Originally posted by @Brent Coombs:
@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
Adam
