I'll cut to the chase. Bloomberg:
Deutsche Bank AG's writedowns on subprime losses were 2.16 billion euros ($3.09 billion) -- less than they would have been if not for the offsetting short trades of Greg Lippmann, the bank's global head of asset-backed securities trading.
and then, near the end, this:
Deutsche Bank recently began meetings to create a new index on another security, Alt-A mortgage bonds. It will allow hedging against defaults by Alt-A borrowers, who have prime credit and get mortgages without verifying their incomes.
Investors will also be able to wager that Alt-A homeowners will quit making payments, potentially turning losses into more and bigger paydays.
If your instincts are piqued by those two paragraphs then maybe this diary is for you. Let's look at the real moral issue at stake here underneath the turbulent roil of the money market of the past twelve or so weeks.
I'm an electrician not a financial analyst. And I'm barely up to speed on even the terminology and technology of what happened to the banking system.
But I do believe all of us are capable of getting to the nuts and bolts of how the sub-prime lending market spread a contagion of greed that, beyond just the issue of bad risk and hoped for stability of the markets,
perpetuates itself at great cost even in the blackest moments of crisis.
In fact bad loans and bad risk is not the issue here. It is merely the opportunity. For a select few to exploit and play at their pleasure and for the grown-ups at the central banks and the Fed to clean up by throwing our money markets out of balance.
Who is this Greg Lippmann at Deutsche Bank AG and why is he central to this diary?
Greg Lippmann before he bet against a variety of mortgage backed bonds, so called Structured Investment Vehicles, actually was the brain child of them in the first place. Ironic, eh? He was the one who gathered the "Group of Five" financial titans and banks to give a structure to a whole new set of debt backed securities that would carry the contagion of bad risk and hide it, through the ratings agencies, and impossible to divine methods for even the most adroit manager. He is young. And he is brilliant. And as the damage continues his star continues to ascend in his new lucrative role as a "hedger".
So when Deutsche Bank announced today that it is offering a new index to bet against Alt-A homeowners we come full circle into the crux of how what is wholly immoral can be evidence of the rot underneath what should be, by agreed upon intents, the role of capital markets.
Now I am not a betting man myself. But I do believe that there is a time and place to gamble. If a casino offers that wagering person a chance commensurate with the risk more or less, who am I to deny the transaction? Besides, I have the confidence that the casino will pay-off if it loses the bet out of it's cash holdings. So whether you allow for the moral argument of gambling or not at least there is an integrity of its system that lends a modicum of stability between the gambler and the house.
But in contrast to that metaphor, what exactly does the integrity of hedge funds like Lippmann's look like?
One stark question is it justifiable to let the man who built the craps table, gamble on it? Just a glaring observation no one seems to mention in any of the articles I've read.
The bigger question puts aside the whole distraction of sub-prime loans and the housing sector's collapse even though those where the vehicles in question. The real issue is the role of that frightfully arcane term, Derivatives. YIKES. Some folks here have diaries that explored that fifth dimension of leveraging new money on other sources of value.
It is sufficient to say that what led to this crisis was the exploitation of certain contracts with the banks and such to pay off in the event of significant defaults. Certain "playas" intimately familiar with the iota of certain packages of these SIV's, targeted and bought up the most risk heavy of them and cut deals to allow banks to create even more securities to sell. Lippmann and others did this knowing full well what they were up to (they designed the prototypes that were all the rage) and knew the windfalls on the types of hedges they were making dwarfed the amount of risk the contracts shifted.
Banks and financial houses were by no means off the hook here as far as complicity goes. To go back to the casino metaphor how does what these banks did square with normal expectations of risk management?
Well a casino pays off, right?, from it's own reserve cash. Banks have a better concession than even legalized gambling houses. Normally, in above board bookkeeping practices, a bank has to keep a percentage reserve capital to make loans. It's the heart of banking regulation. But if they can keep one step ahead of the bank examiner (It's a Wonderful Life anyone?) and constantly create new more abstruse vehicles to expand lending opportunities and the central banks pretend it's fine and dandy, then they will start loaning "off the books". That's what they did with those Collateralized Debt Obligations they offered to pension fund managers across the globe. See, they didn't have to worry about quaint things like "reserves" or "capital", even at the fractions the central banks minimally expect. They could turn around these SIV's and derivative contracts and spin them into gold out of pure nothing like Rumplestilskin. So why not go for more and more and hail all takers to line up on both sides of these deals, damn the torpedoes. They acted like any other speculator or bubble surfer who always counted on that next re-fi to make the jump.
But back to our betting man, Lippmann. He knows the ins and out of what's happening. He knows how it's rigged against a sustainable near future and what is going to be the first most likely snake eyes. He knows all of this because he was central to its developing synthesis. So he starts betting on dogs. Once the housing market stalls his bets start looking amazingly prescient. They also signal a closer look from all parties on exactly what the hell these things were everyone was so hot on. The derivative contracts magnified the losses simply because they were oddly prescient and paid off so well - some by a factor of 6. They shined a light on these SIV's that caught most in that future shock mode. They couldn't fathom it could happen, that the bet alone would pay off. Thereby the values of what everyone else was holding was beginning to look more like dross than Rumplestiltskins gold. That's what evaporated values.
The perception of being had. Being chumps.
So now the banks have no choice but to place the extension of this credit on their books even as it loses value daily. Which means they have to capitalize their ongoing exposure. Which in turn means they have to hoard cash not knowing from day to day if they can make their reserve requirements or if another bank will help them over with a short term loan. Which in the end translates to a very constricted ability to assume their primary role in our economy: Lending money to those who need credit the most - businesses and individuals. Already the Fed here in the U.S. is withdrawing money out of the system by selling Treasuries and redistributing it as liquidity for the banks just to keep the engine oiled.
Were not even talking about putting it in low gear yet.
Full circle brings us back to that last paragraph in Bob Irvy's report in Bloomberg. Lippmann over at Deutsche Bank is at it again. The Casino is open boys! A few side bets never hurt anyone. And besides this is a chance of a lifetime or at least a chance to recoup your losses if you were a sucker last time.
But the deepest question of all for me is how can some people manage to be as unscrupulous or cold blooded to hope in hell that hundreds of thousands lose their homes?
I can't break that down.
But I can take a few side bets in our poll below.