Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
If anyone who is newer to note investing needs a refresher course on what caused most of the NPLs we buy to be available, read The Big Short or go see the movie. Fascinating how corrupted Wall St. brokers and rating agencies can topple a housing market.
Dr. Michael Burry, the neurologist in residency turned hedge fund manager with a glass eye (played by Christian Bale in The Big Short) was the first money manager with the vision to see the subprime mortgage meltdown coming and was able to short the CDO bonds and earn his fund over $2 billion.
In a compelling 2011 lecture for Vanderbilt University, Burry laments that no one has taken responsibility for the subprime financial crisis. He proceeds to name the multiple guilty parties and practices which created the crisis. He calls out Henry Paulson’s convenient change of role, from head of Goldman Sachs – which continued to sell toxic CDOs (collateralized debt obligations) to their clients even as the bank itself was betting against the CDOs itself – to the Treasury Secretary who helped preside over the bailout. Burry defends against the accusation that the money managers who saw it coming were somehow the cause of it.
Watch Michael Burry’s passionate lecture below, “Missteps to Mayhem:”
The Big Short is a fascinating real-life story on how greed and complicity caused a worldwide financial meltdown. This has resulted in an opportunity for us small note investors to help "heal" the wounds of this event, help borrowers if possible and make a profit in doing so.
If anyone who is newer to note investing needs a refresher course on what caused most of the NPLs we buy to be available, read The Big Short or go see the movie. Fascinating how corrupted Wall St. brokers and rating agencies can topple a housing market.
Dr. Michael Burry, the neurologist in residency turned hedge fund manager with a glass eye (played by Christian Bale in The Big Short) was the first money manager with the vision to see the subprime mortgage meltdown coming and was able to short the CDO bonds and earn his fund over $2 billion.
In a compelling 2011 lecture for Vanderbilt University, Burry laments that no one has taken responsibility for the subprime financial crisis. He proceeds to name the multiple guilty parties and practices which created the crisis. He calls out Henry Paulson’s convenient change of role, from head of Goldman Sachs – which continued to sell toxic CDOs (collateralized debt obligations) to their clients even as the bank itself was betting against the CDOs itself – to the Treasury Secretary who helped preside over the bailout. Burry defends against the accusation that the money managers who saw it coming were somehow the cause of it.
Watch Michael Burry’s passionate lecture below, “Missteps to Mayhem:”
The Big Short is a fascinating real-life story on how greed and complicity caused a worldwide financial meltdown. This has resulted in an opportunity for us small note investors to help "heal" the wounds of this event, help borrowers if possible and make a profit in doing so.
Sigh. Hence the reason why I hated The Big Short. It's told from a completely biased viewpoint, and skews facts to make it seem as though they are right. Just for a quick example (because I'm at work and don't have time to tear down the movie point by idiotic point)...
People think that Wall Street was greedy because they were "betting" on CMOs defaulting. How do you figure this? Because they bought credit default swaps...so they were hoping that the assets would fail. That is the most backwards reasoning I have ever heard. First of all, a bank wouldn't buy a credit default swap as a speculative investment. They purchased credit default swaps as insurance. How do you insure against losses when you need 30 days on the books to package your securitized product? You buy a default swap.
Essentially saying CDSs were proof that Wall Street was betting against CMOs is like saying you profited from a car accident. Why? Because you had car insurance, so you must have been betting on a car crash.
Rental Property Investor · Lindon, UT · Member since 2015 · 862 posts · 438 votes
10y
I totally agree. I loved the movie! It portrayed everyone's attitudes, at the time, SO well. I loved the two cocky mortgage brokers at the party. I saw too many guys like that in 2006 and 2007.
Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
10y
So What DID Cause the Financial Crisis?
According to Burry and Michael Lewis’s The Big Short, some of the trends, institutions and events that contributed to the collapse include:
Deregulation which authorized the securitization of mortgages. This practice incentivized mortgage brokerages to originate as many mortgages as possible, then sell them off to Wall Street. Banks and brokerages were paid up front for creating loans while being temporarily insulated from the aftermath of failed loans.
The expansion of mortgage products that popularized interest-only loans, only-adjustable rate mortgages, interest-only adjustable rate mortgages, even negative -amortizing “option arm” mortgages that allowed borrowers to actually increase their loan balances, rather than paying their mortgages down.
Second-lien purchase mortgages that allowed borrowers to escape both mortgage insurance and a down payment.
