The Big Short

by Ouida on May 19, 2010


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My mother gave me a copy of Michael Lewis’ The Big Short: Inside the Doomsday Machine This book is about the financial devilry on Wall Street. 100 pages in and the only thing going through my mind is OMG! I have already written about Goldman Sachs and Magnetar and I have also read the articles by Fareed Zakaria and others urging us to leave Goldman Sachs and other investment banks alone. After all these are the big boys, the most sophisticated investors in the world and, in theory, they shouldn’t need regulation and their precious derivatives certainly shouldn’t. Reading The Big Short and listening to the Planet Money and This American Life broadcasts I keep raving about I cannot help but come to the conclusion that these banks were not terribly sophisticated. Individuals within these banks saw the opportunity to rake in millions in fees and, because derivatives and secondary markets decoupled risk from reward, certain individuals were happy to reap the rewards while redistributing the risk to others. AIG who had developed a solid business insuring the credit worthiness of publicly-traded businesses, simply assumed that insuring the credit worthiness of pools of mortgages made under circumstances they did not control was the same business model. None of the big boys, it seemed, bothered to look under the hood of the jalopy they were all taking a joy ride in. There was a group of investors who did look under the hood, they never got in the jalopy in the first place. They chose to short the market…they bet that the jalopy would run off the road and boy did it. Meredith Whitney of Oppenheimer asserts correctly that these bankers were incompetent failing to understand the implications of their own derivatives and the exposure on their balance sheets.

The bond market is larger than the stock market and is largely unregulated. Views on the stock market from The Big Short:
“Steve Eisman knew enough about the bond market to be wary, and Vincent Daniel knew enough to have decided that no one in it could ever be trusted. An investor who went from the stock market to the bond market was like a small, furry creature raised on an island without predators removed to a pit full of pythons. It was possible to get ripped off by the big Wall Street firms in the stock market, but you really had to work at it. The entire market traded on screens, so you always had a clear view of the price of the stock of any given company. The stock market was not only transparent but heavily policed. You couldn’t expect a Wall Street trader to share with you his every negative thought about public companies, but you could expect he wouldn’t work very hard to sucker you with outright lies, or blatantly use inside information to trade against you, mainly because there was at least a chance he’d be caught if he did. The presence of millions of small investors had politicized the stock market. It had been legislated and regulated to at least seem fair.”

The bond market is much larger than the stock market and the description of it and how it works defies an easy quote and is frightening to say the least. Add this quote about the bond and derivatives market to the mix, “The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street it was a machine that turned lead into gold”, and we find a disturbing trend in America that goes well beyond this book. America as a nation is ill.

The Big Short, is connected conceptually to another book I am also reading called Cheap: The High Cost of Discount Culture and two other books I read several years ago: Nickel and Dimed: On (Not) Getting By in America and Credit Card Nation: The Consequences of America’s Addiction to Credit. Credit Card Nation was published almost a decade ago. It is a treatise on credit, but more than that, it delves into the world of sub prime lending. Bank of America and Citi Group were specifically named as big players in the sub prime game. These 4 books published over the last decade chronicle an economic trend in America that culminated in the financial meltdown of 2008.

After WW II it was possible for a youth to graduate from high school, land a factory job and be set, literally for life. Retire with a pension, supplemented by Social Security and you were guaranteed a level of economic well-being for your entire life. Robert Kiyosaki is fond of saying that that way of living and thinking represented the Industrial Age. When the wall came down in 1989 and with the advent of the Internet the rules changed. We entered a global economy and the citizenry was the last to realize it. Our schools have failed to keep up with the realities competition in a global economy and wages have not only stagnated at home they have declined. 2/3 of our health care dollars will be spent chasing 2 diseases we shouldn’t even have in large numbers, obesity and diabetes. PE has been eliminated from public schools but are our kids better able to compete on the global stage because if it? No.

We fostered industries who produced consumer goods, the manufacture of which could be outsourced, yet failed to make investments at home that cannot be. I remember being enthralled as a kid watching a PBS special about recycling. I collected cans for a year, then my parents drove me all over town looking for a place to recycle them. No such place existed in 1970’s Nashville and the cans ended up in the dump. Today over 30 years later, it still takes extreme dedication for most Americans to recycle. Over 20 years ago we drove through the Sacramento Valley. I saw wind farms for the first time in my life. I thought for sure that I was looking at the future of electricity. A decade later as I drove cross country to begin my career, I saw the plains states devoid of wind farms. Now there is a wind farm in Central Arizona and it is BIG news. When I was a kid, I debated in high school. Consumer product safety was the national topic. My partner and I developed an airtight case around dam safety, no kidding. Dam safety. They were in shoddy shape then. Passive restraints are now standard in automobiles. Laws support seat belts and child seats but our nation’s dams and bridges are in worse shape than they were in 1979 when we ran our case.

It is like we spent our money and good will digging for oil rather than develop an alternative to it and the last 5 to 10 years of our economy were based on extending cheap and ultimately unaffordable goods and services to middle class and lower middle class America. Just as high fructose corn syrup is the answer to cane sugar, credit rather than real economic growth became the answer to stagnant wages.

America is ill because we didn’t address our problems when there was both foreknowledge and opportunity and now, I am afraid, we may be too hobbled to do so no matter how high our taxes go. Amid all this, discussion about whether or not we should regulate financial markets is puerile. Of course we should. In so far as a few guys and gals in suits (or sweats) can target the most vulnerable segment of our society and take the our economy, trillions of dollars of wealth, and several sovereign nations with them. Of course we should.

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