Moneyball author Michael Lewis explains how Wall Street bleeped us all

Michael_ Gee · Nov 15, 2008

Dear Poindexter: What I meant is that the U.S. government operates in a buyers' market. It must sell enormous amounts of debt to somebody, and the somebody is Wall Street. Ergo, Wall Street calls the tune when it comes to regulation of Wall Street.

poindexter · Nov 15, 2008

The Big Ragu said:

Moody's & S&P weren't doing anything illegal. They built a wrong model -- the way a lot of people built wrong models. They made what was a prevalent mistake of thinking that paper wealth -- the run-up in value of certain assets on paper -- was real wealth. They didn't understand that it was a house of cards that could tumble and because the underlying fundamentals were so weak, it was likely that paper wealth would evaporate. If there was anyone disseminating false information in order to profit at others' expense, I am all for prosecuting. And I am open to that if it can be proven anywhere. But Moody's didn't do anything illegal.
Click to expand...

You and I must not even live on the same planet. Not doing anything illegal?

Did you not watch the congressional hearings this fall? Read the internal emails?

The CEO of Moody's told their board that company employees sometimes "drink the Kool Aid" and accede to pressure for undeservedly high ratings, even as the weaknesses of the securities were becoming apparent.

In one document, an S&P employee in the structured finance division writes: “It could be structured by cows and we would rate it.”

In another, an employee asserts: “Rating agencies continue to create [an] even bigger monster - the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.”

http://emac.blogs.foxbusiness.com/2008/10/23/the-credit-rating-agencies-moment-of-shame/
http://www.hispanicbusiness.com/finance/2008/10/23/congress_mauls_credit_ratings_agency_brass.htm

Get out of here with this garbage that "They didn't understand that it was a house of cards that could tumble." Its insulting.

poindexter · Nov 15, 2008

Michael_ Gee said:

Dear Poindexter: What I meant is that the U.S. government operates in a buyers' market. It must sell enormous amounts of debt to somebody, and the somebody is Wall Street. Ergo, Wall Street calls the tune when it comes to regulation of Wall Street.
Click to expand...

ok

harbinger · Nov 15, 2008

This blows me away.

Long Beach Financial was moving money out the door as fast as it could, few questions asked, in loans built to self-destruct. It specialized in asking homeowners with bad credit and no proof of income to put no money down and defer interest payments for as long as possible. In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000.
Click to expand...

The Big Ragu · Nov 15, 2008

poindexter said:

The Big Ragu said:

Moody's & S&P weren't doing anything illegal. They built a wrong model -- the way a lot of people built wrong models. They made what was a prevalent mistake of thinking that paper wealth -- the run-up in value of certain assets on paper -- was real wealth. They didn't understand that it was a house of cards that could tumble and because the underlying fundamentals were so weak, it was likely that paper wealth would evaporate. If there was anyone disseminating false information in order to profit at others' expense, I am all for prosecuting. And I am open to that if it can be proven anywhere. But Moody's didn't do anything illegal.
Click to expand...

You and I must not even live on the same planet. Not doing anything illegal?

Did you not watch the congressional hearings this fall? Read the internal emails?

The CEO of Moody's told their board that company employees sometimes "drink the Kool Aid" and accede to pressure for undeservedly high ratings, even as the weaknesses of the securities were becoming apparent.

In one document, an S&P employee in the structured finance division writes: “It could be structured by cows and we would rate it.”

In another, an employee asserts: “Rating agencies continue to create [an] even bigger monster - the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.”

http://emac.blogs.foxbusiness.com/2008/10/23/the-credit-rating-agencies-moment-of-shame/
http://www.hispanicbusiness.com/finance/2008/10/23/congress_mauls_credit_ratings_agency_brass.htm

Get out of here with this garbage that "They didn't understand that it was a house of cards that could tumble." Its insulting.
Click to expand...

