OT Great Article on the Subprime Crisis

[keno]

http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?page=0

It's a bit long, will take 15-20 minutes to read, but lays out some great material. Paints Wall Street in no uncertain colors and the subprime crisis. Written by the same author, Michael Lewis, who wrote "Liar's Poker", "The Blind Side", "Moneyball" and several others.

keno

[paczki]

That is great. Thank you.

[1happygirl]

Awesome article. Thanks !

[1centaur]

Certainly hits some of my preconceptions: financial industry people work with blinders on, because there's not enough time or incentive for 99% of them to do otherwise. They assume everyone else knows their jobs as well as they know theirs. People selling mortgages don't know anything about credit default swaps. Everyone assumes rating agency models are thoughtful and conservative. CEOs expect everyone below them to be highly competent AND deliver great earnings growth that they can take credit for. Literally, most CEOs think their job is to tell people "you'd better get me good numbers." The quants who create the structured products mostly know only their part of the puzzle, not the whole, and hardly want to question anyone else's part (most likely they view the numbers as an abstraction rather than the result of real people with real mortgages - they are mathematicians at heart, not investors). Throw all that limited focus together in a jumble with massive leverage and what do you get? Calamity, that no government official can really understand or fix. So the TARP throws money at the ballpark and hopes it's enough to get us through the storm until we're all soberly underlevered for the next 30 years because everyone now assumes it's worse than it is. Ironically, if the lenders had made good loans, and the agencies had good models, it would have been fine for Wall Street to build the structured products and for everybody to buy and sell credit default swaps on them. Nobody's going to believe that for a while, so fewer people will get home financing than should because structured products are an efficient way to lower home financing costs. The evil here is at the lender/borrower level, because both parties knew those were not good loans. Ignorance and the singular focus of rushing through the workday pretty much explains the rest of it. The common perception that clever Wall Street types created this mess knowing it was a joke just so they could get rich is off the mark. If they had, they all would have made enormous money shorting everything. Only a few hedge funds succeeded at that.

Invest in rental housing.

[Viper]

Iraq war hits U.S. economy: Nobel winner
Sun Mar 2, 2008

'FLOODING THE ECONOMY'

NEW YORK (Reuters) - The Iraq war has contributed to the U.S. economic slowdown and is impeding an economic recovery, Nobel-winning economist Joseph Stiglitz says.

Asked if the war has contributed to the U.S. slowdown, Stiglitz said, "Very much so."

"To offset that depressing effect, the Fed has flooded the economy with liquidity and the regulators looked the other way when very imprudent lending was going up," Stiglitz said. "We were living on borrowed money and borrowed time and eventually a day of reckoning had to come, and it has now come."

The war has also altered how the United States has reacted to its current economic troubles, he said.

"When America's financial institutions had a problem, they had to turn to the sovereign wealth funds in the Middle East for recapitalization, for the bailout," he said.

"The reason was obvious. The war had led to high oil prices. The war had meant that America had to borrow more money. There weren't sources of liquid funds in the United States. The sources of the liquid funds were in the Middle East," he said.

"It used to be thought that wars are good for the economy. No economist really believes that anymore," Stiglitz said in an interview.

http://www.reuters.com/article/topNews/idUSN2921527420080302

This was written in February, 2008...how true it turned out the be:

http://www.theaustralian.news.com.au/story/0,25197,23286149-2703,00.html

Iraq war 'caused slowdown in the US'

THE Iraq war has cost the US 50-60 times more than the Bush administration predicted and was a central cause of the sub-prime banking crisis threatening the world economy, according to Nobel Prize-winning economist Joseph Stiglitz.

The former World Bank vice-president yesterday said the war had, so far, cost the US something like $US3trillion ($3.3 trillion) compared with the $US50-$US60-billion predicted in 2003.

Professor Stiglitz told the Chatham House think tank in London that the Bush White House was currently estimating the cost of the war at about $US500 billion, but that figure massively understated things such as the medical and welfare costs of US military servicemen.

The war was now the second-most expensive in US history after World War II and the second-longest after Vietnam, he said.

The spending on Iraq was a hidden cause of the current credit crunch because the US central bank responded to the massive financial drain of the war by flooding the American economy with cheap credit.

"The regulators were looking the other way and money was being lent to anybody this side of a life-support system," he said.

That led to a housing bubble and a consumption boom, and the fallout was plunging the US economy into recession and saddling the next US president with the biggest budget deficit in history, he said.

[dauwhe]

The evil here is at the lender/borrower level, because both parties knew those were not good loans.

