Michael Lewis "The Big Short"

[PassedOut]

A great advantage of refusing to take a business public is that you can work a long-term plan without worrying unduly about each quarter's numbers. I truly think that short-term thinking is a destructive force in business, finances, and politics.

 

I like Michael Lewis' phrase "tyranny of the short term" because it captures my view so vividly. Here is a quote from a January 2009 piece by Michael Lewis and David Einhorn: The End of the Financial World as We Know It

 

OUR financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest.

I don't know of an easy fix to this, but I do know enough to avoid being caught up in it. I never worked in a financial firm, but as a young man in corporate management I saw first hand how corrosive the quarterly pressures were on rational decision-making. Although our family businesses are much smaller, the freedom to plan year-to-year (and longer) keeps us from having to change course with every little breeze.

[Winstonm]

If your only source of news coverage is the traditional, you simply don't get access to things like this:

 

In Robin Goldwyn Blumenthal’s Review column in this week’s Barron’s, a poll.

 

The poll is quite informative, and does not bode well for Goldman Sachs if they have to go the distance in front of a jury.

 

The exact survey question was:

 

As Goldman Sachs Group is currently at the center of a legal maelstrom triggered by the SEC’s fraud charge last week, we want to ask you how you currently feel about the charges. Please select one of the below:

 

• I feel the firm is innocent

• I feel the firm is guilty

• I am currently unsure

 

The electronic poll produced the following results:

 

• 55.2% of business leaders feel Goldman Sachs is guilty

• 20.7% of business leaders feel Goldman Sachs is innocent, and

• 24.1% of business leaders are currently unsure

 

Unfortunately, we don't have the size of the polling numbers. Obviously, the larger the sample the better. Regardless, it does inspire confidence in GS's denials.

[mike777]

thank god we have found our whipping boy......GS........the country needed one to kick around.

 

Look how happy it made our posters and the tv commentators.

 

 

So what if it looks like ACA, the company that put this thing together, bet a billion bucks on the upside and lost....and they knew it was a bet and it is accussed that ACA is the company Paulson talked to.....

From the actual SEC complaint: (enphasis added)

 

3.In sum, GS&Co arranged a transaction at Paulson’s request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson’s role in the portfolio selection process or its adverse economic interests.

 

4.Tourre was principally responsible for ABACUS 2007-AC1. Tourre devised the transaction, prepared the marketing materials and communicated directly with investors. Tourre knew of Paulson’s undisclosed short interest and its role in the collateral selection process. Tourre also misled ACA into believing that Paulson invested approximately $200 million in the equity of ABACUS 2007-AC1 (a long position) and, accordingly, that Paulson’s interests in the collateral section process were aligned with ACA’s when in reality Paulson’s interests were sharply conflicting.

 

I would be shocked to find that the SEC does not have ironclad proof of the above statement placed in bold type. If so, this may well rise to the nature of a criminal complaint for fraud.

 

And as Barry Ritholtz has pointed out (quoted in Barron's), the prosecutor only has to provide the barest of essentials at this time - the proof in form of e-mails, wiretaps, etc. does not have to be provided in the complaint.

 

I cannot for a minute believe that a 27-year-old junior GS employee was the sole party to designing and directing this entire multi-billion-dollar transaction (the complaint concerns only a small part of a bigger package). Upper management had to be aware.

 

Like Al Jolson use to say: you ain't see nothin' yet.

btw

 

Paulson's hedge fund says it told ACA it was shorting the pool....

 

ACA put the pool together.

 

ACA bet a billion on the long side, European banks followed it.

 

http://blogs.barrons.com/stockstowatchtoda...cdos-cnbc-says/

 

 

geeez the SEC leaves so much out .....

 

 

Now out of 20 million, 20m million documents...congress found 4 emails that basically say GS wants to make money...lots of it....wow....I am shocked.

-------------

 

If these bus. leaders think GS is Guilty or just plain sleezy and dont want to do business with GS...DONT.....GS will go out of business....case closed.

[Winstonm]

btw

 

Paulson's hedge fund says it told ACA it was shorting the pool....

 

ACA put the pool together.

 

ACA bet a billion on the long side, European banks followed it.

 

 

geeez the SEC leaves so much out .....

 

Mike, my source was a direct quote from the SEC complaint. What is your source for the information you provide above?

 

Did Paulson say under oath somewhere that he or his fund had notified ACA that his fund was shorting? Or maybe we have to wait for a trial to determine if this is true.

 

You say ACA put the pool together - and that is the very nature of the complaint, that Paulson was involved and ACA was not informed. Again, it will take a trial to find out what is provable or not.

