How The Economy Was Crashed

[g5000]

I get tired of debunking all the bullshit out there about the causes of the Great Recession, particularly the manufactured bullshit about the CRA and "the gubmint made da banks make all dem bad loans". I also get tired of hearing that it was all about Fannie and Freddie. So I am going to use this topic to compile some of the better posts I have made about this subject.

Every post from here on by me until I say The End is a verbatim quote of other posts I have made on this forum in the past.

Read on.

 

[boedicca]

I suspect this will be a non-existent thread.

 

[HenryBHough]

Why?


"read on", that is.

 

[g5000]

Does anyone here understand why AIG went under?

AIG sold insurance against the financial derivatives the financial services industry was selling. A bunch of loans were packaged into a CDO. Unlike with MBS, an investor in a CDO could choose their level of risk.

AIG sold insurance against the senior and super-senior tranches in CDOs. AIG considered the premiums being paid to them as free money since it was believed the odds of a senior tranche ever defaulting was on the order of a comet hitting Miami dead center.

What took them several years to realize is that while that was true for the first CDOs sold, it was no longer true for later CDOs. That is because the first CDOs were comprised of good loans made to low risk borrowers. But then greed kicked in. When the financial services industry ran out of good risks, they still wanted to make more money. So they began making worse and worse loans so they could keep building more CDOs. It took a while for AIG to figure out the quality of loans in the CDOs they were insuring was rapidly declining.

A third party analyzing company found that 80 to 90 percent of the loans in the most current CDOs were toxic, and so AIG announced to the world they were out of the CDO insurance business at the end of 2005.

AIG assumed they had gotten out in time.

They hadn't.

But even then, Wall Street did not want the music to stop. So they started selling their own insurance against the toxic CDOs to each other. These were synthetic CDOs. And they sold these to investors knowing full well the investors were going to lose buckets of money on them. When a dealers sells something to an investor knowing they just cheated them, they say with glee, "I ripped his face off!"

Open fraud, people. Open fraud.

Abacus 2007-ac1 is the more famous example. Goldman Sachs and John Paulson.


The investors bought a tranche in a synthetic CDO, and the premiums they were receiving looked identical to the revenue streams they had been getting from a normal CDO tranche. What they did not fully realize is that by accepting the premium payments, they were putting themselves out there as insurance sellers and were liable for any losses incurred by the underlying CDO.

Those things blew up in their faces big time.

The lawsuits are still going on.

Imagine you are a home builder. You are allowed to build a house, sell it, and then buy fire insurance against it. What do you think an immoral home builder will do?

That's right. He will build a firetrap, then he will sell it, then he will buy fire insurance against it. He makes money selling the house, and then he makes money when it burns down.

This is what Goldman Sachs and every other broker-dealer out there did.

This is why CDS need to be regulated just like insurance. They need to have an insurable interest requirement. And believe it or not, they still don't to this very day.

 

[g5000]

The ratings agencies and the financial institutions were using mathematical models built by quants. Mathematicians and economists from the academic world.

I showed EconChick one of the most famous mathematical models in the world, and she did not recognize it, even though it was one of the biggest economic discoveries of the past 100 years and is used by tens of thousands of people every market minute of the day! The guys who came up with it won a Nobel prize.

Anyway, nobody ever plugged in a negative number into the models used to rate CDOs. The underlying assumption was that house prices would go up forever.

 

[CrusaderFrank]

I get tired of debunking all the bullshit out there about the causes of the Great Recession, particularly the manufactured bullshit about the CRA and "the gubmint made da banks make all dem bad loans". I also get tired of hearing that it was all about Fannie and Freddie. So I am going to use this topic to compile some of the better posts I have made about this subject.

Every post from here on by me until I say The End is a verbatim quote of other posts I have made on this forum in the past.

Read on.

You won't tire of it either because you're a fucking moron and incapable of understanding the GSE stamped AAA on subprime paper

 

[boedicca]

A better use of this space is to celebrate the Grateful Dead.

 

[g5000]

I will explain what a synthetic CDO is, but it will take a lot of text. You can skip this post if you don't want to know.

First, I have to explain what an MBS is, then what a CDO is, then what a synthetic CDO is so you can appreciate the beauty of the con that was pulled off by the fraudsters.


If you are a bank, you have a finite amount of cash. If you loan that cash to someone, you have to wait for that loan to be paid back before you can lend it again.

Note: Let's not go off on a diversion into fractional reserve banking, mm-kay? That's for another day.

Under this system, you aren't going to want to make a 30 year loan because you don't want to have to wait 30 years to make another loan. So your loans are going to be short term. And that's the way things were for a long time.

But what if you could make the loan, and then sell the paper for that loan to someone else for a small profit? This way, you get your cash back, plus a small profit, and can make another loan right away. Then you can sell that loan, too, and then rinse and repeat as long as you can find investors to buy the paper for the loans you make.

That would be awesome, right?

