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Another port-mortem on the sub-prime meltdown

Posted by annkathryn (My Page) on
Sat, Nov 22, 08 at 12:53

Michael Lewis, author of Liar's Poker which is an insider's account of the bond market in the mid- to late-1980s, has written an article neatly describing the fundamental causes of the sub-prime buildup and subsequent meltdown. No one emerges unscathed. Subprime lenders are "scumbags". The CEO of Moody's is "delusional". The CEO of Option One, the mortgage originator owned by H&R Block, was a "liar". The rating agencies are "morally bankrupt".

Most of us know that subprime debt was packaged and then sliced into tranches. What I never really understood was that the BBB tranche was sliced up again and part of it resold as AAA. To me, this is the smoking gun.

The article focuses on Steve Eisman of FrontPoint Partners, one of the first to say that the emperor had no clothes, and then to act on it by agressively shorting subprime bonds.

In retrospect, pretty much all of the riskiest subprime-backed bonds were worth betting against; they would all one day be worth zero. But at the time Eisman began to do it, in the fall of 2006, that wasnt clear. He and his team set out to find the smelliest pile of loans they could so that they could make side bets against them with Goldman Sachs or Deutsche Bank. What they were doing, oddly enough, was the analysis of subprime lending that should have been done before the loans were made: Which poor Americans were likely to jump which way with their finances? How much did home prices need to fall for these loans to blow up? (It turned out they didnt have to fall; they merely needed to stay flat.)

(Eisman) draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranchethe bonds Eisman had shorted. But Wall Street had used these BBB tranchesthe worst of the worstto build yet another tower of bonds: a "particularly egregious" C.D.O. (collateralized debt obligations) The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investorspension funds, insurance companieswho were allowed to invest only in highly rated securities. "I cannot f***ing believe this is allowedI must have said that a thousand times in the past two years," Eisman says.

But he couldnt figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. "I didnt 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 Id always get the same reaction. It was a smirk." He called Standard & Poors and asked what would happen to default rates if real estate prices fell. The man at S&P couldnt 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 it turned out, the side bets that Eisman and others were making against the subprime bonds were in turn part of a huge secondary market in credit default swaps that ultimately magnified the losses when the house of cards finally came tumbling down, since these swaps weren't backed by anything. This fantasy market (the author compares it to NFL Fantasy football) wiped out hundreds of billions of dollars when the market melted down.

When Enron and Worldcom imploded, heads rolled. Who is now being held accountable, other than a few regional subprime lenders?

A very sobering read.

Here is a link that might be useful: The End of Wall Street's Boom

Follow-Up Postings:

RE: Another port-mortem on the sub-prime meltdown

WOW, great read, thanks for the link!!!!

RE: Another port-mortem on the sub-prime meltdown

That is a great article - thank you for posting it.

RE: Another port-mortem on the sub-prime meltdown

Good article.

"When Enron and Worldcom imploded, heads rolled. Who is now being held accountable, other than a few regional subprime lenders?"

None. The real crooks have greased the palms of all the right people. Too bad there aren't enough honest regulators, elected officials, etc willing to smack these dirt dealers down where they belong. In prison.

Here is another story about sub-prime BS.

"FHA-BACKED LOANS-The Next Subprime Crisis Looms
By Chad Terhune and Robert Berner

The same people whose reckless practices triggered the global financial crisis are onto a similar scheme that could cost taxpayers tons more.

As if they haven't done enough damage. Thousands of subprime mortgage lenders and brokers -- many of them the very sorts of firms that helped create the current financial crisis -- are going strong. Their new strategy: taking advantage of a long-standing federal program designed to encourage homeownership by insuring mortgages for buyers of modest means.

In April 2007, Goldman Sachs purchased a controlling stake in Senderra Funding, a former subprime lender in Fort Mill, S.C. Goldman, which has received $10 billion in direct federal rescue money, converted Senderra into an FHA lender and refinance organization.

A link that might be useful:,1518,591613,00.html

RE: Another port-mortem on the sub-prime meltdown

Yup you're right, the crooks have 'greased the palms' of all the right people, in Washington DC. The industry begging for a bailout is proof IMO that corporate criminals are running the govt in America. Unless that changes things are going to deteriorate further. I've been alive for over half a century and have seen this countgry go down hill due to corporate lobbying, greed, and fraud. If our elected officials weren't legally allowed to take their money, I don't believe things would be this bad. Our entire economy was based on totally artificial unsustainable garbage. It still is. I stopped believing this was the "best country in the world" when I traveled to Europe and saw that many things there were as good or better. Since that time we've allowed corporations to take out the economy, and seen our congress award the crooks billions as a reward.

RE: Another port-mortem on the sub-prime meltdown

Excellent but frightening analysis in that apparently the Wall st. machine is far more crooked than even I believed...and certainly tends to put to rest all those who are still deluded into thinking this is just about the "stupid irresponsible" people who took out sub prime loans that they could not afford...


"There weren't enough Americans with shitty 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. "They weren't satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn't afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That's why the losses are so much greater than the loans. But that's when I realized they needed us to keep the machine running. I was like, This is allowed?"

"The juiciest shorts-the bonds ultimately backed by the mortgages most likely to default-had several characteristics. They'd be in what Wall Street people were now calling the sand states: Arizona, California, Florida, Nevada. The loans would have been made by one of the more dubious mortgage lenders; Long Beach Financial, wholly owned by Washington Mutual, was a great example.

Long Beach Financial was moving money out the door as fast as it could, few questions asked, in loans built to self-destruct. It specialized in asking homeowners with bad credit and no proof of income to put no money down and defer interest payments for as long as possible. In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000."

RE: Another port-mortem on the sub-prime meltdown

OK, we all know this -- now. What are we going to DO about it? Just let the scum in DC and on Wall Street walk?

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