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Naked Capitalism is Wrong About Who Caused the Financial Crisis: Yet Another Anecdotal Example
This post is from Stone Street Advisors.
Tom Adams - a former Monoline exec - and Yves Smith, proprietor of
the Naked Capitalism blog and authors of Econned, have spent the better
part of the past few months (if not longer) driving up my blood
pressure by consistantly laying the blame for the (structured) credit
bubble squarely at the feet of those people who saw the impending crash
and went short as a result. This, sense does not make.
They
claim "the shorts" drove the demand for creating all of the "toxic"
CDO's that almost brought down the Financial System down because after
all, the Investment Banks couldn't sell a CDO to lazy/ignorant
institutional investors and CDO managers if there was no one to take
the short side of each trade. This logic is so painfully flawed that
I've actually lost sleep over it, especially because they just won't
stop shouting it as if it were infallible, iron-clad truth, which it
most certainly is not.
Sure, you cannot have such a trade without a buyer and seller, but
when history shows the sellers to be the ones who were right, and who
acted on it, I'm not sure how you can not only avoid blaming those who
were wrong - those who were long such deals - but go out of you're way
to blame the people who saw the signs and acted accordingly. That, to
me, is crazy talk, at best, like blaming the United States for the actions of the Third Reich during WWII.
Despite what Tom, Yves, or whomever else wants to blame the shorts
may try to tell you, "the shorts" were the ones who saw
(broadly-speaking) impending collapse and traded accordingly. The
longs were the ones who kept buying things that others - and sometimes
they, themselves - knew were crap, or were likely to become crap.
Hell, the monolines - whose business Ackman, Einhorn, and others had
identified as unsustainable as early as 2002 only dug further into the
structured finance business. As they say, the band played on, so to
speak.
If one really wants to point fingers (which isn't really very
productive), they should be pointed at the Investment Banks, the
Ratings Agencies, lazy/poorly-incentivized money managers, and
Regulators, in that order. Arguing that the shorts who allowed the
banks to create and sell (or retain) long CDO exposure to investors are
making a similar argument to those who blame gun/bullet makers Glock
and Remmington for shooting deaths, or Stanley Hand Tools
for making the hammer that was used in an assault. CDO's, CDS, etc are
like tools, and, when used properly, can be quite effective. But, when
used improperly, or without proper care, they can be deadly,
financially speaking.
Absent fraud (another story for another time) on behalf of the
Investment Banks, originators, and/or servicers, institutional
investors like IKB - who, despite having a dozen or two member
diligence team - still went long CDO's like ABACUS, akin to a child
getting his hands on a loaded machine gun. It was only a matter of
time until they shot themselves in the foot (or worse)...
They did this because as I've said time and time again, portfolio
managers don't get paid to sit on cash (generally); they have to invest
their money, and in many if not most cases there were (and still are)
perverse incentives for PM's to buy the highest-yielding security he
could find as long as had the blessing of the Ratings Agencies. (Naked
Bond Bear can elaborate on this, and has, if you want more nuance).
The same holds true for many other participants, collateral managers
like ACA (infamous for apparently blessing the ABACUS transaction even
though they "knew" the collateral), CDO managers like Chau, etc.
John Paulson, Michael Burry, Steve Eisman, none of these guys forced
their counterparties to take the long side of their winning short
trades. Their counterparties were (mostly) financial institutions with
the resources to do the same research and put on similar trades (or at
the very-least least reduce their risk exposure) as "the shorts."
Others, due to arcane financial regulations (etc), were able to gain
exposure to these securities without having anywhere near the financial
sophistication to understand them, yet they did so, anyway, because
they did not know what they were getting themselves into.
Michael Hyde,
general manager of an Australian council responsible for investing
millions was one of these latter, ignorant types. Mr. Hyde has since
admitted that he did not know what a CDO was, and "admitted to
confusion on his part about the terms "call date" and "maturity date",
which he had believed to be interchangeable. 'I guess (it was)
ignorance. I did not know there was a difference,' he said."
