I'm Right Again Dot Com

                               A new commentary every Wednesday — January 20, 2016

THE BIG SHORT: Inside the doomsday machine

    Like many of you, I have gone to see a movie after reading the book on which the film is based. This time, I saw the highly acclaimed film, "The Big Short" and then immediately purchased the book by Michael Lewis. It is non-fiction, and I must warn you, that from the very first chapter in the book and frame of the film you are immersed in a foreign language that few of us have encountered. I am surprised that such arcane terminology could find an audience.

    Every once in a while a narrator looks at you through the camera lens and gives you a hint of the financial hanky-panky going on with "Credit Default Swaps" in relation to "Subprime Mortgage Bonds." I'll try and save you the agony of my trying to translate that.

    Herein, I'm just going to touch on the fact that ten years ago, great financial institutions on Wall Street became rather quickly and enormously involved in loaning vast amounts of money to poor credit risks.

    The author of "The Big Short," Michael Lewis, does not portray the heads of those magnificent institutions as being dishonest. Just stupid. They would not believe their own bean counters.

    A few numbers-crunchers pouring over data available to everyone became fantastically wealthy...and I can't stress this word more greatly in my discourse: Legally—by predicting a collapse of the house of cards constructed of subprime housing mortgages and betting against the conventional wisdom then prevalent on Wall Street.

    As to the book and film's title: many of us know what "selling short" is, don't we?  For example, since the beginning of time you could borrow some eggs from your neighbor when they are $1.00 a dozen and when the price drops to 50 cents a dozen, you purchase them in a store at that price and hand them over to the neighbor. The world of finance has numerous ways of helping one to do this. Ostensibly, the products were designed to be a hedge or insurance against a sudden market downturn.  

    The best way to describe these "products" in this instance is to call them "artificial securities based on piles of doubtful mortgages" (A quotation taken from Michael Lewis's book.) 

    The primary problem is that major financial institutions did not realize the danger involved because they were too busy sucking in huge numbers of home buyers who were not credit-worthy. 

     Things were perking along pretty well when the Federal Housing Authority agencies: Fannie Mae, Freddy Mac and Ginny Mae were guaranteeing that a certain amount of a home loan was bound to be paid the loaning institution.     

    By the end of 1999 what no longer was being applied to the home loan mortgage business was "regulation." Lenders became less and less rigid in qualifying people who could not make mortgage payments if they suffered unemployment or any other financial speed bump. But, why worry about loan repayment when the risk could be spread among a huge pool of borrowers? That was next. 

    Ostensibly, profits would cover the folks who couldn't fulfill their financial obligations. This mythic hope was found to be untrue.The problem was first forecast by a stunningly high delinquency rate in the pools of debtors, a fact that was not highly publicized by anyone charged with doing so. Yet, neither did anyone hide the data. Let's just say it was not high-lighted.

    Instead, armies of new peddlers in the brokerage houses were urged to forget those stiff-necked appraisers for the Federal Housing Authority. Advertise heavily and write a mortgage contract with anyone and everyone who comes in the door. Then. make big, quick profits by packaging these loans as bonds and sell them to investors—many of whom were little start-up financial companies. (That no longer exist.)

    Things got crazy quickly. In 2000, there were $130-billion in subprime mortgages written with $55-billion repackaged as mortgage bonds. By 2005 this had exploded to $625-billion in subprime mortgages, $507-billion (that's more than a half trillion dollars) of which was converted into mortgage bonds. In short, the subprime real estate bond market dwarfed everything else going on in the banking business, and this monetary colossus was built on sand...like a flimsy jetty on the New Jersey shore, just as a gigantic financial hurricane was forming in the Atlantic. You get the picture? 

    Hold this thought: A bond market was inexplicably tied to the incomes of thousands and thousands of unqualified borrowers who really should not have been approved for a loan—particularly one with a "variable interest rate."  One boost in interest on their variable monthly payment plans and BOOM! (or SPLASH)  they were "under water."

    Full Stop. A very small number of bean counters who realized that a perfect storm was coming made billions legally, by betting against the conventional wisdom prevalent among the Big Money Boys in the investment banks—using instruments available to everyone, to sell short in the subprime housing bond market.

    I may have lost you by now, but what you ought to take away from this screed is: The problem that needs fixing, the one that caused we taxpayers to have to pay off the horrendous mistakes of the overpaid heads of financial institutions "Too Big to go Broke," is De-Regulation. We need another Teddy Roosevelt, a president able to convince both political parties that a regulatory regime is needed that is capable of protecting us... from ourselves.   

      -Phil Richardson, Observer of the human condition and storyteller. "He goes doddering on into his old age, making a public nuisance of himself." - Joseph L. Menchen

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