Sunday, November 16, 2008

Apocalypse Now (financial edition)

This week's must read on all things financial apocalypse is Michael Lewis' "The End" on Even those of us who are exceedingly jaded had to scratch our heads at Lewis' description of how accurate the average person's opinion of Wall Street guys as a bunch of swindling liars is and how much worse the reality was considering, it seems, they weren't just money-grubbing a-holes, they were actually idiots as well. I've included a smattering to wet your whistle but you should really read the whole thing yourself.

What we always knew:
Harboring suspicions about ­people’s morals and telling investors that companies don’t deserve their capital wasn’t, in the 1990s or at any other time, the fast track to success on Wall Street.
What we suspected, but didn't think was quite as common as it turned out to be:
Lots of firms were lending money to people who shouldn’t have been borrowing it.


But the scarcity of truly crappy subprime-mortgage bonds no longer mattered. The big Wall Street firms had just made it possible to short even the tiniest and most obscure subprime-mortgage-backed bond by creating, in effect, a market of side bets. Instead of shorting the actual BBB bond, you could now enter into an agreement for a credit-default swap with Deutsche Bank or Goldman Sachs. It cost money to make this side bet, but nothing like what it cost to short the stocks, and the upside was far greater.

What left portfolio manager Steve Eisman scratching his head:
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.

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