I like the Matt Yglesias post about this:

http://yglesias.thinkprogress.org/archives/2008/11/blame_to_go_around.php

Dave

[keno]

the most incredible information in the piece was that the rating agencies were giving AAA(and equivalents) ratings to top of tranches of debt that they had rated BBB. To me, that's equivalent to giving a top prize to a pro golfer who was at the top of the list of non-qualifiers. To stop at lenders/borrowers is very generous, I think. And that's not to mention the street, much of which knew it was selling crap. The buck stops everywhere.

keno

[ThomasAylesbury]

Forwarded it on...

[MarleyMon]

Invest in rental housing
Yup - 1 month at a time. :rolleyes:

[michael white]

look on the bright side:

when we get really old,
all the other old geezers will still be working too

[Louis]

Let's talk about root causes. It seems to me that at least part of the problem is how these folks were being payed.

1) Was there any incentive for them to do a good job long term? Little.

2) When you're getting tons of money all the incentive is to grab as much as you can now. Who cares about the future - load up today and worry about tomorrow later.

3) Not caring about the long-term consequences of your actions is a recipe for trouble.

Louis

[Pete Serotta]

Bulls :) eye


Let's talk about root causes. It seems to me that at least part of the problem is how these folks were being payed.

1) Was there any incentive for them to do a good job long term? Little.

2) When you're getting tons of money all the incentive is to grab as much as you can now. Who cares about the future - load up today and worry about tomorrow later.

3) Not caring about the long-term consequences of your actions is a recipe for trouble.

Louis

[Pete Serotta]

Thanks Ken. Whether you are interested in finance or not this is a wonderful article on greed both from Wall Street, Rating Agencies, Investors, and even the original folks who took out the mortgage. The greed was on making more money for yourself.


Too little time was spent on understanding what you were doing or the consequences. Even in today WSJ, every 2 or 3 articles is about bailing someone out..... Yes MANY will be bailed out at the cost of the US or its economic future.


If you have the time, read the article, focusing on what was driving the market GREED not anything else. And with greed.SMARTS usually takes a back seat.


Thanks KEN....... :beer:

[Ray]

If you have the time, read the article, focusing on what was driving the market GREED not anything else. And with greed.SMARTS usually takes a back seat.

And the beauty part is that even the guy who saw it all coming, Eisman, was going for greed too, shorting everything in sight. He wasn't better than anyone else, he was just better at the game - a bit smarter a bit sooner. He's not the hero because he did anything to stop the madness (not that he could have) - he's the hero because he took advantage of everyone else's impending misery. What a hero.

-Ray

[Pete Serotta]

;) YEP, greed is not isolated to a few....But you and I need to have some red and a long ride AND then discuss human nature :beer:


And the beauty part is that even the guy who saw it all coming, Eisman, was going for greed too, shorting everything in sight. He wasn't better than anyone else, he was just better at the game - a bit smarter a bit sooner. He's not the hero because he did anything to stop the madness (not that he could have) - he's the hero because he took advantage of everyone else's impending misery. What a hero.

-Ray

[keno]

I disagree that Eisman was no better than anyone else. He ran a hedge fund and represented investors as well as himself. His manner of shorting was largely buying credit default derivatives from people who should have known better than to sell them to him. He was taking advantage of, in my view, a legitimate opportunity as contrasted with those selling crap and not caring where the buyer landed.

To follow your logic to its end, short selling should be illegal. For that matter, so should casinos, as a bettor is effectively short selling mathematical odds favoring the house.

Greed isn't good or bad, it just is.

keno

[jpw]

Economics is the study of rational human behaviour. These people knew they would be saved by an injection of public money by government. Therefore their seemingly 'irrational' behaviour was actually rational. Some suffered (Lehmans et.c.) but most didn't. Government is held hostage by private financial institutions, almost like having a gun to its head. Where would government borrow money from if not private sources?

Why go to war in Iraq? I never did understand the logic of that decision. I understood the Afghan war, denying the 'enemy' the billions available from supplying heroin to the world: no money, no threat. So why also Iraq?

[Ray]

I disagree that Eisman was no better than anyone else. He ran a hedge fund and represented investors as well as himself. His manner of shorting was largely buying credit default derivatives from people who should have known better than to sell them to him. He was taking advantage of, in my view, a legitimate opportunity as contrasted with those selling crap and not caring where the buyer landed.

To follow your logic to its end, short selling should be illegal. For that matter, so should casinos, as a bettor is effectively short selling mathematical odds favoring the house.

