Be To Their Benefit

A weekend topic on the movie, The Big Short. From Intercept, “The Big Short is a movie that normal people will actually enjoy and understand, and that will make them as angry as they should be about what’s been done to us. After you’ve seen it, please come back here and read the rest of this. As good as The Big Short is, the housing bubble was such a gargantuan crime that no movie can capture more than a tiny corner of it. There’s much more to what happened, and even seven years after the bailout, little of it is widely understood.”

“In all the financial industry’s history it’s invented maybe three scams total, which it cloaks in an infinite number of ever-shifting disguises. And the housing bubble was one of those basic scams: In essence, it was a gigantic counterfeiting operation. During the 2000s housing bubble, the market “value” of U.S. homes swelled to about $8 trillion more than it would have been if prices had followed historical trends. To give you an idea of how big a bubble that is, the entire U.S. Gross Domestic Product in 2005 — that is, the value of literally everything produced by the United States that year — was only $13 trillion.”

“Wall Street joyfully issued bonds “backed” by trillions of dollars of that imaginary wealth, and paid ratings agencies to certify that the wealth was real. The effect on the economy was more or less the same as if Lloyd Blankfein had printed trillions in cash in Goldman Sachs’ basement and somehow persuaded everyone it was real and belonged to them. We all felt richer — for a while. The reason financial bubbles are so common is that they feel so good to almost everyone on the way up.”

“In 2010, when Greenspan claimed on Bloomberg TV that ‘everybody missed it, academia, the Federal Reserve, all regulators,’ he was specifically asked about the people featured in the book version of The Big Short who saw it all coming. Greenspan answered: ‘You have to ask yourself why would they make that judgment. The problem that you’re raising is a statistical illusion. … If you took 1,000 people and you split them into two and you had them toss coins against each other, when you get down to the last two guys, tell them that they don’t know how to toss coins.’”

“The second part of what Greenspan said was completely true — that is, correctly calling the timing of a bubble’s collapse is largely luck, and it’s unlikely anyone in The Big Short will be able to do it again as well with anything else. But for Greenspan, that was also completely irrelevant. As Fed chair, he didn’t need to know precisely when the bubble would deflate, something that was essentially impossible. He only needed to know that it existed, something that could be figured out by anyone with a subscription to The Economist.”

From Todays Zaman. “For those who still can’t understand the American mortgage crisis’ cancerous takeover, and how it sank the world economy, this film presents enlightening and understandable information for the layman through simplified examples that are directly explained to the audience through mini-sequences acted out by real-life celebrities. Meet the nerds of Colorado — partners Charlie (John Magaro) and Jamie (Finn Wittrock) — who run a small hedge fund in New York and also make the same bet with the aid of capital coming from retired banker aka “The Man Who Sold His Ferrari,” Mr. Ben Rickert (Pitt).”

“Charlie and Jamie are smart and sweet dudes, but they’re so hyped about becoming rich that they don’t get the big picture. When they accuse Rickert of lacking a celebratory attitude, Rickert replies bitterly, ‘How do you expect me to be celebratory when millions of people have lost their homes?’”

“You wonder whether these men realize their own hypocrisy. They probably do. At least we are relieved that Baum and Rickert do, yet does it really make a difference? Towards the end of the film (there are no spoilers, we all know what happened in 2008) McKay shows how so many lower level employees were fired from the financial institutions they worked in along with the downfall of the rest of the underprivileged population and reminds us that those at the top were not put behind bars but were awarded with a bail-out.”

“We are told that even the American system is rigged and the same thing is happening all over again.”

“If you don’t want to be left with a bitter taste in your mouth, look into what Iceland is doing today. It has jailed 26 bankers and every Icelander will be paid from the sale of the banks. At least there’s still hope in some places in the world.”

From Morningstar. “The Big Short implicitly confesses its sins by periodically informing viewers that an incident ‘really happened.’ We are left to wonder, probably correctly, about the veracity of the incidents that are unaccompanied by that promise.)”