Mr Hyde said he believed that Grange would buy an
investment back from Wingecarribee at three days' notice, or return the
value of the whole portfolio at 30 days' notice.Barrister John Sheahan, SC, for the liquidator of Lehman Brothers Australia, put to Mr Hyde that the contract Wingecarribee signed with Grange provided for the buy-back to be at market value, not face value.
"What you were told was that you could redeem your security at three days' notice, at market price?" Mr Sheahan asked.
"I did not understand that," Mr Hyde replied.
When, in September of 2007, Mr Hyde asked Grange to buy the
investment back from Wingecarribee at face value, the response was
"non-receptive".Mr Hyde said he was told by a Grange employee, "you need to understand Mike, there is no such thing as a capital guarantee".
By then, the Federation note, originally worth $3 million, was valued at $1.02 million.
While it may have been (quite) unethical for Lehman/Grange to have
gotten the council into investments its representatives verbally said
they were not interested in, they did not force the council members to
sign any contracts. At the end of the day, a not-insignificant part of
the blame has to lay at the feet of those who voluntarily gained
exposure to these securities despite having no idea what they were
talking about, let alone what they were signing-up for.
As James Montier of GMO Investments said in his recent letter "The Seven Immutable Laws of Investing,"
1. Always insist on a margin of safety
2. This time is never different
3. Be patient and wait for the fat pitch
4. Be contrarian
5. Risk is the permanent loss of capital, never a number
6. Be leery of leverage
7. Never invest in something you don’t understand
#'s 1-6 are surely important (especially #'s 1, 2, 5, and 6), but
I've highlighted #7 because it is the single best piece of investment
advice anyone can every give you. I would add, after "Never invest in
something you don't understand..." that if you do invest in something
you don't understand, absent fraud, you must accept that you have no
one else to blame but yourself if the investment does not work out as
you'd hoped. Caveat emptor.
People who don't even understand the difference between a call date
and a maturity date (let alone know what a CDO is/how it works) should
NEVER be able to come anywhere close to anything more complicated than
a mutual fund or vanilla bond, and that they were able to do so in this
(and other) case(s) is the fault of the regulatory apparatus, the
"Overseers" tasked with protecting investors.
But as Montier's law #7 says, you should never buy something you
don't understand. And, unless someone made you sign a contract at
gunpoint, it's you're responsibility to make sure you've read the
contract and understand the terms before signing on the dotted line.
If you don't understand, but sign anyway, then you're just begging-for,
if not deserving of losses.
I do feel a bit of sympathy for people like Mr. Hyde who were
pressured by those more sophisticated (I'm not going to say savy, since
that whole Lehman thing worked out so well...) than they, but my
sympathy is limited by the apparent indifference with which Mr. Hyde
and others of his ilk exercized when making their investment
decisions. It's one thing if you want to bet all of your personal
money on something you don't understand and end up screwing only
yourself. It's another thing when you're investing other peoples'
money and/or public monies.
That's analagous to me going into a surgical procedure without
knowing which organ is which, or a crazed alchemist tossing various
liquids and powders haphazardly into a cauldron with little if any
regard for possible - if not downright likely - violent and dangerous
reactions.
The sad part is that it wasn't just financially unsophisticated
people like Mr. Hyde who failed to exercize the proper level of
diligence and caution. I'd be curious - although I doubt we'll ever
know such things - what % or how many of the parties that had long RMBS
(synthetic or otherwise) exposure pre-crisis conducted thorough
analysis at the loan level, on originators' underwriting standards, etc
and turned-down or shorted deals they found to be garbage.
As far as I can tell, the answer is 'not many,' although in fairness
Tom claims they did, in fact, turn down several deals for such reasons,
but I doubt in the grand scheme of things, the ones they didn't do were
anywhere close in number and size to the ones they did.
