Tuesday, November 22, 2011

The Bubble

I recently finished reading Michael Lewis, "The Big Short" which is about the housing bubble, how it started, how wall street traders who originally bought/sold government bonds created mortgage bonds, which then got bundled into credit default swaps and thereafter rebundled again into collaterialized debt obligations, and when people making $10,000 year could no longer afford to pay their mortgage on $500,000 homes, the market crashed. And if you know what any of those things are, you're ahead of 95% of America (not to mention 95% of investment bankers).

The book was quite eye opening. The most surprising thing about the book wasn't that wall street people were greedy, but that the vast majority of them didn't know what the hell they were doing, what any these CDS and CDOs were, they just continued to buy and sell them because everyone was doing so. Frankly, most of them couldn't have cared less whether what they bought or sold for their customers made money or lost money. Every sale or purchase made money for Goldman Sachs, or Lehman Brothers, or the rest of the crooks. Most of the "money managers" who were tasked by pension funds, mutual funds, IRA accounts, didn't care if they buying the crappiest of mortgage bonds disguised as A rated CDOs, because they made money simply by the buying of the bonds. If the bonds burst, the money managers didn't lose a dime.

It also demonstrated that the so-called "neutral" ratings agencies, Moody's, S&P, etc., were anything but. They rated these crappy mortgage bonds and CDOs triple A because if they didn't, Goldman Sachs would just ask (and pay) their competition to do so.

Essentially, the entire housing bubble was nothing but a Ponzi scheme. As long as new suckers were buying houses and taking out mortgages (which the originating bank, after collecting its fee, promptly sold to another bank, who then took its fee and packaged it into a mortgage bond with other crappy mortgages to sell to yet a third bank, who took its fee,then packaged it into a CDO with other crappy mortgage bonds to sell to a pension fund), the system continued. The banks didn't care that the buyer couldn't pay the mortgage, that was the next bank's problem, and the next. All the banks cared about was getting their fees from issuing the mortgage, or selling the mortgage, or mortgage bond.

Once suckers stopped buying houses, once new mortgages slowed down, like a ponzi scheme, the pyramid collapsed. Many people blame those that took out the mortgages, that they should have known that they could not afford such homes when they had such low incomes. Maybe they should have. But you have to realize that so many of these people had no college education. How can you expect someone with a high school diploma (if that even) to understand the complex and opaque financing scheme created by these bankers when most of them didn't even understand it or if they did, even a little, they ignored it because of their own greed. And these are the people the banks claimed that they had to pay six-figure bonuses too to "keep the talent." Yeah, talent for lying and hiding the truth.

I often wonder what my financial situation would be like had I bought a house in 2002 or 2003. Even by that time, mortgages were being made to people with no money down and average income, even on houses $250,000 or more. I probably could have bought something with an interest only rate for the same price I paid in rent, then likely two years later, refi'd into another mortgage on similar terms. Eventually, that quit being an option, one either had to accept the increased interest rate or default. Would I have taken the higher home value and just spent it, still running up my credit cards? Or would I have been smart and saved it or paid down the mortgage? I'd like to think I would have still insisted on a fixed rate, but if that was too expensive, would I have accepted one of those ARM subprime loans? I guess not, since I didn't, but I didn't really check it all out either.

What I do know is that I thought my financial situation wasn't stable enough to qualify for a mortgage at a rate I could afford in a location I wanted to live. So I didn't buy until I actually had some money saved up. Unfortunately, that meant I bought near the top of the price and its probably likely I'm underwater. Not by much, certainly not enough to walk away, but enough that I probably don't have any equity in my house anymore and I doubt I'll be able to get a construction loan for some remodeling in a few years, which was my plan.

What I also know is that wall street is nothing but Las Vegas with my retirement money. All that claim that people should pay lower taxes on capital gains because they "invest" in business and give them money to expand their business is nothing but bullshit. People don't "invest", they gamble. I am fairly certain that less than 10% of people who own stocks (and aren't employees) do so because they really believe in the company. And I guarantee that less than 5% who buy bonds are the same. In fact, many many people make money on wall street because they gamble that companies will default on their loans and go out of business. How is that "investing"? Its not, its gambling pure and simple. That's why these earnings should be taxed at least as much as real income, if not more, in my opinion. Especially those that bet against companies.

The Great Depression was caused due to lack of banking regulation and high speculation on wall street. Our great recession was caused by the exact same thing. How can people say with a straight face that these regulations should not be implemented again?

2 comments:

Dave Mosier said...

"The Great Depression was caused due to lack of banking regulation and high speculation on wall street. Our great recession was caused by the exact same thing."

Huh? Since then we've had a Securities & Exchange Commission and they're still around. They even sent some guys to jail in the 80s...Boesky.....Millken.....so did the system work? Or did the regulations fail?

Also, speculation is going to be difficult to regulate. It's like trying to regulate human nature.

Don't get me wrong. I think penalties and prison terms are appropriate for those who engage in fraudulent activities such as stock fraud. Put them in chain gangs during the day and in tents at night.

However, there's a "herd" mentality on Wall Street that you can't get around. If there's the sense there's some money to be made, the herd stampedes in. If they think they're about to lose, they stampede out. And everybody from the bankers on down to the small potatoes investor wants in on the action.

Warren Buffet once said that if you don't know who the fool in the market is, then you're the fool.

As with stocks and with real estate, risk is inherit.

Caveat emptor.

I think that the

Eponah said...

The primary regulations I'm talking about are the ones that were gutted by Reagan in the 90s. Reducing the regulations let banks buy and sell bonds themselves, rather than being intermediaries of the companies that create the bonds. IOW, Goldman Sachs buys a bunch of mortgage bonds from Deutsche Bank, then instructs its employees to sell those bonds at higher prices to its clients, but not disclosing that the seller is Goldman Sachs and not Deutsche Bank.

Also, the regulations that allowed credit default swaps to exist and give people the ability to bet against companies, people, etc., by betting that the debt won't be repaid.

The regulations that prevent Moody's and S&P from being truly neutral ratings agencies and not pawns of the banks.

The regulations that allow mutual/pension fund managers to buy and sell stocks and bonds for mutual/pension funds and get paid solely on the basis of volume of the amount that gets sold/bought, rather than how well the fund does.

Unfortunately, its hard to prove fraud in the real estate bubble. Recklessness, gross negligence, sure, but you're right that given the herd mentality, most just followed along and didn't really understand anything except they got rich and 90% of the country suffered.