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Friday, February 11, 2011

Winners and Losers in '08

The Big Short: Inside the Doomsday MachineThe odor from '08 won't go away. It's an episode that has been brushed aside but the stench is still there - at least for those who don't suffer from ADHD, which admittedly includes much of Wall Street.  Those who were dead wrong about understanding the markets and the unfolding events  and who were in position to take steps  to lessen the pain and punish the wrong doers remain in charge and tell us that the biggest deficit in history is manageable, that they will right the ship, and get us back on course. All of this is eagerly lapped up by our legislators who themselves will go down in history right up at the top of the list of financially inept rulers - a group it's not easy to climb to the top of!

The problem is well put by Michael Lewis in The Big Short as he mulls the end result in talking with former Goldman Sachs CEO John Gutfreund. As a matter of background, Lewis's theory is that the problems began with Goldman and other Wall Street firms going public. As a public company, the risk of their trades was transferred to their shareholders. He argues that the partners of a privately held company would have never allowed the leverage that Goldman and others took on during this period. This, of course, is a moral hazard issue - if you win the bet, you get the winnings; but if you lose, others pay.

The crux of the issue is explained by Lewis (bolding is my emphasis):

"The people on the short side of the subprime mortgage market had gambled with the odds in their favor. The people on the other side - the entire financial system, essentially - had gambled with the odds against them.  Up to this point, the story of the short could not have been simpler.  What's strange and complicated about it, however, is that pretty much all the important people on both sides of the gamble left the table rich. Steve Eisman and Michael Burry and the young men at Cornwall Capital each made millions of dollars for themselves, of course. Greg Lippmann was paid $47 million in 2007, although $24 million of it was in restricted stock he could not collect unless he hung around Deutsche Bank for a few more years. But all of these people had been right; they been on the winning side of the bet.  Wing Chau's CDO managing business went bust, but, he, too left with tens of millions of dollars - and had the nerve to create a business that would buy up, cheaply, the very same subprime mortgage bonds in which he had lost billions of dollars (my comment: this isn't unusual - we saw it in the S&L crisis - the people who were the problem come in for the clean up) worth of other people's money.  Howie Hubler lost more money than any single trader in the history of Wall Street - and yet he was permitted to keep the tens of millions of dollars he had made. The CEOs of every major Wall Street firm were also on the wrong end of the gample. All of them, without exception, either ran their public corporations into bankruptcy or were saved from bankruptcy by the United States government.  They all got rich, too. (p. 256,257 "The Big Short, Michael Lewis).

There is a saying that has to do with a zero sum game that I paraphrase:  if you're at the table and you can't identify the mark, then you are it. In this particular game, the American taxpayer, once again, was it. We see it in the monthly unemployment report, the record foreclosures, and the potential retirees whose plans have been put on hold. Allowing  the moral hazard game to continue sets the stage for a bigger bust down the road.


  1. This book is on my must read list. Uncle Sap saved the day once again and bailed out the ruling class with the little people's money.

  2. @Grouch I'm not sure you an take this book. When you get to the part about the rating agencies you'll go ballistic. Lewis emphasizes the unthinking nature of Wall Street - hey it has a high rating I'll buy it mentality!

  3. And these rating agencies were not even held accountable. I would put more faith in an eBay seller than Moodys!

  4. @MoneyCone The book details how clueless the analysts at the rating agencies were. Scary.

  5. to sum it up, the US taxpayer was the loser in all of this. In fact, it was not only the US taxpayer, add his children and his grandchildren to the list!

    Yet, what can the tax payer do right now about it all? Does he realize where he was the mark? I wonder...

  6. @Mich Exactly right on the children and grandchildren point. I think the U.S. taxpayer realizes he and she were marks in the sense that they understand they pay high and can't see what they are getting. They aren't getting better education or other government services.