“I’m so bored. I hate my life.” - Britney Spears

Das Langweilige ist interessant geworden, weil das Interessante angefangen hat langweilig zu werden. – Thomas Mann

"Never for money/always for love" - The Talking Heads

Thursday, November 13, 2008

Zona Komiks!

“People are grieving,” said Ms. Goldsmith, a semiretired psychotherapist who counsels fellow residents of the Gleneagles Country Club, a gated community here. “There was a death. Their money died.”

The zona is proving to be quite the beast. Even LI, in whose head wheels of fire turn, and who could stick out his hand anytime to Jonah, Isaiah or Jeremiah and say, cousin, is surprised by the claws on this thing. Our own, perhaps naïve thought was that all the money in the world wasn’t going to help – that in fact, sooner or later, about 65 trillion dollars in derivatives would be nullified. A haircut! Think of the surprise lines drawn around a cartoon character whose been stunned by some sudden news – think of those surprise lines as a trillion each. Nothing, right? But lo and behold, looks like this magic money got comingled with real money. Magic money is, of course, the chief concern of all right thinking people, which is why AIG gets a nice little 30 billion dollar snack yesterday, and today the Bushies are for vetoing any aid to GM. GM evokes a lot of anger from the GOP crowd, because they realize that GM hired thousands and thousands of Union workers – the horror! Not like those wondrous AIG people, people you can recognize, people you might want to have a drink with, or go pussy-hunting with after a long hot day fleecing the rubes – in contrast with those greedhead workers, always trying to get health insurance and pensions. Imagine! It makes a person sick, it really does. Howwegonnastaycompetitive, as the economists always say. After they explain that trade deficits are nuthintoworryabout. That might seem contradictory, until you realize that the world in which innovative financial instruments lead to utopia is in a different column than laborflexibilitycreativedestructioncompetitiveadvantage and other words of that ilk, assuring us that maximizing inequality, stabilizing incomes and invest invest invest is the best thing in the whole world, though it does sometimes lead to crackup, the end of the atmosphere, endless war, and the stupidest sitting with riding crops poised on top of your neck and you watch your life turn into a senseless and pointless debttrap.

But, though it might break the bank and your heart, still, the zona has its charming side. It is funny! Surely this is the funniest depression ever. LI is serious – the best thing I’ve read about the ‘bubble’ so far is this fantastic article by Michael Lewis, of Liar Poker fame, in Portfolio. I read it last night, and I couldn’t stop laughing.

Recently, I read a buncha comments in various blogs mourning the passing of Michael Crichton. Those remarks puzzled me, because all of them would announce that Crichton was a lousy writer who seems to have been addictive. But why? And the plots that he apparently worked out seem, well, to have been either done before and better – Jurassic park, meet the lost world – or not worth doing. Contrast this with fi fiction – or faction, which is what Michael Lewis does. For one thing, he can write – he is definitely not clunky. He has the prose style of the Moviegoer - unsurprisingly, coming from Walker Percy's town. And for another thing, the characters he writes about, who inhabit Wall Street, are monsters ten times scarier than a band of people with star influenza, or who, I don’t know, conspire to trick the world into thinking global warming is a fact. But they are also, as supreme egotists with no culture, extremely funny. The things Lewis' characters do to ruin companies, the lives of individuals, and anybody who gets in their orbit merely to make the next million bucks have just that horror movie note of the unstoppable evil force. At the same time, it is wildly funny. The way they package instruments they don’t understand and sell them to each other is funny. The way they got America, where it is morning and Reagan is the sun, on the hook, the one that is dragging us under. This is what comedy is about. What’s not to love about these characters? Plus, they are real.

The hero of Lewis’ piece is a hedge funder named Steve Eisman. Eisman, like a Michael Crichton character, is set down in the midst of suspicious and whacky doings - Wall Street, 2003. As in Jurassic Park, there seemed to be something genetically suspicious going on – animals were getting bigger and bigger on resources that were lean enough to support merely a crop of mice. In what, to me, is the key to the whole fascinatin mystery, Eisman and his crew at FrontPoint, his fund, learn this:

