The New York Times reports today that in 2007 Goldman Sachs executives in emails planned to make "some serious money" by selling the subprime housing market short. For example, on July 25, 2007 Goldman's chief financial officer David Viniar wrote an email reacting to a $51 million profit that Goldman had made betting housing securities would fall in value. Said Viniar:
Tells you what might be happening to people who don't have the big short.
It is as if Goldman had invested in Bernie Madoff's fund, and then just before the end, bought credit default swaps that Madoff would go bust. It's good business if you can get away with it. And we'll see at Carl Levin's Subcommittee on Investigations this coming week if Goldman CEO Lloyd Blankfein does get away with it by mumbling the usual platitudes. Meanwhile "The Big Short" oddly enough is the title of Michael Lewis' fantastic book on the economic meltdown, and there we have the inside story of how the biggest Wall Street firms played both sides of the subprime catastrophe.
Lewis had the brilliant idea of finding if there were any people who actually made large sums of money betting against the subprime housing market. And he didn't find many -- the vast majority of Wall Street investors were like sheep being led to the slaughter. Almost none of these many investors believed housing prices would ever fall. Almost none seemed to be aware of how the rating agencies had been coopted by the biggest firms. But there were a handful -- and what a handful.
There was first of all Mike Burry, the guy with Asperger's Syndrome, trained as a neurologist. He had always been more interested in numbers than in people, so he set up his own hedge fund and began to look for some very very good bets to make with his own and other people's money. He stumbled across subprime almost by accident. He kept asking brokers questions about these subprime mortgages. He could see with his Asperger's logic that many homeowners were signing up for teaser rates, and that they would not be able to make the mortgage payments once the rates reset. He couldn't believe that serious Wall Street banks were loaning money to people who they knew would not be able to repay them. It was at that moment that he discovered American capitalism's version of a Zen koan, a single cogent idea that summed up all of reality. It was, said Burry, nothing short of "F#!k the poor." So Mike Burry bought credit default swaps on huge tranches of subprime crap and made over a billion dollars for himself and his investors.
Even more amazing is Steve Eisman, the fund manager inside Front Point Partners. His parents had been brokers and he was famously insightful and acerbic about risk. Lewis said that Eisman was that rarest of investors who didn't get buffaloed by Wall Street doublespeak. As Lewis told an interviewer recently, Eisman's colleagues said that...
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..what you find out when you are in a meeting with Steve is that oftentimes, these Wall Street people actually don't know what they are doing. They don't know what they are talking about, and it doesn't make any sense. They are just repeating what they had been told, and so Steve Eisman did what a number, not a lot, but a handful of smart hedge fund traders did. He went out and he identified pools of subprime mortgages that were particularly obnoxious, particularly terrible. Some in Florida, Inland Empire in California, stuff in Nevada and Arizona, stuff where there had been no documentation, floating rate mortgages, no money down -- loans that have never been made before in the history of mankind. So, having identified the pools and the bonds associated with the pools, he then calls up and strikes a deal with them, and htis is the credit default swap market.
So what does all of this have to do with Goldman Sachs? Well, I hope Senator Levin gets a briefing on Lewis' book before the hearing next week, but if he doesn't have time for that he should at least read what Lewis told the interviewer about Eisman's $500 million bet against subprime:
So, he shorted the subprime mortgage market by picking the best things to short. And what is amazing is that these firms created this casino in these bets, and that casino is bigger than the original market. So when you look at what is going on now and you are mystified why the Treasury and the Fed and whoever else is throwing money at them, is throwing $150 billion at AIG (NYSE: AIG) to prevent it from going down and you ask why is an insurance company getting $150 billion in this crisis? What is that about? Well, what that's about is that Goldman Sachs, having taken Steve Eisman's side bet, turned around and laid it off on AIG. And AIG foolishly, essentially, ensured the subprime mortgage market. So, what the Treasury is doing is paying off AIG's bad debts to Goldman Sachs, so the money goes to AIG just so it can go to Goldman Sachs, so it can go to Steve Eisman.
Eisman characterizes the subprime mortgage crash as a "Ponzi scheme." Mortgages were given to people who couldn't afford them. The mortgages were insured with phony insurance called "credit default swaps." The swaps enabled the banks to play both sides - even though both sides were corrupt. The whole thing -- like any Ponzi scheme -- was predicated on constant swelling of the market for subprime.
Some people don't feel "Ponzi scheme" is the correct charcterization. What do you think