 

The complain also says ACA was defrauded - that is not the same as saying ACA bet on the long side and knew all the pertinent information.

 

Geeez, someone leaves a lot out - I don't know if it is the SEC, though....

 

If these bus. leaders think GS is Guilty or just plain sleezy and dont want to do business with GS...DONT.....GS will go out of business....case closed.

 

There is no fraud - there is ONLY Zule. The invisible hand of Zule will fix everything.

 

Are you the gatekeeper?

[phil_20686]

... inflation can come and eat my mortgage.

I am thinking this way too. Would like to hear dissenting voices if there are any.

Very wise decision, in my opinion. Thinking along the same lines my eldest son, 27 years old, just bought his first home.

Dunno what things are like in america, but I have heard that in britian the baby boom generation (about 50-65) own 80% of all of britians privately owned assets. In the street where I grew up (typical affluent neighbourhood with large semi detached houses) I only know of only one house owned by someone younger than my parents, and that is only because the previous owner died. Most are now owned by elderly couples whosse family ahve long since flown the nest. I am bettering that over the next 20 years there will be a glut in family housing as people die or have to sell their houses to pay for residential care.

 

And hence a a corresponding fall in house prices. I will bet for a fall starting about 2020.

[phil_20686]

Housing is still high-priced compared to historical norms.

This is a misleading statement, the last 40 y ears have seen a once in a milllenia realignment of working practices. Now most couples have two salaries rather than one. This has resulted in having more than double the disposable income. Consequently, house prices have risen as people are prepared to pay more for a nice place to live. They will never return to "historical norms" (provided that women dont return to the kitchen).

[Al_U_Card]

Let's see:

 

House 1 (built 1964): 1980-69K; 2003-174K

 

House 2 (built 2003): 2003-205K; 2006-265K

 

House 3:(built 2006): 2006-135K; 20??-???K

 

Next to location, timing is also an issue.

[kenberg]

I was thinking that this discussion of housing prices, past, present and future, was takig us away from the OP but really it isn't. I was listening to Michael Lewis (he seems to be everywhere) talking about the loans with the fancy names and crazy conditions. The underlying assumption was that housing prices would continue to rise. Smoothed over the long run, that's probably so. But there are issues. In particular, the short run increase before the crash was way off from historical trends.

 

It's not so clear to me that housing prices are all that much of an inflation beater. After my mother died in 1963 my father sold the house that I grew up in for $14,000. Sounds like a give away almost. Yes, but a new car was around $2,000 and gas was around 25 cents a gallon. Minimum wage was something like a dollar an hour. And, I think very importantly, houses were smaller. A lot smaller. The house I mention is still standing. I don't know St. Paul Real Estate, or even my local Real Estate, but maybe 1$140,000 would be about right to sell it today. A ten fold increase in value from 1963 beats inflation, or I think it does, but it's not what you would call a financial killing.

 

I suspect that making money in Real Estate is like making money in other things. It can be done, but it requires work. Financially, the thing about owning a home is that after a while you do in fact own it. If you want to move, the housing market is more or less irrelevant. What you own has a value of 1home, however that translates inito dollars. If the market is high, you sell at an inflated price and you buy at an inflated price. if low, you sell at a depressed price and buy at a depressed price. No big deal either way. (A depressed market is somewhat preferable since many transaction fees are a percentage of the sale price.) If you don't move, you just sit there and enjoy.

 

This thought about making money in Real Estate requiring work is important, I think. What happened was that everyone came to believe that there was all this free money to be had. No thought required, no work, just buy low, sell high. As with most dreams and scams, reality bites hard.

[PassedOut]

For home ownership, you need to compare your position after paying a mortgage for a number of years with what your position would be after paying rent for those same years.

[Winstonm]

Housing is still high-priced compared to historical norms.

This is a misleading statement, the last 40 y ears have seen a once in a milllenia realignment of working practices. Now most couples have two salaries rather than one. This has resulted in having more than double the disposable income. Consequently, house prices have risen as people are prepared to pay more for a nice place to live. They will never return to "historical norms" (provided that women dont return to the kitchen).

 

I would venture that misleading is to state assumptions as facts rather than data. Yes, let's forget about inflation and let's forget that the two-income family is of necessity, not to increase purchasing power. There are many metrics to measure historical norms - price to rent is another. Above historical norms.

[phil_20686]

Housing is still high-priced compared to historical norms.

This is a misleading statement, the last 40 y ears have seen a once in a milllenia realignment of working practices. Now most couples have two salaries rather than one. This has resulted in having more than double the disposable income. Consequently, house prices have risen as people are prepared to pay more for a nice place to live. They will never return to "historical norms" (provided that women dont return to the kitchen).