Poin, I specifically said, if you or anyone else can prove that anyone at Moody's or S&P intentionally disseminated false info so they could profit from it, I am all for prosecuting. We should prosecute. But what you just linked to, is not proof of anything illegal. It's proof of incompetence. Henry Waxman's typical grandstanding efforts always make for good scapegoating, and the people called to testify made good punching bags. That is what Waxman does. He loves TV cameras and he beats up on people who have screwed up. He's the best Monday Morning QB in the country. But no one is going to jail, precisely because nothing that came out of that hearing proved any illegalities. If you can prove otherwise, I am all for prosecuting.

Bob Cook · Nov 16, 2008

At the least, Ragu, what rating agencies did was the same thing others on Wall Street did, to ill effect for the rest of us -- told us shit was roses so they didn't lose business to the people submitting their shit for ratings. It's why Arthur Andersen and the Big Whatever Is Left accounting companies approved SEC financial reports when even they knew the numbers were bunk -- because they didn't want the company to leave and find another accountant. It's why analysts stopped issuing "sell" recommendations -- because the underwriting department didn't want to be told to suck it when it was time to find someone to handle the next big IPO.

Did Moody's or S&P intentionally disseminate false info? It depends on what your meaning of "intentionally" is. Did they know it was bad, and called it good anyway? Did they know it might be suspect, but didn't bother to look further? Did they figure, eh, prices are going up like gangbusters, so that makes it good? Who knows? But it's clear that, as happens in most bubbles, no one asks those questions on the way up.

The problem is, unlike most bubbles, it isn't simply about prices in a certain market going way up, up, up. It's all the horse-trading that was done based on that market, and the fact that so few asked those hard questions on the way up means that NOBODY trusts each other in this financial system anymore. Not simply, is this guy trying to screw me. But nobody trusts that a bank or institution will survive into tomorrow, or that the toxic debt on its books is really accounted for. Lenders went from trusting anyone who walked in the door, no matter what their credit, to trusting NO ONE who walks in the door, no matter what their credit. No wonder Paulson decided (wisely) not to buy up toxic mortgage-related commercial paper, because lord only knows whether he could ever buy enough.

However, we truly aren't going to reach the end of Shit Creek until everything is truly accounted for and people start trusting each other again. You know, bank and TRUST?

The Big Ragu · Nov 16, 2008

Bob, Not too many arguments with what you said. I think a lot of people -- from bond rating agencies to traders to lenders -- got caught up in a fallacy. What the Henry Waxmans of the world do is play Monday Morning QB and look to point fingers after the fact. It's populist BS. Everyone always needs a scapegoat.

Where was he when money was cheap and everyone was living large, though? I wouldn't be surprised if he was boasting to his constituents about how home ownership was at an historical high and somehow claiming credit for it.

The problem was that everyone was living large, and in that environment, few people have the courage to say, "Wait a minute, the emperor has no clothes!" even if intuitively a lot of people knew that, and there were people privately saying it to each other at a place like S&P, as a stray e-mail or a captured IM chat might suggest.

Lots of smart people that I know were talking about consumer debt in general, and predicting a recession because of the flawed fundamentals of various economies around the world, but few foresaw the hell we are probably facing the next five years.

The proof of something insidious is always if someone profited from doing something meant to cheat others. Like when a public company is putting out false earnings and the supposedly independent CPA is cooking the books for them to be able to bilk investors. An Enron-type situation. And even those things never start out as intentional fraud. It's usually a case of earnings expectations having been set and management freaked about not living up to the sentiment, so they fudge a little and then get sucked in and fudge a lot.

I am not saying anything like that didn't happen in the CDO market. I don't know. It's just that there is no proof of it. When the big losers were the Lehmans and the Merrills and the Bear Stearns, and even a company like GE, I really do suspect this was just groupthink mentality and not outright corruption, because those are the players who usually win at someone else's expense. They don't lose and lose this big.

Look around at what the subprime meltdown has wrought and tell me who exactly the winners are? If there were any big winners, wouldn't they be the most likely villains if there are villains? And if there aren't any big winners, isn't it more likely that sentiment got carried away and this thing spiraled beyond anything anyone could have imagined.

