The Big Short

In olden days, Mortgages were govt backed, but then they became private and Louis first packaged and sold them as bonds MBS and then the bad unsold MBS ie sub prime mortgages were re packaged up as CDO

Michael Berry from Scion Capital was first to deduce that MBS were full of subprime (shit) mortgages by analysing the default rates of the underlying mortgages of these MBS and so went to multiple banks and decided to short the MBS ie bet against them in 2005. He asked the banks to create a new instrument for this called CDS. CDS is like insurance on MBS/CDOs as it pays (20-1 return on the BBB rated ie worst rated CDOs ) when the MBS goes bust and until they do, whenever the MBS goes up, he’ll have to pay premium on this CDS. He bought CDS worth 1.3 billion and paid premium of 90 million/yr in 2005 06

Due to the greed of the banks to make money selling MBS, these shitty mortgages were given out at adjustable interest and so as soon as the owner defaults on a payment, the interest goes up and so he can’t pay next payment and will default.

He knew that in 2007 these adjustable rates were going to kick in, ie the interest on the loan which was initially 5% will increase and so people are going to start defaulting.

At 8% default the bonds become worthless, as no one will buy them and in 2006 they were already at 4% default

When the market deems a bond (MBS) too risky to buy, the banks just repackage it as a CDO with bunch of other B rated shit and then call the package diversified. They then pay the ratings agencies to give these CDOs A rating.

Slowly in 2006 07 others started investigating the bubble by physically going to these defaulting homes and seeing first hand how the banks were authorising the loans of bad applicants. These swaps, CDS, were offered by banks only to ISDA license holding funds ie those that have 1.5 billion + investments.

The high rating increased the demand of the MBS and so the mortgages became shittier and shittier. They were given to NINJA (No Income No Job) applicants

In Jan 2007 even when the defaults on these mortgages increased, the value and snp rating of the MBS rose as snp were paid off by the banks. So the premiums of these CDS holders increased. This is when they found of that the banks pay the ratings agencies to give these CDOs A rating and to not downgrade them even when the underlying securities (mortgages here) were failing.

The intelligent ones took this opportunity to double down on buying more Swaps as now they had proof that banks were either stupid or greedy shady crooks and that they had created a housing bubble which was bound to burst soon.Some even started to bet against AA tranch (portion) of CDOs as their return was 200 to 1 and they knew that though AA claim to have 90% AAA underlying mortgages, the banks were lying and the mortgages were sub prime.

Banks were selling off thir high risk (due to subprime mortgages) to others as MBS and earning commission, so it was in their interest to make sure the ratings of MBS was high

American Securitization Forum in Vegas was a convention for MBS traders and these CDS investers went there to investigate if these people were really stupid or plain greedy.

by 2007 everyone was buying MBS, not stocks or other bonds, and so MBS had become the bedrock of the economy bringing in half trillion investment.

For 50 mill in subprime loans, the CDOs were created such that there was over a billion dollars betting on it.

The market for insuring mortgage bonds was 20 times the actual mortgages. The way this came to be is by Synthetic CDOs.

Hot hand fallacy is when you have a high probability of winning say 75% and you win say 3 times in a row, then people feel that you’ll win the 4th time when instead you’re most likely to loose the 4th time per probability

During the real real-estate boom, markets were going up and up, and people thought they’ll never go down. So they make a side bet on the chance of the player winning the next round. These are Synthetic CDO. They are bets on bets. Then when someone else bets on the 2nd bet, it’s 2nd level SCDO..This went on for 20th level in CDO mkt.

Then in Apr 2007 Mortgage Lenders were the first ones to file for Bankruptcy . Then banks started to unload their CDOs to their customers and short those of other banks by buying CDS themselves. Now when CDOs were off their books they started to devalue the CDOs and increase the value of CDS.

Benny Klegar from Morgan Bond dept. turns out, had started shorting 2B  BBB CDOs since 2005, but to cover his premiums for 2 yrs he sold a lot of AA swaps (long exposure) as protection. And these long exposures on Morgan’s books were 15 billion. So when it all came crumbling down, Bs and As everything became worthless as defaults went over 8%. Steve Eisman a fund manager from Morgan had also shorted, knew that if Morgan went down, his accounts will also be seized, but decided to hold his shorts .

Others like Brownfield Fund sold their shorts fearing that if the banks from who they bought CDS declared bankruptcy, their swaps will be worthless, and also, if they waited too long to sell, there might not be any market left to sell as they feared a collapse of the economy. They made 50 million.

Michael Berry also sold his 1.3B positions in 2008 and made profit of half billion.

alan greenspan, chairman of Fed was the architect of the Crisis

Bern Sterns and Leman Brothers Collapsed

Michael Berry  had this to say about the crisis: Making money is not like what I thought it would be. This business kills the part of life that is essential, the part that has nothing to do with business. People want an authority to tell them how to value things, but they choose this authority not based on facts or results, but coz it seems authoritative and familiar. But i’ve never have been familiar, so i’ve come to the sullen realization that i must close down the fund.

In the end the Banks knew that they’ll be bailed out, and so took taxpayers’ money and paid themselves huge bonuses.

When the dusts settled from the collapse, 5 trillion dollars in pension money, real estate value, savings and bond disappeared. 8 million lost their jobs, and 6 million, their homes in US.

where did the 5 trillion from the stock market crash of 2008 go?

Did someone gain 5 Trillion? No.This 5 trillion was simply the estimated market value of all the air (synthetic CDOs) that investors had estimated due to the fraud by financial institutions as they bought the rating agencies and the govt (hence lobbying to not regulate the real estate mkt or preventing sub-prime loans) only to gain in COMMISSION when investers when air/products change hands.

If only there was no Synthetic CDOs, this figure would have been 20 times less…

This is what the system does, they know that the value of stuff in the world today, is nothing compared to the wealth that the world has, coz that wealth has been amassed over hundreds of years of blood and sweat of our ancestors and also created out of thin air by banks themselves (remember how they have only 10% reserve), and everyone wants to see profits. So how can the minuscule amount of value(land, energy etc) be used to manipulate people into thinking that they’re all making money? By making them bet on the price of the security (land, resource etc)? Of course not, coz again, value/securities are limited. So they create product 1 that bet on value of product 2 that bet on  value of product 3 and so on, and you’re free to buy any of these 20 fictitious products as banks will make a buck comission on each and coz you don’t care about the underlying security right? You just care that you make a profit. This is all fine and dandy till everyone is happy betting on air, but when the curtain lifts, everyone suddenly realises that air has no value, its not only that those who bet on the value of air loose and other guys win, but also that the Game is over for everyone.

Also, the banks and financial institutions not only know that it’s air (Synthetic CDOs), but also control the curtain (Rating Agencies and SEC), and so always prevail.

In 2015 several banks started offering Bespoke (made to order) Tranche (portion/assorted/diversified) Opportunity, which is just another name for CDO.