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November 14, 2008 07:17 AM UTC

Financial disaster - post of the day

  • 7 Comments
  • by: DavidThi808

from Portfolio.com is the best description I have seen to date of the backstory of the financial disaster – The End by Michael Lewis.

The whole thing is well worth reading, but the key paragraph is:

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?”

In other words, a lot of the loss has nothing to do with any mortgage. And as such, buying the mortgages then won’t help on most of the paper sold.

And for a different look at what is going on, Eric Lundquist at eWeek has a great take:

What if the government had spent $750 billion to bail out the dot-com companies when the Internet bubble collapsed in 2001?

…

The countryside would be crawling with starving, crazed, dangerous pets if the government had not decided to prop up Pets.com with $2 billion in funding in 2000. While similar to the Webvan problem of how to bridge the gap between the hungry pooch at home and the warehouse full of dog food, the pet crisis had an additional, far more sinister twist. Little did homeowners know that when the cute little dog sock puppet got hungry, the pet owner suddenly started to look a lot like dinner.

The American car companies have been living on cheap car loans rather than a quality product. It was a dumb bet, but it was the bet they made, and it is the one they have to live with.

As to the banks, maybe the answer is that they will take over any large ones that are worthless, and then run it, keeping the credit market going, and after building it back up – selling it.

But pumping dollars into these messes – may just lead to more messes.

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7 thoughts on “Financial disaster – post of the day”

  1. from Chris Carey bailout sleuth

    Although the price tag on the Treasury Department’s Troubled Asset Relief Program is $700 billion, the full amount that the government has invested in its rescue effort for struggling financial institutions appears to be closer to $2.5 trillion.

  2. I love these guys at frontpoint, their crotchety nature and utter disdain for the street reminds me of myself (Liar and/or fool was my favorite game).  I also love how they completely called out the rating agencies who I feel have not gotten their share of the blame.  Class action lawsuits are the reward the rating agencies deserve.

    But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.

    As an investor, Eisman was allowed on the quarterly conference calls held by Moody’s but not allowed to ask questions. The people at Moody’s were polite about their brush-off, however. The C.E.O. even invited Eisman and his team to his office for a visit in June 2007. By then, Eisman was so certain that the world had been turned upside down that he just assumed this guy must know it too. “But we’re sitting there,” Daniel recalls, “and he says to us, like he actually means it, ‘I truly believe that our rating will prove accurate.’ And Steve shoots up in his chair and asks, ‘What did you just say?’ as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him.”

    “With all due respect, sir,” Daniel told the C.E.O. deferentially as they left the meeting, “you’re delusional.”

    This wasn’t Fitch or even S&P. This was Moody’s, the aristocrats of the rating business, 20 percent owned by Warren Buffett. And the company’s C.E.O. was being told he was either a fool or a crook by one Vincent Daniel, from Queens.

    …

    The models don’t have any idea of what this world has become…. For the first time in their lives, people in the asset-backed-securitization world are actually having to think.” He explained that the rating agencies were morally bankrupt and living in fear of becoming actually bankrupt. “The rating agencies are scared to death,” he said. “They’re scared to death about doing nothing because they’ll look like fools if they do nothing.”

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  4. from the Denver Post

    Several regional banks operating in the state have won preliminary approval to participate, including U.S. Bancorp, KeyCorp, TCF Financial and Zions, which operates Vectra Bank Colorado. CoBiz, United Western and Guaranty Bank, all based in Denver, also have applied.

    The government hasn’t yet said whether privately held banks, a large group that includes FirstBank Holding Co. of Lakewood, can participate.

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