Look at that clip someone posted on another thread in which all those pundits on one of the financial news channels were talking up the banks and investment banks as good values even as their value started to melt away. This was well after the crisis started last year and it was easier to see what was happening. They weren't trying to screw people. They just couldn't conceive of the credit markets drying up and a stallwart like Lehman or Merrill losing all of its value because it had leveraged its assets at levels no one realized.

harbinger · Nov 16, 2008

Daily Kos had a great explainer about the crisis today. The only link is to dailykos.com, and I thought it wouldn't work if this was no longer on the home page. So I cut and pasted here. So sorry for the length, but it's definitely worth the read for those still trying to understand how the collapse came about.

Down the Republican Rabbit Hole
by Devilstower
Sun Nov 16, 2008 at 07:00:03 AM PST
History may be written by the winners, but that doesn't stop the losers from wasting a lot of ink in the attempt. This time, it's the GOP revanchists who are busy trying to come up with a reason -- any reason -- for the economic crisis that doesn't point directly to their conservative ideology and the greedy green horse of the Apocalypse, deregulation.

There are dozens of letters percolating through Republican chain mail, and a matching number of posts on right wing blogs, all trying to spread the same message: Democrats loaned money to black people!

Here's an example plucked from my own mailbox.

We're on the brink of an economic disaster and another Great Depression. This was not caused by Republicans. This was caused solely by Democrats.

In 1977 Democratic President Jimmy Carter passed the Community Reinvestment Act to provide housing to poor people. In the 1990s Bill Clinton had Attorney General Janet Reno threaten banks under red lining rules into giving loans to people who could not afford them. Then in the last 8 years, the leftist group ACORN, which has ties to Barack Obama, went to banks and threatened them to relax their rules again. Banks had to give loans to people who had no jobs or no identification.

You have to hand it to them. In terms of bringing together the maximum number of Republican demons -- Carter, Clinton, Reno, Obama -- with the smallest amount of connecting narrative, this is a keeper.

It's a satisfying bedtime story for the right. They can snooze and dream of revenge, when the wonders of True Conservatism will pave the streets with a mixture of gold and liberal bones. Unfortunately for them, it's not only simplistic, not only demonstrative of deep prejudice, it's also dead wrong.

The Community Reinvestment Act and other red lining laws weren't passed to force banks to make loans to African-Americans and other minorities. They were there to make the rules consistent. Previous to the passage of the CRA, minorities were often required to have better credit, and make larger down payments to get loans equivalent to those awarded whites. Nothing in these laws required that banks lower their lending standards, only that they be fair, consistent, and operate in a "safe and secure" way. There was no evidence then, and no evidence now, that minorities with the same initial credit rating as whites tend to default on their loans at any greater rate.

Want proof? Mortgage failure rate in 2000: 1%. 2001: 1%. 2002, 2003, 2004, 2005, 2006? One (1) as in ONE percent. But wait! Everything that Carter, Reno, and Clinton could do was already in there. The nefarious community organizers of ACORN had already grown their little oak trees of pressure. Carter's poor people had been sitting in their new homes so long, that many of those initial mortgages were paid off and gone.

What does legislation passed 31 years ago have to do with problems today? Nothing. Neither do tweaks Clinton made to that legislation in the mid 90s. The real culprits require a much shorter trip down memory lane.

Subprime mortgages (and all mortgages, really) are a fraction of the current problem. The bailout would have been enough to buy out every subprime mortgage in foreclosure across the country. In fact, it was enough to do that several times over. So why not do that?

The reason is that the purpose of the bailout (at least as Treasury Secretary Paulson sees it) isn't to stop mortgage foreclosures, but to save the banks. And the banks have some self-inflicted problems that make those mortgages an afterthought.

