“That Wall Street has gone down because of this is justice... They fucked people. They built a castle to rip people off. Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience."
- Steve Eisman
One decade before he became famous for the being the inspiration behind Mark Baum's character, played by Steve Carell in the movie the "The Big Short", Steve Eisman was making hundreds of millions predicting the next big short, namely the collapse of the subprime mortgage industry. Which is why every appearance of the otherwise reclusive financial guru sees broad popular interest, and this past Sunday, when Eisman appeared at the beachfront Fontainebleau Hotel in Miami, where several thousand Wall Street securitization professionals are convening this week for their 22nd annual ABS East Conference, was no different.
Incidentally, it’s the same gathering where, in one scene of the film "The Big Short," the character based on Eisman bursts into outrage at a mortgage executive giving a talk.
Eisman hadn’t attended a securitization conference since 2007. But Information Management Network, the organizer of an annual confab in Miami, decided to changed that when it invited him to give the keynote speech Sunday.
So what did did Eisman have to say to the industry that he helped bring down? “You fuckers blew up planet earth. Shut up and move on.” adding that “it feels like Daniel in the lion’s den."
Cited by the Asset Securitization Report, he then apologized in advance for offending his audience, and launched into an explanation of the mortgage crisis and an assessment of the current state of the economy and financial system, or “why things still suck.” The bottom line, in his view, we don’t have the three prerequisites for a full-blow crisis: too much leverage, a big asset class that blows up, and a lot of banks holding this asset class.
By that measure, neither subprime auto loans nor student loans are going to be the next mortgage crisis. Eisman seems more concerned about Europe, where banks are still much more highly leveraged than in the U.S., and where regulators in peripheral countries like Italy, Spain and Portugal have been slow to force them to recognize losses.
But while the big picture may not be so bad right now, Eisman said he is not a big believer in marketplace lending. “Silicon Valley is clueless,” he says.
“If you buy a book on Amazon, that’s the end of the relationship.” Whereas, if you make a mortgage, “that’s the beginning of the transaction.” And there are only two business models. “The first is to originate the loan and hold it, which means you’re a bank. That’s a low margin business. The second is to originate a loan and sell it, and who are they going to sell it to? You [Wall Street]. And you are fickle.”
As Bloomberg adds, Eisman said that the central problem is that lending startups, their founders and backers in particular, don’t have a lot of experience making loans to consumers, and some of them approach loan-making as they would retail sales, Eisman said.
As Bloomberg notes, more than 160 startup firms of this kind have emerged since 2009. The biggest include LendingClub Corp., Prosper Marketplace Inc. and Social Finance Inc. Together these companies arranged more than $36 billion of financing in 2015, mainly for consumers, up from $11 billion the year before, according to a report from KPMG. A spokeswoman for SoFi declined to comment about Eisman’s remarks; representatives for LendingClub and Prosper didn’t return messages seeking comment.
“We have seen loans underperform from their expected loss estimate at the time of underwriting,” Stephanie Yeh, a director at Credit Suisse Group AG, said on a Monday morning panel discussion. “There still isn’t a lot of data.”
Earlier this year, a spike in delinquencies and defaults from some lenders rippled through the community of investors who buy these securitizations. Investors demanded that lenders raise their rates to protect the high returns that they’ve come to expect from the debt. In an audience poll on the same panel, more than 50 percent of the crowd said in a live electronic survey that there is not sufficient data for investors to assess risk tied to unsecured consumer loan securitizations.
To be sure, proponents of peer 2 peer lending cite the benefits of this technology, which include faster approval times, cheaper transaction costs, and more availability of credit to borrowers who may otherwise not qualify for traditional consumer loans, typically of several thousand dollars and with higher interest rates. Big banks, money managers, hedge funds, insurers, trustees, law firms and credit ratings firms are all competing for the online lenders’ business. But these lenders and their wares are new, and they haven’t been tested in an economic downturn yet. This has drawn concern from skeptics like Eisman, who say there’s no telling how the loans will perform long-term. He said Sunday night the business will never scale to the proportions that its proponents claim.
That said, if the recent woes of former lending giant LendingClub are any indication, one won't even need to wait for a downturn before the industry faces its own subprime moment.
Then there is the "risk" of heightened regulation, to which Eisman had an emphatic answer: "Tough," Eisman told an audience member who raised a question about whether regulations from the Dodd-Frank Act should be forced upon companies that specialize in other kinds of consumer debt aside from mortgages. "You live in a bad neighborhood, you blew up planet Earth, so shut up, and move on."
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But while the focus of Eisman's address was his bearish outlook for the marketplace lending model, he had some other just as notable remarks:
On Quantitative Easing.
“QE is no more than monetary policy for rich people,” the money manager quipped. He said that central banks “use QE to go out the risk curve, so people invest in the stock market, but it does not impact the economy. Most people do not invest in the stock market, they invest in banks [they are saving more] and banks don’t pay interest on their money.”
From a corporate perspective, GDP is lower than pre-crisis, if you buy back stock you get a return on your investment that’s fairly certain, or build a new factory, where the return is uncertain. In a zero interest rate environment, you’ll choose the more certain reward. Very low interest rates have a negative signaling effect. A lot of people think something has to be wrong.
On GSE Market Share
“I’m about as left-wing as they come. Obamacare does not bother me. GSE dominance [of the mortgage market] does.” “The reason that Fannie Mae and Freddie Mac continue to dominate the mortgage market is the federal government decided not to put people in jail. Instead it fined banks. Banks don’t want to get fined, so they don’t make [nonconforming] mortgages.”
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Finally, and most importantly, he explained what he believes the next "big short" will be.
“In 2007, I’m so happy I can’t stand it. But in 2008, it was planet earth [in trouble]. I told someone I felt like Noah … do you think Noah was happy?”
Asked to name the next big short, Eisman initially declined. “I’m not in such a rush to do it again,” he said. “It took years off my life.” Then he relented, saying, “The only big short out there is when the world loses confidence in QE.”
Predictably, Eisman did not offer any ideas on how to profit when his prediction is - again - proven to be right, since the collapse of the central bank model will mean all fiat-denominated conventional finance as we know it will come to an end, and force the world to revert to "traditional" hard assets, such as gold.