Elf M. Sternberg elfs



It's not hard to understand. Margin Call, says that the film "barely attempts to explain the insanely complex financial shenanigans that caused the crisis." He says that's a positive, because the film is a solid movie that doesn't need to explain it.



The problem with this is that I think it's wrong to tell people that what happened is "hard to understand." There were no "insanely complex financial shenanigans." Once you believe that, you will discover that the entire problem was actually quite simple to grasp.



There were "insanely complex financial instruments" created in the period leading up to the crisis. These instruments were deliberately designed to be opaque and hard to trace; this forced the credit rating agencies to try and understand them, and allowed the manufacturers of those instruments to get the AAA ratings they wanted despite the fact that the underlying real-world components of those instruments were utter crap. But deliberately designing a maze to be impossible, and understanding the intentions of the maze-maker, are two different things.



Many people believe you need a PhD in economics to understand what went wrong in 2008. This is a myth. It doesn't take a PhD to:



1) understand that mortgage companies engaged in fraud, misrepresentation, and misprison to build up their portfolios of mortgages. They did this by selling people mortgages they couldn't possibly pay for, using those misrepresented mortgages on their books as assets to get loans from banks. When the mortgages went bad, the brokers offered "refinancing" that would hold off foreclosure for another year, but at a higher rate with higher starting points. This made the brokers' accounting books look great. The banks, some of which knew but most of which didn't, eagerly participated in this new form of mortgage brokering known as "sub-prime," especially since they didn't have to manage the mortgages and foreclosures themselves.



2) Wall Street banks saw the "money" being generated by small banks taking "risks" (i.e. joining the fraud, or being taken in by fraudulent numbers) and felt they had to get in before their competitors did



3) Operatives in Wall Street knew what was going on but since they were conduits for these transactions with no risks of their own, they kept playing because the cash was amazing.



4) The Wall Street banks didn't want to hold and manage mortgages either, so they repackaged the mortgages into huge blocks and sold them as bonds. AAA-rated mortgages are fine as bonds: bonds are expected to pay off at a given rate, and so are AAA-rated mortgages. But these weren't AAA-rated mortgages, so Wall Street sliced them (using the French word for slice, 'tranche', to give it some, er, cachet, and to hide what it really was.) These things become known as a Collateralized Debt Obligation (CDO). They gamed the system to make the top slices AAA, and then repackaged the sub-AAA into new "synthetic CDOs". The ratings agencies, unfamiliar with these products, graded on a curve: the top was always AAA. Played long enough, and even the crappiest of bond packages could be made to seem like a AAA-bond. (It's like taking the worst baseball player at every high-school, putting them all onto one team, and then saying the best player from that team would make a great major-leaguer.)



5) A commonplace tool for avoiding the risk of default was the Credit Default Swap (CDS). It was called a 'swap' rather than an 'insurance' because using the word 'insurance' would trigger an SEC regulation. The issuer would take in a set amount of money every month, comfortable that few CDOs would go bust, and the risk of them doing so was low. Few of these institutions knew about the fraud in (1) above. Those that did, jumped into step (3). The money was just that good.



6) All of this would have been fine if the issuers of CDSs hadn't then bundled the CDSs and resold them in bond packages. The CDSs were then themselves sliced into even more "synthetic CDOs". They were assumed to be safe because their underlying assets were supposed to be safe. They were thus rated on the same curve as (4).



7) People in (3), and there were starting to be a few of them, took out CDSs on bonds they didn't even own. While legal at the time (and it still is!), this was essentially a form of gambling: betting against the CDS issuer that a third-party obligation would fail. The government, then run by the Bush administration secure in the knowledge that the market knew what it was doing, looked the other way.



8) The banks saw the brokerages in (7) make their move, and saw the demand for these assets, and starting selling them synthetic CDSs based on the synthetic CDOs mentioned in step (6). This was the beginning of the death spiral. These were the insanely toxic assets that nobody understood, because for every level down, the number of assets you needed to track exploded. Worse, those assets were held by an exploding number of institutions. This was the evil hyper-leveraging where everyone starting putting unrealistic figures on the amount of money they were supposedly commanding.