For example, the wonderful credit default swap. In essence, credit default swaps are (or were) nothing but insurance policies for loans. And yet in 2007 the total number of credit default swaps traded far exceeded the value of all loans. In fact, it may have touched $70 trillion dollars, which puts it above the gross domestic product of the entire planet.

How is that possible? Come with me back to the primitive world of 1999, when SUVs ruled the roads and cell phones did not yet shoot video, and let's see how this clumsy bit of fiscal jargon conquered the planet.

The Evolution of the Credit Default Swap

Stage 1 (Perturbo mutans)
You have just made a loan to someone, and now you're nervous that this scoundrel might not pay. What to do, what to do? Ah, but you need not worry! I happen to have assets on hand that can easily cover your petty loan. What's more, for a small monthly fee, I'll be happy to provide you with insurance of a sort. Should the person to whom you've extended a loan prove unreliable, I'll shoulder the burden -- so long as you keep up the payments. Let's call this insurance a... credit default swap.

In 1999, these credit default swaps already existed, but they were a niche product. Only a fraction of banks employed them and then only on a fraction of loans. Without some knock to the system, swaps would probably have remained a relatively small player.

Stage 2 (Perturbo furtiva)
Knock, knock. In 2000 Republican economic hero, Phil Gramm, with the assistance of a small legion of lobbyists, created the Commodity Futures Modernization Act. Along with ushering in the Enron disaster, this bill provided the one thing that credit default swaps needed to grow and mutate -- invisibility. Thanks to the CFMA, not only were credit default swaps unregulated, they were impossible to observe directly. Like black holes in deep space, you could only spot swaps by looking at how other things acted nearby.

So, now you've made a loan to someone, and you're worried about it. I want to offer you a credit default swap so I can collect the fee. Trouble is, I don't have the assets to cover your loan. So how can I... hold on, credit default swaps are so unregulated that no one says I actually have to be able to deliver on my promise. Hey, over here! Have I got a swap for you, and it's a bargain.

So now the CDS is a means of moving the risk, but the risk is still as high (or higher, since the original lender might have been better able to cover the loss). In fact, credit default swaps have gone from being a risk mitigator, to a risk magnifier.

Stage 3 (Peturbo veloxicresco)
You have a loan you're worried about. That's good, because lots of people want to offer you swaps. After all, you don't have to have any assets to issue a swap. The investment bank of First Me and The Change I Found In the Couch Cushions can offer swaps for all the debt at Morgan Stanley, and that's okay. I get free money for issuing the swaps, and the swaps have value on the books. So both me and my pal Mr. Stanley have values that are inflating faster than a tick in a blood bank.

Now you can get a swap for any loan you want, and with all the competition, the cost of these swaps is lower, and lower, and lower. Here's an idea: why not go out and make more loans, riskier loans. Why not offer anyone you can collar on the street a loan, no matter whether or not they can pay it off, not because some 30 year old law makes you do it, but because your friend the credit swap makes it perfectly safe!

So many people are offering these things that you could give a loan to Saddam while the bombs are falling without a care in the world. You can always get a swap.

Stage 4 (Fatum casus)
I have a swap. I really, really want someone to take my swap. Only even with every incentive I can offer, not enough people are loaning. Sure, there's a record amount of hypothetical money sloshing around the system thanks to me and my swaps, but it's still not enough. So what can I...

Wait a second. Swaps are unregulated. No one says I have to have enough resources to cover the swap, and even better, no one says I have to offer the swap to the person who actually made the loan! Hey buddy, see that loan over there? You may think it's iffy, but I think it'll hold up. In fact, I'm so sure it will, I'll sell you a credit default swap on it that pays off if it fails. You don't make the loan, you don't have to pay off on the loan, you don't have anything to do with the loan. You just pay me the fee. And if that guy loses his money, you collect. How sweet is that!

This mutation is enormous (see how the genera changed up there?). At this point, credit default swaps have become completely divorced from the original function. A single loan can be covered by multiple swaps. There's a complicated fiscal term for this. It's called gambling, and at this stage, that's all that remains of those little "insurance" policies. They no longer protect anyone from anything, they just offer a chance to place enormous overlapping side bets on everything.