Greed isn't good or bad, it just is.

keno
Ken, I have to plead a certain level of ignorance again, because when I read an article like that I'm just barely hanging onto a very limited level of understanding. But my understanding of short selling is that its basically just betting AGAINST the value of an asset, right? Betting on it to fail? If so, I just don't see what productive role that plays in the economy.

I understand what Wall Street's role is to allocate funds to where they'll be used most efficiently and I get how important that is to a functioning market economy. But short selling sounds to me like its taking an otherwise productive enterprise that involves risk and just turning the whole enterprise into the moral equivalent of a casino. That doesn't mean I think it should be illegal - I'd have to understand it way better than I do before I'd even begin to have an opinion on that. And besides, I think drugs and prostitution should be legal :cool:. But I don't see it as useful or productive, except to those who make a bundle doing it. So I don't see Eisman as less greedy or any less of a bad guy - he was just smart enough to see what was coming sooner than most. I'm sure I have a lot of this wrong and I look forward to being set straight by some of the fine financial minds who hang out here, but I guess that's where my criticism stems from.

-Ray

[Pete Serotta]

Greed is a human behavior, especially lately...I truly do not believe they thought that far....They got theirs and that was enough for them. "Me think" you are giving them too much credit. As to IRAQ - how about another human behavior - EGO! :confused:

Economics is the study of rational human behaviour. These people knew they would be saved by an injection of public money by government. Therefore their seemingly 'irrational' behaviour was actually rational. Some suffered (Lehmans et.c.) but most didn't. Government is held hostage by private financial institutions, almost like having a gun to its head. Where would government borrow money from if not private sources?

Why go to war in Iraq? I never did understand the logic of that decision. I understood the Afghan war, denying the 'enemy' the billions available from supplying heroin to the world: no money, no threat. So why also Iraq?

[keno]

Ray,

Without going into the pros and cons of short selling, it has been a market staple for the longest time with its good and bad. One good is that it provides some support for stocks going south. Those covering their short sales, that is buying back the stock in order to return it to those who lended it to the short seller, moves prices upward. There are naked shorts, 'speculators', hedging shorts, and other short strategies.

By the same token, if you sell a stock at what you believe is a top, aren't you engaging in a type of short sale in that whoever buys from you is buying an asset about to fail? Up and down are neutral in a market sense, it is how you use them.

jpw,

I mentioned "Predictable Irrationality" a few weeks back, which without question demonstrates that humans are quite irrational in their $ decisions. This demonstrated to me with scientific basis why economics can be so bogus.

keno

[RPS]

There are naked shorts, 'speculators', hedging shorts, and other short strategies.

kenoAre naked shorts legal?

Like Ray I don't understand it fully, but think that as long as there is an actual asset that is being shorted, it's not that different than buying and selling. On the other hand if naked shorting (as I understand it) is legal then I would have a problem with that. It seems powerful speculators would be able to manipulate price of smaller companies too easily.

[Joellogicman]

Iraq war hits U.S. economy: Nobel winner
Sun Mar 2, 2008

'FLOODING THE ECONOMY'

NEW YORK (Reuters) - The Iraq war has contributed to the U.S. economic slowdown and is impeding an economic recovery, Nobel-winning economist Joseph Stiglitz says.

Asked if the war has contributed to the U.S. slowdown, Stiglitz said, "Very much so."

"To offset that depressing effect, the Fed has flooded the economy with liquidity and the regulators looked the other way when very imprudent lending was going up," Stiglitz said. "We were living on borrowed money and borrowed time and eventually a day of reckoning had to come, and it has now come."

The war has also altered how the United States has reacted to its current economic troubles, he said.

"When America's financial institutions had a problem, they had to turn to the sovereign wealth funds in the Middle East for recapitalization, for the bailout," he said.

"The reason was obvious. The war had led to high oil prices. The war had meant that America had to borrow more money. There weren't sources of liquid funds in the United States. The sources of the liquid funds were in the Middle East," he said.

"It used to be thought that wars are good for the economy. No economist really believes that anymore," Stiglitz said in an interview.

http://www.reuters.com/article/topNews/idUSN2921527420080302

This was written in February, 2008...how true it turned out the be:

http://www.theaustralian.news.com.au/story/0,25197,23286149-2703,00.html

Iraq war 'caused slowdown in the US'

THE Iraq war has cost the US 50-60 times more than the Bush administration predicted and was a central cause of the sub-prime banking crisis threatening the world economy, according to Nobel Prize-winning economist Joseph Stiglitz.

The former World Bank vice-president yesterday said the war had, so far, cost the US something like $US3trillion ($3.3 trillion) compared with the $US50-$US60-billion predicted in 2003.