The Analyst
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I blame the FED,but you are who posting here is doomed,because i counted over posts and asked to vote for FED existence in my blog:
http://trendybull777.blog.com/2011/02/21/hello-world/
But it was just 3 brave people to respond,which meaning that all of you is sartisfied with current environment and you probably forgot that today Jasmin reolutions based on internet first by FED elite to screw nations,I calling for thoose who wish FED abolished to vote or to leave comments at least,the thing which is world lags today is trust between us!!!
Go and vote,World should not affaid of monster eating into our wealth on everyday basic
you spelled derivatives wrongly...
JUST BUY GLOD AND SLIVER!
Permit me to ask... is English your fourth language?
I posted on Abracadabra, his native language is Russian, a language with an alphabet much more complex and rich than English. Plus he speaks better English that 70% of the drop out thugs in Los Angeles County. Good blog site. Appreciated it.
There is no way Russian has a bigger vocab than English.
No argument there, but I said Russian is more complex and rich. Syntactic complexity is not a function of the number of words in a given language, it in fact is the opposite. Russian alphabet has more sounds than English, resulting in increased symbolic complexity, but expressed with fewer words.
Won't argue with you there. Either way Solzhenitsyn should be required reading for every human being.
Indeed...or at least rented on nflx.
It's a poznip scram everywhen.
Some just dont cement.
No. That's how the public school system "educates" serfs.
There is a difference between being short a CDO and being short a CDOSquared. The latter is who they are blaming and there is a case for that since there was no demand for equity and those CDOs would not have been created otherwise.
They don't blame the crisis on short sellers, they blame the last 25% of the crisis on these people.
I have often wondered whether "CDOs-Squared" should simply be banned.
My impression is that their incoming cash flows are typically derived from the "garbage tranches" of other CDOs. Their chief purpose seems to be to further bury (obfuscate, hide) such "garbage tranches". Does anyone disagree?
When composed as described above, "CDOs-Squared" are typically risk-concentrators, rather than risk-diversifiers.
If one examines the historical volume of the issuance of "CDOs-Squared", it correlates very well with the housing bubble.
http://dealbreaker.com/2010/01/stiglitz-as-far-as-i-know-cdos-squared-didnt-solve-world-peace/
http://www.risk.net/credit/feature/1522744/re-securitising-cdos
http://www.securitization.net/pdf/Nomura/CDO-Squared_4Feb05.pdf
@ChrisD - yes - it's true that without the equity tranche, eaten by the shorts (as a loss leader of sorts), the product could not have existed. But it's also true that without the billion dollars of ignorant incompetent capital buying the higher rated tranches of the same deal, the product couldn't have existed. I believe this is what Anal_yst is trying to get at, and I very much agree.
I don't disagree with you that there was dumb money out there. But, there is a reason GS paid one of the largest fines in history for the Abacus deal. You shouldn't be able to purposefully choose dead deals and sell them to people.
This is a question of failure by a number of large banks, the SEC and the investors on both sides. But it is pretty clear that Magnetar and others probably excaberated the crisis with these transactions.
that's the Naked Capitalism line: Magnetar exacerbated the crisis. I prefer to take the other side of that view - and I dont mean this flippantly: IKB, ACA, etc exacerbated the crisis via gross ignorance, incompetence, and failure of fiduciary duty.
If only they'd done the same work Magnetar had, they wouldn't have bought the steaming pile of shit and lost billions... see where I'm coming from?
Magnetar's trade was a SOLD TO YOU, SUCKA trade. I don't fault them for that - it's kinda the point of financial markets, whether people like that fact or not. The goal is to make money by being right, and if there's a sucker on the other side, you don't explain it to him or owe him an explanation.
That's where you're wrong Kid, and you are being (unspeakably) flippant.
The NC line is exactly right and you know it. (Review Chapte 9 of ECConned and footnotes if ur dubious)
The Magnetar trade didn't exacerbate the crisis, it was at the the heart of crisis.
If IKB, ACA etc had done the same 'work', as you say
They would have bought the equity tranche before they " bought the steaming pile of shit". Yet had they done that they would have realized that the equity tranche was the loss leader, and the rest was shit, which Magnetatr, et al ), understood.