The loosening of credit standards that allowed borrowers with poor credit, few assets, and/or no verified income to buy homes they would not be able to sustain.
Public policy and presidential speeches which created a demand for home ownership even among those who would not ordinarily qualify for mortgages. Just prior to the subprime crisis, the home ownership rate climbed to 69%. Unfortunately, 69% of U.S. citizens could not afford houses. (In 2015, the rate was hovering between 63% and 64%, the lowest rate of home ownership in over 20 years, according to U.S. census figures and a comparatively more sustainable figure than 69%.)
Borrowers who took out mortgages they could not afford, buying the biggest house they could on interest-only and deferred interest loans, turning a blind eye to future rate increases.
Mortgage fraud as high as 90%. “No income verification, no asset verification” loans invited both lenders and borrowers to falsify information to obtain loan approval.
Mortgage brokers and banks who focused on approving buyers for mortgageswithout regard to whether or not they would be able to afford the loans beyond the “teaser rate.”
The expansion of speculators into housing markets. Fueled by easy-lending standards for investors, speculators helped drive up housing prices in certain markets.
Historically low interest rates that ensured housing prices would rise more quickly than income levels as consumer dollars stretched further.
The failure of rating agencies to actually research and rate the safety of mortgage securities, and their unwillingness to act once the problem was apparent.
The Federal Reserve’s unwillingness to stop lending that could jeopardize the economy (even though they had the right to do so).
Rampant cash-out re-financing that made homes “ATMs” for consumers who wished to purchase what they could not afford.
Fiscal policy built on the assumption of never-ending home appreciation, and the dependency of jobs and consumer spending on never-ending home appreciation.
A derivatives market which multiplied the amount of money at risk beyond the value of the underlying assets. At the peak, the derivatives market represented $60 TRILLION dollars – a figure roughly equal to the gross domestic product of the world!
The repeal of the Depression-era Glass-Steagall Act, which separated commercial banks from Wall Street risks after such activities caused widespread bank failure in the early 1930’s.
Wall Street’s ability to conceal the financial sickness that lay beneath until some of the key corporations (such as Goldman Sachs) had purchased credit default swaps to be on the “winning” side of the economic crash.
If anyone who is newer to note investing needs a refresher course on what caused most of the NPLs we buy to be available, read The Big Short or go see the movie. Fascinating how corrupted Wall St. brokers and rating agencies can topple a housing market.
Dr. Michael Burry, the neurologist in residency turned hedge fund manager with a glass eye (played by Christian Bale in The Big Short) was the first money manager with the vision to see the subprime mortgage meltdown coming and was able to short the CDO bonds and earn his fund over $2 billion.
In a compelling 2011 lecture for Vanderbilt University, Burry laments that no one has taken responsibility for the subprime financial crisis. He proceeds to name the multiple guilty parties and practices which created the crisis. He calls out Henry Paulson’s convenient change of role, from head of Goldman Sachs – which continued to sell toxic CDOs (collateralized debt obligations) to their clients even as the bank itself was betting against the CDOs itself – to the Treasury Secretary who helped preside over the bailout. Burry defends against the accusation that the money managers who saw it coming were somehow the cause of it.
Watch Michael Burry’s passionate lecture below, “Missteps to Mayhem:”
The Big Short is a fascinating real-life story on how greed and complicity caused a worldwide financial meltdown. This has resulted in an opportunity for us small note investors to help "heal" the wounds of this event, help borrowers if possible and make a profit in doing so.
Sigh. Hence the reason why I hated The Big Short. It's told from a completely biased viewpoint, and skews facts to make it seem as though they are right. Just for a quick example (because I'm at work and don't have time to tear down the movie point by idiotic point)...
People think that Wall Street was greedy because they were "betting" on CMOs defaulting. How do you figure this? Because they bought credit default swaps...so they were hoping that the assets would fail. That is the most backwards reasoning I have ever heard. First of all, a bank wouldn't buy a credit default swap as a speculative investment. They purchased credit default swaps as insurance. How do you insure against losses when you need 30 days on the books to package your securitized product? You buy a default swap.
Essentially saying CDSs were proof that Wall Street was betting against CMOs is like saying you profited from a car accident. Why? Because you had car insurance, so you must have been betting on a car crash.
Roseville, CA · Member since 2008 · 13 posts · 2 votes
10y
Nice list Bob,
One thing I've often wondered is what happened with PMI. Shouldn't rates have started skyrocketing a few years before the crash with all the crazy mortgages, and if that had happened that alone might have damped down too much overborrowing.
Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
10y
Very interesting topic. Thanks Bob Malecki for bringing it up. I wonder what Bill Gulley and Dion think about this??
In my limited experience, it seems like a huge number of mortgages were securitized in a short amount of time before the crisis. Now, it seems like it's taking a lot longer to unsecuritize all these mortgages before they can be worked out and resolved. It also seems like the buyers of the biggest pools are in no big hurry to sell their pools down the line. In some cases, I've heard of traders that sabotage trades because once all of their notes are sold, they'll be out of a job. I've heard some of the delay is because a lot of funds make a good chunk of their money from management fees. The less assets you're managing, the less fees you generate.
The thing I'd like to know is how long will it take to get the level of NPN's out there back to a "normal" level. How long will this opportunity be out there? One asset manager I know said that he crunched some numbers and it appeared to him that at the current run rate, there'll be NPN's for the next 20 years. Who knows how accurate his numbers are....
Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
10y
@Adam Hershman, (first off, I haven't seen 'The Big Short', but I think I understand the premise, given that I remember nine years ago quite well).
You wrote: "First of all, a bank wouldn't buy a credit default swap as a speculative investment". But (again, don't know), weren't these guys acting OUTSIDE their Banks' modus operandi? ie. going rogue? And wasn't that the point? THEY could see what was coming before the Banks did?
And yes, insured people DO profit from car crashes, quite regularly. I get the drift that you were also pulling the script apart for using perhaps inaccurate terminology, but, in practice, you CAN sell stocks before you've even bought them - in anticipation of their price dropping before the date you agree to buy them. You get that, right? Why wasn't EVERYONE "shorting" a portfolio in 2007, and closing out their Accounts in late 2008?...
Investor · Tampa, FL · Member since 2016 · 14 posts · 1 vote
10y
I don't think the movie blames the default swaps,they were only options that would be triggered on 15% default of the security.
It was the lax lending standards and the rating companies exchanging ratings for dollars,coupled with crazy derivatives that were being sold to institutional fund managers as safe investments.The movie even showed the consumers had a part in acting irresponsibly.Although the banks allowed it.The NINJ no income,no job loan is not a good idea it turns out.
If the fed had not jacked up interest rates knowing(should have known) that all those ARM's would follow the index and cause overextended owners to sell it may not have happened at all.The housing market would have probably just peaked and maybe only 8-12% of the securities would have defaulted.The reinsurance companies could have survived that.The Fed laid the straw that broke it.
@Adam Hershman, (first off, I haven't seen 'The Big Short', but I think I understand the premise, given that I remember nine years ago quite well).
You wrote: "First of all, a bank wouldn't buy a credit default swap as a speculative investment". But (again, don't know), weren't these guys acting OUTSIDE their Banks' modus operandi? ie. going rogue? And wasn't that the point? THEY could see what was coming before the Banks did?
And yes, insured people DO profit from car crashes, quite regularly. I get the drift that you were also pulling the script apart for using perhaps inaccurate terminology, but, in practice, you CAN sell stocks before you've even bought them - in anticipation of their price dropping before the date you agree to buy them. You get that, right? Why wasn't EVERYONE "shorting" a portfolio in 2007, and closing out their Accounts in late 2008?...
Hey Brent,
First, So like I said, I did't have time earlier to tear it up point by point, but now I'm at home and I have a 6 pack of Fresh Squeezed and nothing but time
Second, if you haven't seen the movie and want to, don't read this as it will be a huge spoiler.
SPOILER ALERT
So yes, there are those in the movie who are shorting various CMO debt instruments. But they are the main focus of the movie, and are portrayed as the "Robinhood" types who are betting against big banks er..."wall street". So the premise of the movie is that these guys see the housing collapse coming and decide to bet against it, with Michael Burry leading the way and actually convincing banks to create CMO bond products. And Jared Vennett as a slick wall street broker who turns whoever Steve Carells character is onto the scheme in a classic "insider screws wall street for their greed, while making a huge profit" scenario.
(So here's my first rub...somehow, big banks buy an insurance policy, or a credit default swap on a CMO they are issuing. Yes they could buy CDSs speculatively, but they didn't and or wouldn't, I'll explain that later. But when investors or hedge fund managers (including Michael Burry who essentially created the CDS market on CMOs) decide to short CMO derivatives (not to be confused, CMOs are derivatives themselves, so derivatives of derivatives) that they requested the "wall street" banks create for them, for the purposes of shorting and costing the "wall street" bank money, they are they heros? Apparently heros for screwing the big "wall street banks" that were selling these CMOs? In fact these bets against CMOs were owned by wall street banks and accelerated the housing crash when it eventually came, not very hero-ish.