10) One day, the mortgage sellers in (1) just couldn't find another person willing to upsell another bad mortgage another day. They defaulted. When people started demanding cash value, there wasn't enough cash in the world to support the unwinding. It didn't exist. The whole synthesis death spiral had created obligations thirty times greater than all the money in the world.



11) Worse, six months prior to (10), several brokerage houses knew what was going on. They could see the end coming. They borrowed stock in the banks and brokerage houses involved, and immediately sold them. They made a bet that the stock's values would plummet and within a year they'd be able to buy back the stock of those companies at a much reduced value, give the stocks back to the institutions they'd borrowed them from, and pocket the difference. This is the basis of short selling. When the shit hit the fan, people owed them billions of dollars, and didn't even want the stocks back.



There. That's basically what happened. Ten easy steps, with vultures looking on at (11). You can look up all sorts of things about how deregulation led to the mortgage madness, and how the Savings And Loan Crisis of the 1980s led to the deregulation as a way of re-inflating a suppressed housing market in the 1990s, and so on. But it comes down to this: the positive incentive of money was there to do crazy stuff with people's lives and homes, and the negative incentive of criminal prosecution was virtually non-existent.



It's a myth, and a harmful one, to portray what happened on Wall Street as an "insanely complex event nobody could understand." It's easy to understand. Really. You just need to see past the alphabet soup bullroar to see what was really going on. David Levine, in his review of, says that the film "barely attempts to explain the insanely complex financial shenanigans that caused the crisis." He says that's a positive, because the film is a solid movie that doesn't need to explain it.The problem with this is that I think it's wrong to tell people that what happened is "hard to understand." There were no "insanely complex financial shenanigans." Once you believe that, you will discover that the entire problem was actually quite simple to grasp.There"insanely complex financial instruments" created in the period leading up to the crisis. These instruments were deliberately designed to be opaque and hard to trace; this forced the credit rating agencies to try and understand them, and allowed the manufacturers of those instruments to get the AAA ratings they wanted despite the fact that the underlying real-world components of those instruments were utter crap. But deliberately designing a maze to be impossible, and understanding the intentions of the maze-maker, are two different things.Many people believe you need a PhD in economics to understand what went wrong in 2008. This is a myth. It doesn't take a PhD to:1) understand that mortgage companies engaged in fraud, misrepresentation, and misprison to build up their portfolios of mortgages. They did this by selling people mortgages they couldn't possibly pay for, using those misrepresented mortgages on their books as assets to get loans from banks. When the mortgages went bad, the brokers offered "refinancing" that would hold off foreclosure for another year, but at a higher rate with higher starting points. This made the brokers' accounting books look great. The banks, some of which knew but most of which didn't, eagerly participated in this new form of mortgage brokering known as "sub-prime," especially since they didn't have to manage the mortgages and foreclosures themselves.2) Wall Street banks saw the "money" being generated by small banks taking "risks" (i.e. joining the fraud, or being taken in by fraudulent numbers) and felt they had to get in before their competitors did3) Operatives in Wall Street knew what was going on but since they were conduits for these transactions with no risks of their own, they kept playing because the cash was amazing.4) The Wall Street banks didn't want to hold and manage mortgages either, so they repackaged the mortgages into huge blocks and sold them as bonds. AAA-rated mortgages are fine as bonds: bonds are expected to pay off at a given rate, and so are AAA-rated mortgages. But these weren't AAA-rated mortgages, so Wall Street sliced them (using the French word for slice, 'tranche', to give it some, er, cachet, and to hide what it really was.) These things become known as a Collateralized Debt Obligation (CDO). They gamed the system to make the top slices AAA, and then repackaged the sub-AAA into new "synthetic CDOs". The ratings agencies, unfamiliar with these products, graded on a curve: the top was always AAA. Played long enough, and even the crappiest of bond packages could be made to seem like a AAA-bond. (It's like taking the worst baseball player at every high-school, putting