Stage 5 (Fatum insanus)
I have swaps! Get your swaps here! Want a swap on a loan you made? Okay. Want to bet that the bozo in the next cube is making bad loans? We can do that. Want to bundle up some loans and bet on those? Buddy we can do better than that. I can give you a swap on the value of other swaps. Now we're really in business.

Who owns the original loan? Don't know, don't care. Who's actually responsible for the money if that loan should fail? Ehhh, can't really say. Has anyone noticed that a single bad loan could cause a cascade of swap calls that bounce around the system like a rocket-power pinball? Shut up.

Isn't anyone worried that this is the most massive house of cards ever constructed in human history? Lookit, what part of "we took 120 billion in bonuses out of this place in the last five years" are you missing?

Stage 6 (Fatum exicelebritas)
Hey, my loan went bad. Can I have my money from that swap, please?

Stage 7 (Fatum cerus)
Oh shit.

Now that people are paying attention, it turns out that the value of most credit default swaps is not just bupkis, it's Bupkis Plus. More computer power went into modeling these things than has been invested in predicting climate change, but everyone overlooked the giant "and then a miracle occurs" at the center of all the equations that allowed credit default swaps to generate revenue ex nihilo.

Trying to blame the 1977 Community Reinvestment Act for the current fiscal crisis is like blaming a spot on your windshield for engine failure while ignoring the gaping wound in you head gasket. Republicans are scribbling hard to create their new version of reality, and you never know what's going to sell. After all, people bought a "Book of Virtues" authored by Bill Bennet.

But in this case, even the Mock Turtle and the March Hare think the GOP line is too outlandish.
Click to expand...

poindexter · Nov 17, 2008

The Big Ragu said:

Bob, Not too many arguments with what you said. I think a lot of people -- from bond rating agencies to traders to lenders -- got caught up in a fallacy. What the Henry Waxmans of the world do is play Monday Morning QB and look to point fingers after the fact. It's populist BS. Everyone always needs a scapegoat.

Where was he when money was cheap and everyone was living large, though? I wouldn't be surprised if he was boasting to his constituents about how home ownership was at an historical high and somehow claiming credit for it.

The problem was that everyone was living large, and in that environment, few people have the courage to say, "Wait a minute, the emperor has no clothes!" even if intuitively a lot of people knew that, and there were people privately saying it to each other at a place like S&P, as a stray e-mail or a captured IM chat might suggest.

Lots of smart people that I know were talking about consumer debt in general, and predicting a recession because of the flawed fundamentals of various economies around the world, but few foresaw the hell we are probably facing the next five years.

The proof of something insidious is always if someone profited from doing something meant to cheat others. Like when a public company is putting out false earnings and the supposedly independent CPA is cooking the books for them to be able to bilk investors. An Enron-type situation. And even those things never start out as intentional fraud. It's usually a case of earnings expectations having been set and management freaked about not living up to the sentiment, so they fudge a little and then get sucked in and fudge a lot.

I am not saying anything like that didn't happen in the CDO market. I don't know. It's just that there is no proof of it. When the big losers were the Lehmans and the Merrills and the Bear Stearns, and even a company like GE, I really do suspect this was just groupthink mentality and not outright corruption, because those are the players who usually win at someone else's expense. They don't lose and lose this big.

Look around at what the subprime meltdown has wrought and tell me who exactly the winners are? If there were any big winners, wouldn't they be the most likely villains if there are villains? And if there aren't any big winners, isn't it more likely that sentiment got carried away and this thing spiraled beyond anything anyone could have imagined.

Look at that clip someone posted on another thread in which all those pundits on one of the financial news channels were talking up the banks and investment banks as good values even as their value started to melt away. This was well after the crisis started last year and it was easier to see what was happening. They weren't trying to screw people. They just couldn't conceive of the credit markets drying up and a stallwart like Lehman or Merrill losing all of its value because it had leveraged its assets at levels no one realized.
Click to expand...