Professor Stiglitz told the Chatham House think tank in London that the Bush White House was currently estimating the cost of the war at about $US500 billion, but that figure massively understated things such as the medical and welfare costs of US military servicemen.

The war was now the second-most expensive in US history after World War II and the second-longest after Vietnam, he said.

The spending on Iraq was a hidden cause of the current credit crunch because the US central bank responded to the massive financial drain of the war by flooding the American economy with cheap credit.

"The regulators were looking the other way and money was being lent to anybody this side of a life-support system," he said.

That led to a housing bubble and a consumption boom, and the fallout was plunging the US economy into recession and saddling the next US president with the biggest budget deficit in history, he said.
Along with Keno's link, two great articles

The post WW2 boom really mislead a lot of people into thinking war is economically beneficial. What they overlook is that so much of the rest of the world's industrial, agricultural and financial capacity had been severely compromised if not totally destroyed by the war. The UK and France emerged at least somewhat intact, but found strained their economies past the breaking point trying to maintain control of their empires.

As late as the mid-1950s, the US still had well over half the world's industrial capacity, was by far the number grain exporter, and US banks were lending at good interest rates.

Vietnam was another story. Sure the oil embargo hurt. But the billions that had been pulled out of the economy to fly large jets day and night dropping bombs on jungle - along with all sorts of other intentionally destructive acts sure did not help.

Add in the mess Keno's article shows the Wall Street gamblers made of things and you have a real economic disaster. The scary thing is that Iraq is starting to heat up again, and Afghanistan is at a high boil. Who knows where the troubles in Somalia and the Congo are going to end.

[Viper]

Why go to war in Iraq? I never did understand the logic of that decision. I understood the Afghan war, denying the 'enemy' the billions available from supplying heroin to the world: no money, no threat. So why also Iraq?

The six trillion dollar question :rolleyes: . Iraq, the topic would require a discussion of post 9/11 reactions with a plan put in place for Syria, Lebanon, Iraq and Iran, the middle of the middle east. Chief of Staff Rahm Emanuel's father recently placed words (while shoving his foot down his throat) text into the form of what perhaps drove us to Iraq and it most certainly, according to the media, has placed the new administration on a rough start already:

http://swampland.blogs.time.com/2008/11/13/rahm-emanuels-father-problem/

http://www.usnews.com/blogs/john-farrell/2008/11/14/barack-obama-israel-and-rahm-emanuels-fathers-intemperate-remarks.html

[Pete Serotta]

We are starting to digress and if you read the VIPER's references on Emanuel, please do not let it go down a "slippery" slope emotionally.

THANKS pete (ps - viper must speed read or have a bunch of Irishmen doing investigative reporting :beer: )

The six trillion dollar question :rolleyes: . Iraq, the topic would require a discussion of post 9/11 reactions with a plan put in place for Syria, Lebanon, Iraq and Iran, the middle of the middle east. Chief of Staff Rahm Emanuel's father recently placed words (while shoving his foot down his throat) text into the form of what perhaps drove us to Iraq and it most certainly, according to the media, has placed the new administration on a rough start already:

http://swampland.blogs.time.com/2008/11/13/rahm-emanuels-father-problem/

http://www.usnews.com/blogs/john-farrell/2008/11/14/barack-obama-israel-and-rahm-emanuels-fathers-intemperate-remarks.html

[Viper]

THANKS pete (ps - viper must speed read or have a bunch of Irishmen doing investigative reporting :beer: )

It's a topic near/dear to my heart. I'm a researcher/writer who rides Campy. I know nothing about Shimano! :)

[Pete Serotta]

It's a topic near/dear to my heart. I'm a researcher/writer who rides Campy. I know nothing about Shimano! :)

I ride and love CAMPY but know SHIMANO works better :)

[Ray]

By the same token, if you sell a stock at what you believe is a top, aren't you engaging in a type of short sale in that whoever buys from you is buying an asset about to fail? Up and down are neutral in a market sense, it is how you use them.
OK, I get that. But isn't a short sort of an entirely different entity? I really dug the analogy to the relationship between the NFL and fantasy football. If a fantasy football "owner" drafts Peyton Manning, he doesn't actually create another Peyton Manning that influences what happens on the field in the NFL. He just creates a little parallel universe for entertainment purposes. But if you short a stock, you're creating "another Peyton Manning" that actually has an impact on what happens on the field, no? Again, I'm flying blind in terms of my understanding of the details. And I'm not saying that Eisman was any more bad than anyone else, just that he was no better. He was playing the same game, just playing it more effectively. But that's all sort of an academic argument anyway.