them all onto one team, and then saying the best player fromteam would make a great major-leaguer.)5) A commonplace tool for avoiding the risk of default was the Credit Default Swap (CDS). It was called a 'swap' rather than an 'insurance' because using the word 'insurance' would trigger an SEC regulation. The issuer would take in a set amount of money every month, comfortable that few CDOs would go bust, and the risk of them doing so was low. Few of these institutions knew about the fraud in (1) above. Those that did, jumped into step (3). The money was just that good.6) All of this would have been fine if the issuers of CDSs hadn't then bundled the CDSs and resold them in bond packages. The CDSs were then themselves sliced into even"synthetic CDOs". They were assumed to be safe because their underlying assets were supposed to be safe. They were thus rated on the same curve as (4).7) People in (3), and there were starting to be a few of them, took out CDSs on bonds they didn't even own. While legal at the time (and it still is!), this was essentially a form of gambling: betting against the CDS issuer that a third-party obligation would fail. The government, then run by the Bush administration secure in the knowledge that the market knew what it was doing, looked the other way.8) The banks saw the brokerages in (7) make their move, and saw the demand for these assets, and starting selling themmentioned in step (6). This was the beginning of the death spiral. These were the insanely toxic assets that nobody understood, because for every level down, the number of assets you needed to track exploded. Worse, those assets were held by an exploding number of institutions. This was the evil hyper-leveraging where everyone starting putting unrealistic figures on the amount of money they were supposedly commanding.10) One day, the mortgage sellers in (1) just couldn't find another person willing to upsell another bad mortgage another day. They defaulted. When people started demanding cash value, there wasn't enough cash in the world to support the unwinding. It didn't exist. The whole synthesis death spiral had created obligations thirty times greater than all the money in the world.11) Worse, six months prior to (10), several brokerage houses knew what was going on. They could see the end coming. Theyin the banks and brokerage houses involved, and immediately sold them. They made a bet that the stock's values would plummet and within a year they'd be able to buy back the stock of those companies at a much reduced value, give the stocks back to the institutions they'd borrowed them from, and pocket the difference. This is the basis of short selling. When the shit hit the fan, people owed them billions of dollars, and didn't even want the stocks back.There. That's basically what happened. Ten easy steps, with vultures looking on at (11). You can look up all sorts of things about how deregulation led to the mortgage madness, and how the Savings And Loan Crisis of the 1980s led to the deregulation as a way of re-inflating a suppressed housing market in the 1990s, and so on. But it comes down to this: the positive incentive of money was there to do crazy stuff with people's lives and homes, and the negative incentive of criminal prosecution was virtually non-existent.It's a myth, and a harmful one, to portray what happened on Wall Street as an "insanely complex event nobody could understand." It's easy to understand. Really. You just need to see past the alphabet soup bullroar to see what was really going on. Tags: shrill

Current Mood: annoyed

From: tagryn Date: October 23rd, 2011 10:22 pm (UTC) (Link) Without analyzing the argument's merits and debits, which I'll leave to others, I can say that ten (eleven) steps is way too long to work as an explanation that most people have the time to comprehend. It needs to be boiled down to a paragraph, at most, to reach non-economists. Something like: "Mortgages were a bubble/Ponzi scheme that both homeowners and banks gambled on, and some lost when the bubble burst, just like what happened in the tech bubble of the '90s. The government chose to bail out the banks because of the fear that the whole financial system would collapse, while homeowners have largely been left to fend for themselves." From: sandhawke Date: October 23rd, 2011 11:02 pm (UTC) (Link) That kind of leaves out the fraud bit, where mortgage originators, and everyone downstream from them, systemically lied about the quality of the instruments they were creating. They're claiming to have merely been stupid, but various investigations have provided evidence to the contrary. From: ideaphile Date: October 24th, 2011 02:52 am (UTC) (Link) Rationalization, thy name is Elf This is like summarizing today's Seahawks game by saying nothing more than "Seattle achieved 137 yards of total offense, resulting in a Steven Hauschka field goal."