Well, that is the way it worked from about the 1930s until about the year 2000.

Loans get bought and bundled into Mortgage Backed Securities. The monthly payments from each borrower makes a revenue stream. That revenue stream gets divided among all the investors who bought into the MBS pool.

If any borrowers default, every MBS investor loses money equally.

Note: Let's not go off on how MBS revenues can be sliced and diced. We are sticking to generalities for brevity.

The nice thing about an MBS is that the investors are looking for a long term income. This facilitates the creation of 30 year mortgages. An MBS investor gets a nice steady income of principal and interest payments for 30 years as they live their golden years in Florida.

Not really. The average home loan lasts about 8 years before the borrower refinances. Then the principal is paid off all at once. But you get the idea.

Okay. So that's how things worked until fancier derivatives were invented.

Now, if you are that original banker, and you were lending money to a borrower, you were going to do some serious due diligence on that borrower because that was your money you are lending. You are going to want to see some pay stubs, a semen sample, and get a lien on their first born, right?

In the MBS system, you are relieved of a lot of risk. The investors who buy your loans are taking on most of the risk now. But if you make too many bad loans, there goes your business. They won't buy from you any more.


Then along comes the Collateralized Debt Obligation.

I should pause here to mention that home loans are not the only revenue stream. Auto loans, home equity lines of credit (HELOC), student loans, signature loans, credit card debt, and so forth. All of these are revenue streams. The principal payments and the interest payments that come in each period.

All of these forms of revenue can be bundled.

Continued in next post.

 

[g5000]

A CDO differs from an MBS in that you get to choose how much income you want for a given dollar investment. The more income, the higher the risk you are taking.

I like to explain it thusly:

Imagine the revenue stream as an actual river. And someone is offering to sell you a cup to dip into that river. You can buy a big cup, a medium sized cup, or a small cup. The cups come in many sizes.

The people who buy the smallest cups get to dip their cups into the river first. The people with the biggest cups dip their cups last.

The bigger cups are cheaper than the smaller cups.

The risk the bigger cup buyers are taking is that there won't be any water left when their turn rolls around.

But in the entire history of the Universe, no one has ever seen a river dry up before anyone gets to dip even one cup into the river. This is the actuarial upon which all risk models and ratings agency grades are built.

The source of all the rivers is a snowcapped mountain.

As a CDO investor, you are buying a tranche (cup) based on how much risk you want to take. The equities tranches are big cups, the senior tranches are little cups.

AIG sold insurance against the little cups. They believed this was free money because no river had ever run dry before a little cup got to dip in the water.

But here's the thing. Nature (the natural business cycle) had created natural rivers. These had always been there and big towns had been built on them. Everything worked pretty well, and the banks made money for decades selling the same-sized cups to investors.

Then the variable-sized cups were invented. Still no problem.

But then...Wall Street began digging man-made rivers and selling variable-sized cups for those.

When these artificial rivers were dug, no one changed their assumptions about rivers running dry. They assumed the risks were identical!

What no one stopped to think about was that the snow on the mountain was finite. And it was just a matter time that with all those cups dipping into all those rivers, it was just a matter of time before EVERY river dried up.

When rivers dried up when only a handful of small cups had dipped into them, suddenly AIG had to pay out on the insurance they had sold.

Guess what? They didn't have it. They thought the premiums were free money and so they had not put aside any cash in the eventuality of having to pay out on a policy. They believed that was an impossibility.

More in the next post.

.

 

[g5000]

AIG made their money by collecting premiums for collateralized debt swaps (CDS). A CDS is a lot like insurance, except for one very critical difference. They do not require an insurable interest.

What is an insurable interest?

What if you could buy a life insurance policy against your neighbor's life? What do you think would happen to the murder rate? You could buy an insurance policy against your bitch ex-wife and then have her killed and collect on the policy. Win/win.

What if you could buy fire insurance for any house on the planet? What do you think would happen to the arson rate? You pay a hundred bucks for insurance on some guy's house who you don't even know, then collect $200,000 when his house burns down.

What if ten people could insure one $200,000 house? If it burns down, the insurance company isn't out 200 grand. They are out $2 million.

That is why you have to have an insurable interest to buy insurance. You have to stand to lose something if something happens to what it is you are insuring. You have to suffer a personal loss.

Not so with CDS. You can bet against someone else's loan.

So what do you think happened to the loan default rate?

TA-DAAAAAA!

If you get to build a house, then sell it, then buy fire insurance against it, what will happen to the quality of houses being built?

TA-DAAAAA!

That's what happened to the quality of loans being made.


Okay, let's back up a little bit now.

"AIG made their money by collecting premiums."

Think about what money coming in from premiums is.

Got it yet?

That's right! IT IS A REVENUE STREAM!

And what can we do with a revenue stream? We can bundle it into a CDO!


And that is what a synthetic CDO is. It is the revenue stream built out of insurance premiums.

