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The Big Short
Apr. 13th, 2010 10:05 amI just finished reading Michael Lewis' wonderful book The Big Short: Inside the Doomsday Machine
. It's about the recent financial collapse, and it's an indictment of the greed and stupidity of investment banking which directly led to the collapse. Lewis, who has a Wall Street background, clearly explains how the collapse came about, using the stories of several individuals who "went short" or were betting on a collapse. Needless to say, the shorts were right and are now rich.
The financial collapse was caused by unregulated mortgage and consumer finance companies lending money to people who would never be able to repay it. These finance companies (not banks - Federal regulations prohibited writing these shit loans) would then sell the loans to Wall Street investment houses, who would write and sell bonds based on the loans. Nobody (or almost nobody) seemed to understand or care that this was all a house of cards.
Consider, for a second, one of the products sold to a consumer by a finance company: the no-payment negative amortization mortgage. Basically, if you had this loan, for the first 2 years, you didn't need to make a payment. Your payment would just be added to the principal. Who gets such a loan? People who are either planning to sell the house before a payment is due or those who have no income. Either way, default rates are astronomical, especially if housing prices merely stop rising.
Now, Wall Street actually bought these loans. In fact, they created bonds that were 100% negative amortization loans! Who buys a bond from people that are never going to pay them back? Lots of people, especially if the rating agency says it's a AAA investment - defined as "essentially riskless!"
When I was getting my MBA, my finance professors told me that markets were efficient, and that all risks were priced into them. This was a few years before the tech bubble burst. Having read The Big Short, I am absolutely convinced that "efficient markets" are deader than door nails.
. It's about the recent financial collapse, and it's an indictment of the greed and stupidity of investment banking which directly led to the collapse. Lewis, who has a Wall Street background, clearly explains how the collapse came about, using the stories of several individuals who "went short" or were betting on a collapse. Needless to say, the shorts were right and are now rich. The financial collapse was caused by unregulated mortgage and consumer finance companies lending money to people who would never be able to repay it. These finance companies (not banks - Federal regulations prohibited writing these shit loans) would then sell the loans to Wall Street investment houses, who would write and sell bonds based on the loans. Nobody (or almost nobody) seemed to understand or care that this was all a house of cards.
Consider, for a second, one of the products sold to a consumer by a finance company: the no-payment negative amortization mortgage. Basically, if you had this loan, for the first 2 years, you didn't need to make a payment. Your payment would just be added to the principal. Who gets such a loan? People who are either planning to sell the house before a payment is due or those who have no income. Either way, default rates are astronomical, especially if housing prices merely stop rising.
Now, Wall Street actually bought these loans. In fact, they created bonds that were 100% negative amortization loans! Who buys a bond from people that are never going to pay them back? Lots of people, especially if the rating agency says it's a AAA investment - defined as "essentially riskless!"
When I was getting my MBA, my finance professors told me that markets were efficient, and that all risks were priced into them. This was a few years before the tech bubble burst. Having read The Big Short, I am absolutely convinced that "efficient markets" are deader than door nails.
