Blog on the Run: Reloaded

Friday, November 14, 2008 9:48 pm

“Wall Street had built a doomsday machine”

Filed under: We're so screwed — Lex @ 9:48 pm
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Michael Lewis, the author of the Wall Street classic “Liar’s Poker” (which was so entertaining I read it on my honeymoon), has written an article that ought to be required reading for anyone interested in knowing how the economy got to where it is today, i.e., in a helluva mess. It looks through the eyes of people who not only foresaw the disaster but also placed their financial bets accordingly. The money they’ve made on this will be legendary — they went way short on a bunch of stocks that, because of the mortgage fiasco, are gone or next to worthless today. But I get the feeling they’d trade most of it for a healthy economy:

FrontPoint was net short the market, so this total collapse should have given [Danny] Moses pleasure. He might have been forgiven if he stood up and cheered. After all, he’d been betting for two years that this sort of thing could happen, and now it was, more dramatically than he had ever imagined. Instead, he felt this terrifying shudder run through him. He had maybe 100 trades on, and he worked hard to keep a handle on them all. “I spent my morning trying to control all this energy and all this information,” he says, “and I lost control. I looked at the screens. I was staring into the abyss. The end. I felt this shooting pain in my head. I don’t get headaches. At first, I thought I was having an aneurysm.” …

“Look,” [Steve Eisman] said. “I’m short. I don’t want the country to go into a depression. I just want it to f—–g deleverage.”

The article also shows, among other things, that the problems went far worse than bad mortgages. The problem also included, essentially, imaginary ones:

That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with s—-y credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all.

And the Masters of the Universe couldn’t figure out that these securities had nothing behind them.

One of the big lessons we take from this is one that the screenwriter William Goldman has often used about Hollywood: Nobody knows anything.

Either that, or a whole lot of people ought to be going to prison.

Maybe both.

Which is bad enough. What’s worse is that China, which holds the second biggest chunk of our debt behind Japan last I checked, sees an opportunity in our troubles that ought to have us shaking. One of its leading economists is saying, “Hey, trillion-dollar-deficit guy! You want me to keep buying your debt? Then we’re gonna go all IMF on your butt.” (That might not be a direct quote.)

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