There were also officials, other players, and a whole other TEAM that contributed much more to the game, just as others made more significant contributions to the mortgage crisis.



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From: ionotter Date: October 24th, 2011 04:34 pm (UTC) (Link) Re: Rationalization, thy name is Elf That's the whole point of the post.



I don't know shit about football or finance, but I *did* understand this.



Perfectly.



And because I understand this perfectly, I NOW know the following:



1. This is criminal.

2. Those who perpetrated it are criminals.

3. Those who looked the other way are criminals.

4. The criminals MUST be apprehended and put to trial.



You, sir, are putting the money from the sale of the contents of the oxcart in front of those contents, which are laying in the road in front of the oxcart which is in front of the ox. From: ideaphile Date: October 24th, 2011 05:01 pm (UTC) (Link) Re: Rationalization, thy name is Elf No, the whole point of the post was that mortgage companies and "Wall Street" were entirely responsible. They were not.



I agree that this situation involved criminal behavior and that the criminals should be punished. There are many such criminals still working in the mortgage industry and on "Wall Street". There are also many such criminals in the US Senate and House of Representatives and in various Federal government agencies.



It's too late to imprison William Proxmire, but Barney Frank is still a free man, and that doesn't seem just.



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From: ionotter Date: October 24th, 2011 04:36 pm (UTC) (Link) pingback_bot I'm going to mirror this in a few places. Expect a visit from From: expandranon Date: October 25th, 2011 08:51 am (UTC) (Link) This needs to reach a lot more people. Do you plan on posting it elsewhere? From: _candide_ Date: November 2nd, 2011 05:22 pm (UTC) (Link) Eh, you oversimplify it in a few places, Elf. But it's faaaar better than the usual, "It was all the fault of poor people (read: not-white people) being sold mortgages that they couldn't afford," B.S. that Certain People run around peddling.



There's one other piece: Yes, a lot of these exotic financial instruments were several levels of abstraction away from the actual loans. But their value wasn't a, "complete mystery." The Quants … the guys with the PhDs … had models that quite accurately¹ described their value. But, when the Head Quant went to the Head Trader and said, "Listen, you're waaaay overexposed to risk. These CDO's are horribly overvalued; don't touch 'em anymore," the Head Trader responded, "F!@# You &mdash we're making money, so you don't know what you're talking about." At that point, the Head Quant had a problem: pick a political fight by going over the Head Trader's erm, head, or keep quiet.



Since most of the upper execs were going to tell him the same thing, the Head Quant at every last one of these companies did pretty much the same thing: they ruefully went back to their desks, knowing that Doom was coming.





¹One exception on those models: AIG. But in that case, it was because they were using the wrong model. Namely, they were modeling the Credit Default Swaps using the math for auto insurance, life insurance, homeowners insurace, etc. (Now, in addition to the obvious problems with this, there's one other: you can take a CDS and do the equivalent of, "taking out a life insurance policy on yourself." But, you can't kill youself in order to collect on your life insurance; you're dead, after all. With a CDS, however, you can do the equivalent of that.)

From: _candide_ Date: November 9th, 2011 03:40 am (UTC) (Link) Oh: My statements about the Head Quants came directly from a talk during a 2008 conference in Financial Mathematics. The panel consisted of some of those Head Quants. One quoted the then-recent garbage in the news, that it was "all the fault of Geeks with Equations being in charge." He retorted, "Gee, you could've fooled me that I was in charge!" He then told a story about the encounter that he had with a Head Sales Trader. Others in the room indicated that they'd experienced much the same.



(The bit about AIG's models also came from that same conference.) From: lovingboth Date: January 7th, 2012 10:41 pm (UTC) (Link) The vultures in #11 seem the nicest lot of the bunch...