The movie follows these guys around as they do some research and find out that there are essentially massive amounts of either fraud or extremely lax lending standards that allow people to buy multiple houses that they can't afford. There is even a conversation with a stripper who owns 5 houses or something, all with ARM loans that she constantly refi's because the price of RE never goes down. Of course, in this move, she is the victim of a lying scumbag loan agent who feeds her all these lies and is ultimately another in the long line of those that suffer at the hands of...you guessed it "wall street".
That's where my second issue comes in, is there really no blame to be placed on homeowners/investors/apparently big short strippers who buy too much RE they can't afford? Everyone hates banks for being overleveraged, but not the individual? And the whole reason lending standards were relaxed was in an effort to drive lending or more quixotically "homeownership" that and the fact that EVERYONE LOVED CMOs. Literally...everyone...mortgage originators loved them because everyone was looking for loans to package into CMOs, effectively creating a bidding war for loans. Banks loved them because they were backed by an asset that hadn't declined in value in a century. Plus anyone packaging CMOs were making a nice fee doing so, which means investment firms loved them. Insurance providers (AIG) loved them because they could sell credit default swaps for assets that were backed by mortgages (again hadn't declined in a century) and collect a hefty fee for insuring what appeared to be an exceptionally safe asset, most of the time insured by Freddie or Fannie. Investors loved them because the returns were considered pretty exceptional for the amount of risk you took on. All of this did work from 1997-2005 and would have continued to work. The issue became "homeownership" had reached a saturation level, there just weren't any more people to sell primary residences to who could afford them. You know the story from there.
So again, how is "wall street" evil here? If anything you could argue that mortgage originators and lenders were more to blame, countrywide my be owned by BoA now, but they weren't when they were writing all these crap loans. Again I have to question, if toxic CMOs are made up of toxic loans, is there really no blame to be laid on the people applying for these loans that are so toxic? Isn't it the very nature of the toxic loan that these people who applied for loans, with no coercion, were either too stupid or too dishonest to pay for their property when values declined? Look at it from a "wall street" perspective. You have a CMO, which is a bunch of different mortgage classes called tranches that are packaged together. These mortgages are insured by federal subsidized entities (freddie and fannie) for losses. The only real risk is that interest rates would drop substantially and homeowners would refi out of the mortgages that your CMO is made up of. Plus you get a substantial return considering the low risk. Obviously the unknown risk is eventually your CMOs will eventually see lower and lower quality loans, but how do you as a "wall street" bank know that? You're counting on a lender to tell you what the mortgage is, because you're not in the mortgage business, you're in the securitization business. By the way securitization works, only 5% of CMO mortgages defaulted for a loss, the reason the CMO market crashed was because of the fear in the market that CMOs would fail, effectively making the demand zero which any economist will tell you makes the value zero. Because "wall street" has tons of these CMOs on the books trying to sell them when the confidence crash happens, they are staring at billions of dollars of worthless securitized loans on their books. Stock prices collapse, credit markets dry up, queue the ensuing chaos of 2008-09.
Oh also, I said I would explain later that "wall street" wasn't buying CDSs as speculation. There was not a single "wall street" bank that had enough CDS coverage to zero their exposure to CMOs, in other words, the banks didn't even own enough insurance to cover their loses. That certainly doesn't seem like betting against CMOs.
Sorry that got away from me in terms of length...lol
Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
10y
@Adam Hershman, no need to apologize for the spoiler alert. You're right: I "know the story from there". I've heard that the success of this film is largely BECAUSE you find yourself rooting for the people who helped America (ie. many of the audience) become bankrupt! Apparently, you don't like being suckered?.
Sort of like 'Ocean's Eleven' - you WANT the crooks to succeed. In the original version, they didn't - until Hollywood remade it so they [Spoiler Alert] did! {Or, did you ONLY like the original}? Cheers...
@Adam Hershman, no need to apologize for the spoiler alert. You're right: I "know the story from there". I've heard that the success of this film is largely BECAUSE you find yourself rooting for the people who helped America (ie. many of the audience) become bankrupt! Apparently, you don't like being suckered?.
Sort of like 'Ocean's Eleven' - you WANT the crooks to succeed. In the original version, they didn't - until Hollywood remade it so they [Spoiler Alert] did! {Or, did you ONLY like the original}? Cheers...