 

I would venture that misleading is to state assumptions as facts rather than data. Yes, let's forget about inflation and let's forget that the two-income family is of necessity, not to increase purchasing power. There are many metrics to measure historical norms - price to rent is another. Above historical norms.

price to rent is not an independent metric. It has a strong co-relation with price to buy. Its pretty obvious that if it was much cheaper to buy than to rent people would buuy, and if it was much cheaper to rent peoople will rent. See the german housing market, for example, where relatively small fraction of people buy their house as rents effectively go down with the length of time in which you live in teh ouse due to restrictions on repricing housing without changing the tenant.

 

The two income family is neither wholly from necessity nor from choice. Provided that at least some people choose it as a lifestlye then that will effect the market, effectively pushing those who dont want it into worse houses. If they want to compete to have nice houses then it can become a necessity. However, its not that clear cut as not everyone wants the same kind of house....

 

I would like to see a graph of average house prices normalised against average wages. That would be an interesting graph. Then I would like to see a graph of the average disposable income of a couple superimposed on that. Anyone have such a graph handy?

 

What I was objecting two was not the fact that haouse prices are above historical norms, but that by saying it you imply that you think historical norms are relevant for total house prices. If the historical norms you were talking about were what fraction of total household income is spent on housing, that would be interesting. But I dont think that has changed all that much.

[y66]

Louise Story is live-blogging the Senate Hearing on Goldman today.

[Mbodell]

For home ownership, you need to compare your position after paying a mortgage for a number of years with what your position would be after paying rent for those same years.

Home ownership needs to include the position after paying the mortgage, including all the interest, plus the maintenance costs, plus the property taxes, plus the opportunity costs of the down payment, plus the capital gains tax, plus the transaction costs of selling it (6% Realtor commissions), plus a cost to represent the lack of flexibility about location, minus the mortgage interest tax credit, minus the amount of capital gains that are excluded in a primary residence.

 

Renting only needs to compare the rental price, possibly with the addition of the opportunity cost of any security deposit. But you gain the freedom to move around with jobs (different regions) or even life style changes (rent in the good school district only while your children are school aged).

 

The only two main reasons, historically, that real estate has been a good investment for many people are:

 

1. leverage (if you can put 0% down and make a bet with other people's money, you are doing well. Just ask GS). If you have a 1% real appreciation on real estate but only put 10% down then you are getting a 10% ROI (more or less). But of course leverage increases the returns when things are good and amplifies the losses when things are bad (as many are learning the hard way now).

 

2. forced savings (some folks would never save, so the monthly mortgage is a forced savings). A 401k or IRA or 403b or whatever would work too.

[mike777]

Yes. leverage is a key issue here. Also the ability to walk away if you lose.

 

If you put zero down you basically rented the joint for a while got a bit of tax break, and may or may not have put something extra in the place.

-----------

 

 

Forced savings is a big deal when so many live paycheck to paycheck and end up pulling their money out of iras,...401k for any excuse.....

 

------------

 

 

With all of that said....I do think people forget owning a house is expensive....it basically starts falling apart day one......:)

taxes, insurance, upkeep, your time...that is all an expense no one ever counts....

[PassedOut]

About six years out college, after having well settled into my first home, I began to buy rental properties with the goal of eventual financial independence (this was 1975). I only bought a property if I calculated that the rents I collected would cover mortgage, maintenance, taxes, insurance, and vacancies -- plus 15% extra to salt away from the rents each to pay for my work and investment.

 

In my experience, when you pay rent you pay rent you pay all of the landlord's expenses, including maintenance, plus his or her profit, and the landlord also gets the tax breaks.

 

Of course I used leverage, but was very selective about what I bought. That most of the properties did in fact appreciate substantially was a very welcome bonus, but I would have done okay without that.

 

The only bad result I had was when I joined with 7 other investors to buy a large apartment complex that eventually went under, but I knew that was risky from the start and could afford the loss (although not happily). But there is always risk: I've had big losses now and then in stocks also.

 

Of course one needs to be very careful in buying a home, just as with any major purchase, but I certainly think that a smart buyer is usually bound to be better off rather than renting.

 

This would be incorrect, though, if you need to be flexible as to location for employment reasons. You could lose ground if you had to give up a big salary increase in order to stay put. Both times that I relocated, I had no trouble selling my home, but that's not always the case.

[Winstonm]

Barry Ritholtz is one of the few who eliminates to the best of his ability any ideological notions and works simply with data. His conclusions:

 

"Home prices are still too high. It's just working from a basic concept of mean reversion, where we look for standard deviations above the norm on the traditional metrics. Whichever metric you look at--income-to-home price, rent-versus-buy, percentage of GDP--we're still 10 percent or 15 percent above that. And the way you can get back to trend is either by dropping 15 percent tomorrow or going sideways for 5 to 7 years."