At the end of 2004, Eisman, Moses, and Daniel shared a sense that unhealthy things were going on in the U.S. housing market: Lots of firms were lending money to people who shouldn’t have been borrowing it. They thought Alan Greenspan’s decision after the internet bust to lower interest rates to 1 percent was a travesty that would lead to some terrible day of reckoning. Neither of these insights was entirely original. Ivy Zelman, at the time the housing-market analyst at Credit Suisse, had seen the bubble forming very early on. There’s a simple measure of sanity in housing prices: the ratio of median home price to income. Historically, it runs around 3 to 1; by late 2004, it had risen nationally to 4 to 1. “All these people were saying it was nearly as high in some other countries,” Zelman says. “But the problem wasn’t just that it was 4 to 1. In Los Angeles, it was 10 to 1, and in Miami, 8.5 to 1. And then you coupled that with the buyers. They weren’t real buyers. They were speculators.” Zelman alienated clients with her pessimism, but she couldn’t pretend everything was good. “It wasn’t that hard in hindsight to see it,” she says. “It was very hard to know when it would stop.” Zelman spoke occasionally with Eisman and always left these conversations feeling better about her views and worse about the world. “You needed the occasional assurance that you weren’t nuts,” she says. She wasn’t nuts. The world was.

By the spring of 2005, FrontPoint was fairly convinced that something was very screwed up not merely in a handful of companies but in the financial underpinnings of the entire U.S. mortgage market. In 2000, there had been $130 billion in subprime mortgage lending, with $55 billion of that repackaged as mortgage bonds. But in 2005, there was $625 billion in subprime mortgage loans, $507 billion of which found its way into mortgage bonds. Eisman couldn’t understand who was making all these loans or why. He had a from-the-ground-up understanding of both the U.S. housing market and Wall Street. But he’d spent his life in the stock market, and it was clear that the stock market was, in this story, largely irrelevant. “What most people don’t realize is that the fixed-income world dwarfs the equity world,” he says. “The equity world is like a fucking zit compared with the bond market.” He shorted companies that originated subprime loans, like New Century and Indy Mac, and companies that built the houses bought with the loans, such as Toll Brothers. Smart as these trades proved to be, they weren’t entirely satisfying. These companies paid high dividends, and their shares were often expensive to borrow; selling them short was a costly proposition.”

What is the meaning of the shift from 3 to 1 to 4 to 1? Well, we will hear, we are hearing, our ears are deaf with hearing, that we brought this on ourselves, us selfish pigs, overspending, never saving, bad bad bad people. Of course, this is a pile of shit. What this means is that housing prices were going up while the benefits of increased productivity went solely to the investor class. In actuality, people, selfish greedy pigpeople, were operating under the rational assumption that they were going to make more money as time went along. That is because they had four decades of experience in which, as time went along, they made more money: the sixties, seventies, eighties and nineties. What was different under the Great Fly’s years? They hit a wall. The wealth was spread among the wealthiest, while the little people – greedy fucks! – finally got shut out. After all, as suave economists like those who write for Freakonomics point out, the poor are really the lucky duckies – look at how prices for plastic tat from China have plunged! Why, Walmart is proof positive that the hillbillies are engrossing the benefits of free trade, free markets, and our wonderful health care system! While the rich (sob!) have to be content with taking the profits from the system for themselves. This makes the Freakonomic guys emotional, it really does.

Anyway, to get back to our pump and dump saga, Lewis shows Eisman and associates going to various new housing developments, talking to dealers in CDOs, and getting a feel for the New World. It is pod people time.

For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.

But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.

As an investor, Eisman was allowed on the quarterly conference calls held by Moody’s but not allowed to ask questions. The people at Moody’s were polite about their brush-off, however. The C.E.O. even invited Eisman and his team to his office for a visit in June 2007. By then, Eisman was so certain that the world had been turned upside down that he just assumed this guy must know it too. “But we’re sitting there,” Daniel recalls, “and he says to us, like he actually means it, ‘I truly believe that our rating will prove accurate.’ And Steve shoots up in his chair and asks, ‘What did you just say?’ as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him.”

“With all due respect, sir,” Daniel told the C.E.O. deferentially as they left the meeting, “you’re delusional.”

I’d continue this story, but I’d rather just whet your appetite for it. Go and read the terrific Portfolio piece. Have a laugh! Then figure out how you are going to eat for the next coupla years.


Praxis said...

That Levitt post ought to win some kind of prize.

northanger said...

you're the last person i'd think would go for a GM bailout. but, what exactly are we bailing out?

Long Beach Financial? Long Beach Financial. i think they're the guys who wanted to repo my car when the last payment was late. i told them to come pick it up. ok ok, slight exaggeration since i'm about to drive the dirty old thing downtown. :) i know Baby'll be so pleased she got blogged.

Anonymous said...

That Levitt, not one word on the cost of buying politicians and parties. Walmart don't even stock 'em.

And more tangibly, as you imply, it's isn't just the money-price, it's also the quality of the goods. If it's broke as soon as you buy it, who cares if it's cheap.

Chuckie K (aspriing to afford Walmart)

roger said...