Actually, I didn't find myself rooting for anyone, but rather being quite upset that the movie portrays individuals who figured out the crash was coming and made money as heros, while decrying "wall street" banks as evil and greedy despite losses. If you see the movie you'll see what I mean, basically the pot is a hero while the kettle is a villain.
Investor · Peachtree Corners, GA · Member since 2014 · 1k+ posts · 1k+ votes
10y
This is an excerpt from the left wing Village voice from 2008. His punishment ELECTION as Governor of New York! I bet he got campaign cash from both the bankers and from the hedge funds. I didn't read the book or see the movie but I wonder if Cuomo is even mentioned.
Andrew Cuomo, the youngest Housing and Urban Development secretary in history, made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis. He took actions that—in combination with many other factors—helped plunge Fannie and Freddie into the subprime markets without putting in place the means to monitor their increasingly risky investments. He turned the Federal Housing Administration mortgage program into a sweetheart lender with sky-high loan ceilings and no money down, and he legalized what a federal judge has branded "kickbacks" to brokers that have fueled the sale of overpriced and unsupportable loans. Three to four million families are now facing foreclosure, and Cuomo is one of the reasons why.
Investor · Boca Raton, FL · Member since 2012 · 1k+ posts · 1k+ votes
10y
Very interesting synopsis provided here, particularly by @Adam Hershman
As per the points made by Bob above on what caused the crisis, there are many eerie similarities happening in Canada at the moment. With the ever increase in home prices, and tightening lending criteria, more and more buyers are resorting to doctoring their reported incomes. Many are borrowing their down payments from friends and relatives as well - rarely does a lender confirm where this money comes from. Securitization of mortgages into Mortgage Backed Securities has surged from 10% of all loans in the early 2000's to over 35% currently. This is allowing the Big 5 banks to get the loans off their books, so they can re-lend again. CMHC (Fannie Mae equivalent) backs 100% of the total loss on a loan to the bank, in the event of default, encouraging more lending. Home ownership rate is at its highest in history at 70%. Interest rates at lowest point in history. More and more "private" lenders and insurers springing out of nowhere. And the list goes on....
To put things into perspective, this is a good example of how out of whack things are getting: A realtor friend of mine is representing a single mom of 3 with $80K income, who just got approved for a $600K mortgage with only $50K down. The next Big Short may just be coming to Canada....
A little update to you points above. Many of the Big-5 have been using Genworth to insure the "safer" mortgages (those which are low enough risk to not need insurance, but the borrowers wanted to make a 10% downpayment so were obligated to carry the insurance. This has allowed them to place only the very high ration (5% down payment) and riskier borrowers with CMHC.
BTW: CMHC's limits were increased a few (3 - 4) years ago, by the previous government, as it had bumped-up against the legislated liability limit they were allowed to carry.
Very interesting synopsis provided here, particularly by @Adam Hershman
As per the points made by Bob above on what caused the crisis, there are many eerie similarities happening in Canada at the moment. With the ever increase in home prices, and tightening lending criteria, more and more buyers are resorting to doctoring their reported incomes. Many are borrowing their down payments from friends and relatives as well - rarely does a lender confirm where this money comes from. Securitization of mortgages into Mortgage Backed Securities has surged from 10% of all loans in the early 2000's to over 35% currently. This is allowing the Big 5 banks to get the loans off their books, so they can re-lend again. CMHC (Fannie Mae equivalent) backs 100% of the total loss on a loan to the bank, in the event of default, encouraging more lending. Home ownership rate is at its highest in history at 70%. Interest rates at lowest point in history. More and more "private" lenders and insurers springing out of nowhere. And the list goes on....
To put things into perspective, this is a good example of how out of whack things are getting: A realtor friend of mine is representing a single mom of 3 with $80K income, who just got approved for a $600K mortgage with only $50K down. The next Big Short may just be coming to Canada....
Iam a Realtor in Ontario and have yet to hear or see of any case of people doctoring their incomes to get mortgages. Where did you hear about this?
Any chance you know the articles I would be interested in checking them out. Curious to see the recourse of those people committing mortgage fraud and what lenders they used( if they were B lenders or the big guys)
There are several more I've seen, just do a search for Mortgage Fraud.
The BNN was an interview I saw a few months ago. It was with several mortgage professionals who regularly see applicants falsifying their information on their applications, and then some brokers blindly submitting this info to lenders. Can't seem to find it though.