 

I also have a nice chart but I can't get it to post - it has a lot of visual power against the it-wasn't-a-bubble crowd.

[mike777]

About six years out college, after having well settled into my first home, I began to buy rental properties with the goal of eventual financial independence (this was 1975). I only bought a property if I calculated that the rents I collected would cover mortgage, maintenance, taxes, insurance, and vacancies -- plus 15% extra to salt away from the rents each to pay for my work and investment.

 

In my experience, when you pay rent you pay rent you pay all of the landlord's expenses, including maintenance, plus his or her profit, and the landlord also gets the tax breaks.

 

Of course I used leverage, but was very selective about what I bought. That most of the properties did in fact appreciate substantially was a very welcome bonus, but I would have done okay without that.

 

The only bad result I had was when I joined with 7 other investors to buy a large apartment complex that eventually went under, but I knew that was risky from the start and could afford the loss (although not happily). But there is always risk: I've had big losses now and then in stocks also.

 

Of course one needs to be very careful in buying a home, just as with any major purchase, but I certainly think that a smart buyer is usually bound to be better off rather than renting.

 

This would be incorrect, though, if you need to be flexible as to location for employment reasons. You could lose ground if you had to give up a big salary increase in order to stay put. Both times that I relocated, I had no trouble selling my home, but that's not always the case.

I am a bit surprised you could charge and get enough rent to cover all of that plus a profit......well done......

 

If you dont mind being a landlord and all that comes with it....great.

[mike777]

Barry Ritholtz is one of the few who eliminates to the best of his ability any ideological notions and works simply with data. His conclusions:

 

"Home prices are still too high. It's just working from a basic concept of mean reversion, where we look for standard deviations above the norm on the traditional metrics. Whichever metric you look at--income-to-home price, rent-versus-buy, percentage of GDP--we're still 10 percent or 15 percent above that. And the way you can get back to trend is either by dropping 15 percent tomorrow or going sideways for 5 to 7 years."

 

I also have a nice chart but I can't get it to post - it has a lot of visual power against the it-wasn't-a-bubble crowd.

interesting.....

[Winstonm]

price to rent is not an independent metric. It has a strong co-relation with price to buy

.

 

Phil, if you don't like a well-known and oft-used pricing metric because it has a correlation with price (isn't home pricing what we are talking about?) how about another?

 

the ratio of median income to median home prices, which suggests whether people can afford a house - above historical norms

the value of the national housing stock as a percentage of gross domestic product - above historical norms.

 

I am challenging this statement of yours:

 

the last 40 y ears have seen a once in a milllenia realignment of working practices. Now most couples have two salaries rather than one. This has resulted in having more than double the disposable income. Consequently, house prices have risen as people are prepared to pay more for a nice place to live. They will never return to "historical norms" (provided that women dont return to the kitchen).

 

I am providing data you can look up to determine if home prices are high or low. Do you have similar data to reflect your claims?

[Echognome]

It's not so clear to me that housing prices are all that much of an inflation beater. After my mother died in 1963 my father sold the house that I grew up in for $14,000. Sounds like a give away almost. Yes, but a new car was around $2,000 and gas was around 25 cents a gallon. Minimum wage was something like a dollar an hour. And, I think very importantly, houses were smaller. A lot smaller. The house I mention is still standing. I don't know St. Paul Real Estate, or even my local Real Estate, but maybe 1$140,000 would be about right to sell it today. A ten fold increase in value from 1963 beats inflation, or I think it does, but it's not what you would call a financial killing.

The return on the house (if $140k is the right amount now) is an annual increase of 5% a year. Inflation runs at approximately 3% a year. So in that sense, it may not seem like mutch. However, another way to look at it is that inflation would account for an increase from $14k to approximately $56k over that time period. The remaining $83k (or approximately 60% of the current value) is due to an increase in equity, or alternatively, an increase in housing prices as compared to an inflation index. Note that these two are not completely independent as the Consumer Price Index (arguably the most common measure of inflation) has the price of housing as part of the bucket of goods that comprises the measure.

[PassedOut]

I am a bit surprised you could charge and get enough rent to cover all of that plus a profit......well done......

 

If you dont mind being a landlord and all that comes with it....great.

For every rental I bought, I passed on very many. The numbers had to look right. Otherwise, why buy?