What's funny, too, is that it imperturbably turns upside down the whole argument for free trade. Instead of a productivist argument, in which, due to comparative advantage, the workers will be working at higher value jobs, producing higher value stuff - an argument that I'm even partial too - one simply pretends that that argument didn't happen, and the new argument is, although the jobs are crappier, the pay is shitty, the security is zip and the education system slips beyond the power of you and your kids - you can get cheap shit! So what are you complaining about?

I loved that Freakonomics column and bookmarked it because you so rarely see the economist simply, rawly, nakedly give up all the bullshit and operate as a p.r. spokesman for the new feudalism. Since, in fact, the driving tendency in the economics of the Great Moderation has always been - what's in it for the top 1 percent? - and the tattered rhetorical disguise is: really, we are so concerned with the general social welfare - I sorta liked this. It was a breathtaking bit of truth, put out there without ornament. These people are the true enemies of the people. For those with eyes to see.

northanger said...

ah, here it is. Walter Reuther (The Most Dangerous Man in Detroit, Siphoning G.M.’s Future), the Treaty of Detroit, and Engine Charlie & the dependency ratio. (also, someone has a nifty table on legacy costs & it seems i was rightly thinking auto sector's symbiotic-parasitic relationships).


roger said...

Nice links, North.
Now, don't mistake me for a lover of the car culture. My solution to our car problem is to return to horses and donkeys. Unfortunately, I think I'm alone, here. So, given that reality is not going to correspond with my fantasy - of course I'm for the bailout, if it is done correctly.
I have a feeling it won't be enviro friendly, which will be a rotten missed chance. But it is insane to bail out a financial sector which employs its thousands, and unplug the car sector, which employs, through its networks, literally millions.

northanger said...

let's not confuse business failures with systemic failures. GM should go through chapter 11. we can excise the legacy cost & perform a quick loaves & fishes miracle thingy.

Anonymous said...

“He’s sort of a prick in a way, but he’s smart and honest and fearless.”

Why, that's Roger!

roger said...

My friend mr. d! I believe that is you, coming up for air after four months!

In the South, there is a saying known by every overweight Cracker Barrel diner: if you're sucha prick, why ain't you rich?

I ask myself that every day. Or every other year. Or something...

roger said...

North, actually, I think government intervention can do something good about the auto business, but I don't think it is going to fix the systematic problem. One notices that Paulson apparently decided to sit on the 700 billion dollars we needed immediately. That makes some sense - when the gov announces that we need nearly a trillion dollars one day, after whistling and clapping about how the economy is fundamentally sound, the crater that makes will be a nice 700 billion dollar crater.

I read a lot of what I consider silliness about the crack-up. The crack-up is a long way from over. The financial services sector is going to shrink brutally. Saving or not saving Lehman, or AIG, was not and is not going to make that much of a difference. What would make a difference is what, I see, nobody is doing, after pretending like they were going to do it - making a transparent institutional forum to bring the shadow financial system down to reality. Destroy the OTC, peer to peer system of sales, make selling CDS-es and synthetic CDS-es and synthetic synthetic CDS-es public, where any trader who wants to know about it can view the transaction. An efficient market can't operate if the traders are systematically ignorant.

So, besides giving painkillers to the dying and forcing such institutional change, I don't see the State as being the knight that is going to save the financial system. But, on the contrary, the State could very well be the intervener of first resort to not only save the U.S. automobile industry, but to bring that industry into the 21st century. At great expense, after all, the U.S. provides the roads without which the cars couldn't move. That was, of course, a government choice - as was the choice in the last century to give railroads land so that they could be built. Transportation is something a State is good at, as a matter of fact. I'm not sure if we need to go the European way, put in diesel motors and make diesel available at every gas station (which would be good! economic activity like that is just what we need right now) or what, but if we disregard ideological qualms that will die as the State succeeds - and that will ultimately prove of benefit to the private sector - this is a fantastic opening.

Anonymous said...

no, not mr. d, but I am a huge admirer. Roger, you're brilliant and a great writer, and a treasure. I often disagree with you for no good reason, so you're perspective helps purify.

northanger said...

I don't see the State as being the knight that is going to save the financial system. But, on the contrary, the State could very well be the intervener of first resort to not only save the U.S. automobile industry, but to bring that industry into the 21st century

oh geez roger. how do you come up with this shit?

roger said...

North, as you well know, all my ideas about economics come to me when I play classic Metallica records backwards. This, by the way, is the same method Thomas Edison used to invent the lightbulb.

P.M.Lawrence said...

"...the same method Thomas Edison used to invent the lightbulb".

Ah, but what method did he use to invent the phonogram in the first place?

northanger said...

roger, my bad. i keep forgetting you have strange muses.