“Well, that’s entertainment. ‘The Big Short’ accurately relates the basic story: Housing prices had soared and mortgage-lending standards had plunged, leading to the creation of millions of dubious mortgages (mostly with adjustable-rate features that would boost required payments when short-term interest rates increased). Those loans were packaged into complex securities that received higher credit ratings than their underlying collateral would have. As 2007 began, few understood how large that time bomb was and how easily it would be triggered by rising short-term rates.”

“Ultimately, the film deconstructs itself. ‘The Big Short’ wishes to have it both ways, deriving comic effect from the mass cluelessness while casting Wall Street banks as Ernst Blofeld. But that circle cannot be squared. Either those Wall Street workers were caught up in the moment along with everybody else or they were not. And the film shows that they were not. Greedy? Sure. Unlikeable? Check. But criminally knowing? Not many. As with most giant financial flops, the mortgage-bond con was largely unintentional, with those who received, wrote, securitized, and bought mortgages all happily believing in the housing fairy.”

“So, too, did those who wrote government policies that supported home ownership, and those who worked in agencies that furthered that aim. The villains of the business press’ version of this morality play (and make no mistake, ‘The Big Short’ is very much a morality play), Fannie Mae and Freddie Mac, receive nary a mention. As the business press has (mostly) told the story, government drove private enterprise into this disaster. ‘The Big Short’ portrays just the opposite, with government’s only fault being that it policed the baddies too loosely.”

“Those are two sides of the same elephant. ‘The Big Short’ is correct that the usual human failings of greed and arrogance drove Wall Street to make and distribute bad products, products that eventually would not only impoverish many retail investors, but also sink several Wall Street banks themselves. And the business press is correct that government policies, also created by flawed humans, offered support and encouragement for these mistakes. They are both right–and they are both wrong.”

“To which I would add the failings of Main Street. Homeowners have delighted in feeling aggrieved, sometimes at ‘The Big Short’s’ demon of the big banks and sometimes at business press’ demon of government. In blaming others, Main Street has been outstanding. In accepting responsibility, not so much. The greed inspired by the house-flipping TV shows and the arrogance of coworkers who turned real estate profits was no different than the greed and arrogance found at Wall Street banks, aside from scale. Nobody was forced to buy a house. Nobody was forced to overstretch for a mortgage. Just as nobody was forced to write a mortgage or package them into bonds. People did all those things because they believed it would be to their benefit.”

“If we look into a mirror, we will see who caused the mortgage-bond bubble. I certainly did my part, upgrading to a pricier house in early 2006. Fortunately for those who purchased my mortgage–the bank sold it almost immediately–I have obediently made my monthly payments.”

“My point? ‘The Big Short’ implies that if government clamps down hard enough on Wall Street, market bubbles, and therefore market crashes, may be averted. The business press suggests a similar result–if government is kept at arm’s length. Each has a point, but each is deeply flawed in believing that bubbles come from a single, evil source. Bubbles, at least of the very large variety, come from throughout society, and from people behaving … just like people. That is how they become so thoroughly encompassing, so difficult to identify, and so challenging for investors. Bubbles are us.”

The Worcester Telegram. “One of the many things that enraged me about that crisis was the oft-repeated false statement that nobody had warned authorities about the pending collapse. Let’s look at what is nefarious about the link between Wall and Main and how that played out during the 2008 financial crisis. The problem I refer to is the heads-I-win, tails-you-lose game that Wall Street plays with Main Street. In December 2006, I argued that subprime lender NovaStar Financial, whose shares then traded at $106 apiece, was heading for a huge fall because borrowers would be unable to repay the loans. NovaStar was delisted in 2008 after its shares fell below $1, changed its name to Novation and now its shares sell for 14 cents.”

“I was not alone. According to The New York Times, in 2005 ‘there were 1,628 articles in major world publications included in the Nexis database that used the term ‘housing bubble.’”

“A key question that the movie raises in my mind is where is the next big short opportunity? The movie does not provide an answer, but it suggests some signs to investigate. First, the bubble must be built globally by many different industry participants. Second, those participants must be motivated by an incentive system that rewards closing deals fast, not long-term profitability. Third, it must be based on borrowing large amounts of money. Finally, it must depend on convincing Main Street that it can win the lottery.”

Bits Bucket for January 10, 2016

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