 

My experience was that duplexes, triplexes and townhouses weren't a lot of trouble. Families would stay for years and keep the places nice. Apartment buildings with lots of units, though, were a big hassle with more turnover and a higher percentage of careless tenants. That did sour me on apartment buildings as I got older, and we don't have any rentals now.

[Winstonm]

For anyone interested, here is a chart of home prices in the U.S. from 1970-2010. I can't get it to post so here is one of many links that used this same chart.

 

http://vreaa.wordpress.com/2010/03/26/us-s...sted-1970-2010/

 

Home prices went parabolic in the 2000's - they are getting back close to normal averages. It's not a particularly bad time to buy, but I wouldn't expect a house to suddenly start rocketing up in value over the next 5-10 years.

 

The unwinding of credit is still occurring, although not as fast as before. But it most likely will take a few years yet before all the interventions of the Federal Rerserve are apt to kick-start any serious inflation.

[pdmunro]

Any of this sound familiar?

 

"The Senate committee hearings that Pecora led probed the causes of the Wall Street Crash of 1929 ... Pecora's investigation unearthed evidence of irregular practices in the financial markets that benefited the rich at the expense of ordinary investors, including exposure of Morgan’s “preferred list” by which the bank’s influential friends (including Calvin Coolidge, the former president, and Owen J. Roberts, a justice of Supreme Court of the United States) participated in stock offerings at steeply discounted rates. He also revealed that National City sold off bad loans to Latin American countries by packing them into securities and selling them to unsuspecting investors, that Wiggin had shorted Chase shares during the crash, profiting from falling prices, and that Mitchell and top officers at National City had helped themselves to $2.4 million in interest-free loans from the bank’s coffers.

 

http://en.wikipedia.org/wiki/Ferdinand_Pecora

[hrothgar]

I'd like refer people back to some of my earlier posts regarding the covariance of the assets that made up a CDO...

 

More specifically, recall that the CDOs only work when the underlying securities are independent of one another.

 

Guess what happens to a CDO when someone is cherry picking all of the underlying assets to have the same set of characteristics?

 

Do you understand why this type of information might have a material impact on the value of the asset?

 

With this said and done, CDOs are constructed from hundreds (sometimes thousands) of mortgages...

 

I can guarantee you that the entities buying these CDOs had neither time nor the information required to inspect all of the loans that made up an individual CDO. Rather, these entities trusted that the companies selling the CDOs would provide appropriate disclosure regarding the nature of the products being sold.

 

It is alleged that Goldman Sachs did not provide appropriate disclosure.

 

If the statements being made are true - Goldman Sachs sold a structured product without describing all material information about the nature of said instrument - then I suspect that a number of folks are headed off to jail...

 

FWIW, there is an interesting paper being presented at the American Economic Association this Saturday. You can read a summary at:

 

http://www.bloomberg.com/news/2012-01-06/goldman-citigroup-cdos-were-tip-of-iceberg-the-ticker.html

 

Here's the relevent quote from the Bloomberg article:

 

Using a unique database published by the investment firm Pershing Square Capital Management, Faltin-Traeger and Mayer identified the underlying bonds in some 528 ABS CDOs issued between 2005 and 2007, and compared their performance to similar bonds that weren't included in CDOs.

 

They found that the bonds in the CDOs performed a lot worse. Even if one holds observable characteristics such as initial ratings and yields constant, the bonds in the CDOs suffered ratings downgrades that were 50 percent to 90 percent more severe. As of June 2010, for example, bonds with initial triple-A ratings had been downgraded by an average 11.84 notches, compared to 5.99 for those not in CDOs. The bonds in the CDOs were also more likely to have been rated by all three major credit-rating firms.

 

The research provides strong support for the idea that banks -- with the help of pliant ratings agencies -- put together the CDOs and sold them to investors in a premeditated effort to get rid of some of their most toxic assets, or to provide vehicles for clients who wanted to bet against the worst possible assets. As the authors put it: "It would have been very hard to randomly choose securities with such poor ex-post performance."

 

The lawyers are going to have a field day...

[blackshoe]

For anyone interested, here is a chart of home prices in the U.S. from 1970-2010. I can't get it to post so here is one of many links that used this same chart.

 

http://vreaa.wordpress.com/2010/03/26/us-s...sted-1970-2010/

 

Home prices went parabolic in the 2000's - they are getting back close to normal averages. It's not a particularly bad time to buy, but I wouldn't expect a house to suddenly start rocketing up in value over the next 5-10 years.

 

The unwinding of credit is still occurring, although not as fast as before. But it most likely will take a few years yet before all the interventions of the Federal Rerserve are apt to kick-start any serious inflation.

 

Be interesting to see what housing prices looked like say from 1925 to 1970. B-)