The Big Short – How Wall Street Destroyed Main Street

Politics / Credit Crisis 2008
May 11, 2010 - 04:57 AM

By: James_Quinn

Day after day, bankers have been paraded before Congressional committees regarding their role in the financial crisis which brought the financial system to the edge of the abyss on September 18, 2008. Every one has claimed that they were not responsible in any way for the disaster. They blame once in a lifetime circumstances that no one could have anticipated. It was a perfect storm and they had no way of knowing. These Harvard MBA Wall Street geniuses, who collected compensation in excess of $100 million each before the collapse, had no idea what was going on within their own firms. Ignorance and stupidity is no excuse for losing a trillion dollars.



The truth is that the CEO's of all the Wall Street banks encouraged a casino culture of greed and gambling. The generation of fees became the sole driving incentive for every firm. It started with collateralizing subprime mortgages into packages of mortgage backed securities. Then they created Credit Default Swaps as insurance on these mortgages. When they ran out of chumps to put into houses, they created side bets with Credit Default Obligations that didn't require an actual homeowner.

The fees generated by creating this crap were incomprehensible. The Masters of the Universe were taking home pay packages of $25 million and weren't satisfied. They only made one small mistake. They deluded themselves into thinking the crap they were selling to suckers wasn't actually crap. They ended up buying their own toxic paper. Even though they knew that the ratings agencies were basically whoring out AAA ratings for fees, they believed that AAA rated securities they were buying and insuring weren't actually worthless. They didn't understand that they had created Frankenderivatives. Author Michael Lewis has done a fantastic job making this sordid tale of greed understandable to the common person.

You are probably thinking that the title of this article is strange, but you will understand in a few minutes. Michael Lewis wrote the classic Wall Street book about the greed of the 1980's Liar’s Poker, published in 1989. He detailed the absurdity and greed of Wall Street from his firsthand experiences working at Salomon Brothers fresh out of college. He captured the destructive culture of Wall Street in a very funny 290 page classic. He immortalized the term Big Swinging Dick regarding Salomon ("If he could make millions of dollars come out of those phones, he became that most revered of all species: a Big Swinging Dick."). He also described the act of Blowing up a customer -Successfully convincing a customer to purchase an investment product which ends up declining rapidly in value, forcing the client to withdraw from the market.

He described an old mortgage bond trader named Donnie Green who once stopped a young callow salesman on his way out the door to catch a flight from New York to Chicago. Green tossed the salesman a ten dollar bill. "Hey, take out some crash insurance for yourself in my name", he said. "Why?" asked the salesman. "I feel lucky," said Green. Some other memorable snippets included:

The larger the number of people involved, the easier it was for them to delude themselves that what they were doing must be smart. The first thing you learn on the trading floor is that when large numbers of people are after the same commodity, be it a stock, a bond, or a job, the commodity quickly becomes overvalued.
In any market, as in any poker game, there is a fool. The astute investor Warren Buffet is fond of saying that any player unaware of the fool in the market probably is the fool in the market.
The firm’s management created a training programme, filled it to the brim, then walked away. In the ensuing anarchy the bad drove out the good, the big drove out the small, and the brawn drove out the brains.
Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience.
The only thing that history teaches us, a wise man once said, is that history doesn’t teach us anything.
That was how a Salomon bond trader thought: he forgot whatever it was that he wanted to do for a minute and put his finger on the pulse of the market. If the market felt fidgety, if people were scared or desperate, he herded them like sheep into a corner, then made them pay for their uncertainty. He sat on the market until it puked gold coins. Then he worried about what he wanted to do.
Stupid customers (the fools in the market) were a wonderful asset, but at some level of ignorance they became a liability - they went broke.
Michael expected that his book would convince many smart college students to pass on Wall Street and pursue worthwhile careers. Instead he was bombarded with fan mail thanking him for making Wall Street seem so appealing. The unquenchable desire for millions in compensation and unfettered greed on Wall Street only grew during the two decades since his book.

He has now book-ended two decades of greed with his latest masterpiece The Big Short: Inside the Doomsday Machine. He was able to link the two books by interviewing John Gutfreund, his former boss at Salomon Brothers, at the end of his new book. Lewis is able to explain the most recent financial crisis caused by Wall Street through the eyes of a few oddball skeptics. It is a truly enlightening book and reveals the true nature of the Wall Street mega-banks. Lewis summarizes the big picture in the following sequence:

By early 2005, the sub-prime mortgage machine was up and running again. If the first act of sub-prime lending had been freaky, this second act was terrifying. $30bn was a big year for sub-prime lending in the mid-1990s. In 2005 there would be $625bn in sub-prime mortgage loans, $507bn of which found its way into mortgage bonds. Even more shocking was that the terms of the loans were changing in ways that increased the likelihood they would go bad. Back in 1996, 65% of sub-prime loans had been fixed-rate. By 2005, 75% were some form of floating rate, usually fixed for the first two years.

By the time Greg Lippmann, the head sub-prime guy at Deutsche Bank, turned up in the FrontPoint conference room, in February 2006, Steve Eisman knew enough about the bond market to be wary. Lippmann’s aim was to sell Eisman on what he claimed was his own original brilliant idea for betting against – or short selling – the sub-prime mortgage bond market.

Eisman didn’t understand. Lippmann wasn’t even a bond salesman; he was a bond trader: “In my entire life, I never saw a sell-side guy come in and say, ‘Short my market.’â€