Look. you've been wrong on Volcker (big time ,do I need to remind u) , and you are even more wildy wrong on this. Who do u work fot?
No question, I think your point is solid. But strictly speaking, they were buyers of that garbage before as well. Then the market dried up completely. If it weren't for Magnetar (without them there wouldn't have been a deal) the problems might not have been as bad.
I can see both sides equally well, I fall out as agreeing with Naked Cap.
and material AAA misrepresentations on worthless shit?
You bring to mind the T-mobile commercial where the dumb-ass punchline is: "It makes sense-- if you don't think about it.
Who are you mad at in that comment? The ratings agencies? they suck horrificly.
But it's not Magnetar's job to represent anything. I'm talking about Mangetar, Eisman, Paulson and Burry. THEY are the ones who did the work - they didn't just say "oh, it's AAA, it must be good"...
There's some pure wrongness with the authors argument.
When the same entities pumped up the "shitty deal" with the right hand also went short with the left - that's not being smart.
That's being shitty.
I just can't agree with the we showed up to teach the suckers a lesson rationale. Not us then somebody else.
The whole thing is a financial cesspool that has no place in a productive capital market. Its like taking bets on whether some guy will jump of a building. Just because stupid schmucks wind up managing other people's money, does that mean we should have a system that encourages sharks to have an unlimited free for all?
Just because stupid schmucks wind up managing other people's money, does that mean we should have a system that encourages sharks to have an unlimited free for all?
Natural selection got us this far. Why not run with it?
Also, great artwork. Love your posts.
I blame white people.
Hey, we're not all white, some of us just look that way.
Jim.... have you been playing with the bleach again?...
Hmm, you probably could construct a sound argument for that as well. ;-)
I go one step further.
I think the whole thing was one humongous fucked up financial video game and everyone involved with it is at fault.
This guy in the article talks about Mr Hyde...but he never mentions ...Dr Jeckyl!!
Something wrong there on such a momentous subject of ....two faced lies!
No-one cares about about their fellow human....they just want to be in with the winners. Its just as much ego as $. What really is for the greater good of our society? WGAF (who gives a fuck).
We are all involved.....good analogy (video game). Where is the POMO regenerating plasma rifle?
Phased Plasma Rifle in 40 Watt range.
http://www.youtube.com/watch?v=JJRLoGYtkEM
1210 Billionaires VS 7 Billion Peasants.
http://www.youtube.com/watch?v=NsDNs90eDFA
Carlos Slim should be ashamed of himself as well as should all Mexicans for letting this rotting fat corpuscle live.
http://www.youtube.com/watch?v=AkVV3Ode3Ok&feature=related
Viewers comments:
"Hi I'm Mexican but I moved to the US due to work. When I hear that the richest man in the world is? Mexican, far from feeling myself proud I feel ashamed. This weasel has make his fortune buying politicians and lawmakers to keep his monopoly untouched. He is not like the other rich guys in the world that make his fortune in free competition, he make it in unlawful game. Poor my compatriots, this money this thief has belong to them all. This sir has nothing to teach us about success. Shame on him!"
"El problema aquí es que el Ing. Slim no desarrollo su fortuna así como lo hizo un Bill Gates o un Steve Jobs. A principos de los? 90's un buen amigo de él llamado Carlos Salinas le otorgó una concesión de una paraestatal (TELMEX) a un 10% de su valor real. Desde ese entonces el Ing. Slim ha sabido sacarle provecho a esa concesión. Mas que un Empresario éxito el Ingeniero ha sabido relacionarse y le ha sacado provecho a nuestro endeble sistema de competencia."
http://www.youtube.com/watch?v=vvTppnkDhjI&feature=related
Full disclosure: I'm not Mexican and Spanish is not my native language but I am fluent and google translate is my friend.
in the spirit of eek vs. eke, it's "whoever" not "whomever" in the fourth paragraph above. although, literally, this mistake can be made in either direction, at least since "the old man and the sea" it really only matters in this direction.