The fact that the cheerleaders and kool-aid drinkers on CNBC couldn't recognize a problem in no way convinces me that there wasn't serious problems and illegal activities in Wall Street. There were plenty of smart persons that have been writing about the effects this will have on the economy, just not many I have read on the mainstream media (BLOGS!).

Oh to be a fly on the wall. When S&P ratings guys are emailing that “It could be structured by cows and we would rate it.” I don't think it takes a genius to figure out the modus operandi.

For pete's sake, I've written on this board that *I* started shorting financial stocks in September of 2006. And I'm nothing but an idiot who links female teacher sex stories. Who cares about pundits and CNBC? They aren't in the business of providing business "news".

Did you ever get a fortune cookie fortune that told you you were going to die? Of course not. Fortune cookies aren't in the business of giving you bad news. That's pundits and CNBC.

You are right Ragu, I don't have iron clad proof. And I don't think for a second that anyone is going to jail. But it doesn't change what my nose knows.

Bob Cook · Nov 17, 2008

Also, I don't find anything inherently wrong with the concept of mortgage-backed securities, or even credit-default swaps. Both help spread risk, which is not an all-bad thing. With an MBS, a bank can basically collect its loan upfront and not have to worry about what happens if one goes poof, thus allowing for more people to be able to buy homes. The credit-default swap is reinsurance, which is a longstanding product. Even the so-called subprime part of this isn't all bad, because there are people who are perhaps just starting out in their careers, or who had a rough go at some point in their lives but have put things mostly back together, or are in a situation where they could handle a payment but do require a higher interest rate because of past problems.

The problem comes when the financial system is set up so that ANY mortgage is classified, for the purposes of MBS, as high-grade, and when those credit default swaps have swaps on top of swaps on top of swaps. No wonder lenders would give money to anyone without documentation -- why bother when you can sell the loan and get your money right away?

harbinger · Nov 17, 2008

Bob Cook said:

Also, I don't find anything inherently wrong with the concept of mortgage-backed securities, or even credit-default swaps. Both help spread risk, which is not an all-bad thing. With an MBS, a bank can basically collect its loan upfront and not have to worry about what happens if one goes poof, thus allowing for more people to be able to buy homes. The credit-default swap is reinsurance, which is a longstanding product. Even the so-called subprime part of this isn't all bad, because there are people who are perhaps just starting out in their careers, or who had a rough go at some point in their lives but have put things mostly back together, or are in a situation where they could handle a payment but do require a higher interest rate because of past problems.

The problem comes when the financial system is set up so that ANY mortgage is classified, for the purposes of MBS, as high-grade, and when those credit default swaps have swaps on top of swaps on top of swaps. No wonder lenders would give money to anyone without documentation -- why bother when you can sell the loan and get your money right away?
Click to expand...

The CDs were not a problem until Phil Gramm rewrote the rules with the Commodity Futures Modernization Act. By setting up a system that is unregulated, and allowing for every bank/investment firm/you name it to sell CDs without any money to back it up, they set up this house of cards. First, the fees on CDs were so enticing that lenders started pushing for more mortgages to create even more mortgage-backed securities and CDs. That's when anybody and everybody started getting mortgages. When those certain-to-fail mortgages did fail, those who bought CDs started asking for the payoff. That's when the sh-- hit the fan. Not solely because of the mortgages, because of the CDs.

Sheesh, even Las Vegas is regulated. Casinos have to have enough money to back up every chip. But in the casino known as Wall Street, no such back-up was required.

terrier · Nov 17, 2008

If you haven't read Lewis' "Liars' Poker," his book about being a Wall Street trainee in the mid-'80s, you gotta.
His tales about the "big swinging dicks" that ran the shops sound even more prescient today.
Dude married well, too.

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Moneyball author Michael Lewis explains how Wall Street bleeped us all

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