So if you buy a tranche in a synthetic CDO, your income is coming from insurance premiums (CDS payments). And if you accept an insurance premium, then you are on the hook for what is being insured.

D'oh!

And that is how Wall Street was able to keep the music playing after AIG got out of the CDS business in 2005. They just tricked their investors into selling insurance against the firetraps they were building in the home mortgage world.


Don't believe me?

Google "ABACUS 2007-ac1".

 

[g5000]

The thing about the CDO chain is that the person at the beginning of the pipeline is the one making the loan. If he can sell that loan before the ink is dry, and he doesn't have to keep a piece of that loan on his books, then what has happened to the incentive to do due dilegence on the borrower?

It has vanished. In fact, the broker has an incentive to make as many loans as possible now. More loans means more profits he makes for selling them into the pipeline. He has ZERO risk. All the risk goes into the pipeline.

Then the broker-dealer (Goldman Sachs, et al.) bundle those loans into CDOs and sell all those cups to the investors. They also have no risk. They are getting fees for building and managing the CDOs. All the risk is on the buyers of all those cups. They have the risk of the artificial river drying up on them before they get to dip their cup in the revenue stream.

The whole game of a CDO is to dip your cup into the stream and get more money out than you paid for your cup before the river dries up.

It is much worse for the buyer of a synthetic CDO. They are risking having to shell out more than they invested in the cup!

Remember that $200,000 house that had ten insurance policies against it? When it burns down (the loan defaults), someone has to pay $2 million to the people who bought those policies.

The synthetic CDO investor paid fifty bucks for their cup, got eight dollars (if they were lucky) as their share of the premiums revenue stream, but now they have to cough up $2 million.

 

[g5000]

Lehman Brothers wanted to ensure their pipeline could never be hijacked/outbid by other broker-dealers, and so they bought their own supply chain of mortgage brokers to make sure they would never run out of loans to be fed into their CDOs. They had exclusive feeds into their chain.

And they were not subject to the CRA. And they went to the SEC and asked for a waiver of capital reserve requirements so they could leverage the shit out of themselves. And they got it.

This is why I laugh hysterically whenever I hear someone say "Da gubmint made da banks make all dose loanz!"

 

[g5000]

Tell me something. As you drove around your white suburban town and noticed all the For Sale signs on all those foreclosed houses, did you look at your neighbor and think to yourself, "I had no idea Biff was a Negro!"?

When Iceland's banking system totally collapsed, did you think it was the negroes of Iceland who caused it?

When the Royal Bank of Scotland sank under the waves, did you blame Jesse Jackson?

When Ireland's banks collapsed, did you think, "Oh my God, those fuggin negroes are taking down the Micks!"?

When Spain's banks went down, did you start to think to CRA tards at Fox News were really onto something?

Jesus H. Christ, you have to have seven pounds of brain damage to believe the global derivatives crash was caused by darkies.

 

[boedicca]

I think you should just get a grip and read "Reckless Endangerment".

 

[g5000]

You won't tire of it either because you're a fucking moron and incapable of understanding the GSE stamped AAA on subprime paper

As I already explained to you once today, the GSE's didn't rate their CDOs. The ratings agencies did. If you don't even know the basics of the financial system, I strongly suggest you run away before rambling any more of your retardation here.

 

[g5000]

The End

 

[g5000]

Now I can just refer those who have deliberately kept in ignorance by their hack media outlets here and save myself the trouble of repeating myself.

 

[g5000]

The GSEs were followers. Wall Street led the rush into derivatives products and the GSEs followed in order to cash in on the feeding frenzy. But by 2005, they were a small player in the global secondary market.

Were they overloaded with toxic securities? Yep. Just like every other player. That in no way establishes them as a prime reason for the crash. Not even close.

http://www.gao.gov/decisions/majrule/d04896r.pdf

Read that document in the link. The SEC unanimously voted to approve a wavier of net capital requirements for the five biggest broker-dealers. And if you think Fannie or Freddie were in that group, you would be dead wrong.

They were Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley.

As a result, three of those firms went belly up four years later, and the other two had to convert to bank holding companies so they could be bailed out by the federal government.

It wasn't the implosion of the GSEs which triggered the global derivatives crash. It was the collapse of Bear Stearns followed by that of Lehman Brothers.

And not one of those firms was subject to the CRA.

 

[g5000]

I used a river analogy to explain CDOs. I also used natural rivers and man-made rivers to distinguish between the baseline financial system and the maniacal financial system which came later.

The ratings agencies based their AAA ratings on the performance of natural rivers. They applied the same model to the man-made rivers that they had used for the natural rivers, and that was their downfall and the downfall of the entire system.

This ridiculous focus by Crusader Frank on GSE CDOs and the AAA ratings they got misses the forest for the trees. EVERY player in the secondary market was getting AAA ratings on their toxic shit. Zeroing in on one of the smaller players and saying they were the reason for the crash is about as retarded as it gets.

 

[deltex1]

I will make a copy of this thread
I will read it when I'm dead