-Ray

[keno]

RPS, naked shorts are legal within limits. There is a 3-day rule, in which the naked seller must borrow the shares for delivery. Also, there have been lists at various exchanges on which are stocks that may not be shorted in that manner. Recently, the lists were quite long.

Ray, by your logic you would eliminate the largest financial market in the world - derivatives. A derivative is merely a contract between two parties (there may be more complex derivatives with more than two, but I don't know of them) and there is no underlying stock, bond or asset having any intrinsic value that would move into one of the parties' hands. If I understand the Peyton Manning example, the short sale would not replicate Manning's achievements but his failures. In any event, why should two parties not be able to contract where the payoff is determined by extrinsic events? At this time, the derivatives market is unregulated, BTW.

Hardly digressing, the put option is another form of the short transaction. I'm guessing that you already know that it is a contract under which A has the right to sell shares of X company to B at a price P. Clearly, if the current price is lower than P, the option will be exercised, or sold. I do not believe that the option seller need own shares of X to do this if certain margin rules are met. Some options (American style) allow the holder to exercise at any time and others (European style) settle on a specific day. American style and European style are the bulk, however. There are a wide variety of "exotic" options not worth going into. My point, though, is that by your logic that put options should go by the board in your logic, as well.

I have no idea if you are a betting man, Ray (I'm guessing not), but theoretically would you find it uncomfortable giving or taking points in on a football game bet? You would be betting that your team, if getting the points, could lose the game and you would get paid if within the spread. Or you could be thinking that the other team will lose, a short.

keno

[Ray]

I have no idea if you are a betting man, Ray (I'm guessing not), but theoretically would you find it uncomfortable giving or taking points in on a football game bet? You would be betting that your team, if getting the points, could lose the game and you would get paid if within the spread. Or you could be thinking that the other team will lose, a short.

You're right. I rarely bet on things I have absolutely NO control over the outcome of. Occasionally I do, but only to be social and only in social amounts. And I thoroughly HATED fantasy football the one year I played - totally screwed up the way I watched football. I couldn't just root for a team - I had to root for and against specific players, often at cross purposes. Terrible time. I won my division but pretty much hated every minute of it and sold the franchise for a cheesesteak the next year.

This probably explains some of my bias. The rest is based largely on ignorance and gut feel. I freely admit this.

-Ray

[paczki]

You're right. I rarely bet on things I have absolutely NO control over the outcome of. Occasionally I do, but only to be social and only in social amounts. And I thoroughly HATED fantasy football the one year I played - totally screwed up the way I watched football. I couldn't just root for a team - I had to root for and against specific players, often at cross purposes. Terrible time. I won my division but pretty much hated every minute of it and sold the franchise for a cheesesteak the next year.

This probably explains some of my bias. The rest is based largely on ignorance and gut feel. I freely admit this.

-Ray


Think of it in terms of risk. I contract some non-unique commodity, let's say a set of Edge wheels, to you for a week for a fee. I am promised a set of identical wheels back in identical condition plus the fee. I don't need them that week so it's a good deal for me. You want to borrow them because you think you will be able to sell them for a good price and then pick up an identical pair cheaper to then return to me profiting in the deal. I could sell my own wheels high and buy low but this is a low-risk way to make a small amount of $. You on the other hand are willing to assume a greater risk -- that things will turn out the way you think they will and you won't have to pay a lot more to buy Edge wheels. You are betting that the market will go south.

Nothing much creepier than that, as far as I understand (I'm not a finance person) until what is described in the article begins to happen.

[RPS]

RPS, naked shorts are legal within limits. There is a 3-day rule, in which the naked seller must borrow the shares for delivery. Also, there have been lists at various exchanges on which are stocks that may not be shorted in that manner. Recently, the lists were quite long.Thanks Keno, I appreciate the clarification. I’m probably way oversimplifying but it seems there is little difference between shorting and buying/selling outright. As long as it takes two parties with opposing positions (i.e. – opinions on likely outcome), then one will lose at the expense of the other gaining. In both cases they seem to be gambling on what they think is a likely outcome -- the main difference I see is whether up or down.

[keno]

generally I agree with you. I don't see the buyer and seller in a zero sum game. A true zero sum game is one in which there is a winner and a loser, or perhaps a tie, such as a game of chess. Those are limited games. The stock market buyer/seller relationship does not fit that definition. For example, the seller may take what he sells for and invest it in a stock that soars and the buyer may benefit as well from his purchase if the stock continues to go up.

If a proof is needed to demonstrate that the stock market is not a zero sum game, just look at the recent past. Everyone lost, save the short sellers whose gains hardly approached the losses of the longs, theoretically without a share changing hands.

keno