Tuesday, October 4, 2011

Was the ‘Big Short’ Moral?

I am reading Bill Cohan’s book on Goldman Sachs (yes, despite the ridiculous title—Money and Power: How Goldman Sachs Came to Rule the World—and the gaudy cover art in which some silly gilded “Moneybags” font sits astride a slightly flattened and cowering satellite image of the Earth). Sorry to report the book is really quite bad, but then I should have known, because Cohan’s previous book about Bear Stearns was really mediocre. It was very obviously rushed out to capitalize on the morbid fascination with the financial crisis (“disaster porn,” perhaps as something to read for “disaster tourists” a la Michael Lewis). Every paragraph of the Bear book was the same: a short introductory sentence followed by six or seven lines of unedited interview transcripts. You can just imagine Cohan and his assistants running around with scissors and glue to make that monstrosity.

The Goldman book was put out with slightly more time, but the amateurishness remains patent. The editor, if one was used at all, is conspicuously AWOL. To choose just one example, there is a lengthy paragraph about Hank Paulson getting busted one night in a small town where he was doing his ROTC, because he broke into a closed swimming pool with his girlfriend at night. What insight does this anecdote provide, exactly? Absolutely none.

In any case, the material on the SEC Goldman lawsuit surrounding the “Big Short” against mortgage-backed instruments—which arguably sank the world economy into the biggest crisis since the Great Depression—is worth reading. Although I was pretty appalled by the clueless performance of Goldman brass and during last year’s Congressional hearings, I am beginning to have some second thoughts about how egregious the whole thing was (Cohan’s book, by the way, is not exculpatory and is dripping with the “secret-cabal-of-people-who-hold-Eyes-Wide-Shut-orgies” obsession typical of a lot of Wall Street people). Yes, the bastards bet with John Paulson, the mastermind of the Greatest Trade Ever (another really bad book), against their own clients. Yes, that is despicable. Yes, they are a bunch of slimeballs. And yes, if you are a Goldman client you should probably keep your cards very close to your chest and a close eye on the nearest fire exit.

However, one question nobody asks is whether better regulation would have saved the hapless IKB bankers et al. from getting fleeced. Retrospectively, the size of the gains from the Big Short and the amazing prescience with which Goldman’s traders placed the bet makes it seem as though they made a mega-billion sure bet. But that is Monday morning quarterbacking. How did the bet look at the time? My question is, if you had slapped a skull and crossbones and a big seal spelling “C-R-A-P” on these mortgage-backed travesties, would that have deterred what were ostensibly very stupid and greedy clients? I mean, isn’t that what we have done with cigarettes? The packaging for a carton of smokes in Britain nowadays is so revolting people hesitate to touch them. And yet millions still smoke the contents (the cigarette tax alone pays for the whole of the British armed forces).

Remember the housing bubble? I do. I saw it play out in Europe and read about some of the euphoria in the U.S. People were drunk on paper gains from real estate. We criticize Wall Street for greed, but what do you call people who think their house will rise in price 25% every year without lifting a single finger (in the midst of historically low inflation)? Does that sound like the Protestant work ethic?

Of course, there is the issue of fraud, of which I am well aware. Normal, hardworking people with good credit scores who got pushed into subprime mortgages. That is shameful and sad. That, however, is another issue. Imagine for a moment that the guys in Michael Lewis’s Big Short had climbed on the steps of Saint Patrick’s Cathedral with bullhorns in 2004 and screamed at passersby that the mortgage market was going to blow up like a GE nuclear plant. Would anybody have believed them? No, they would have been indistinguishable from all the other hundreds of pathetic nutjobs who wander the streets of New York warning about the end of the world next to the immigrants dressed like Minnie Mouse.

The thing is that responsible, moral, decent people who were warning about ridiculous home prices in 2005 and 2006 were also made to sound like crackpots. Robert Shiller, the behavioral economist who teaches at Princeton, correctly called the Internet boom of the late nineties a bubble in his now classic Irrational Exuberance. In 2005, he put out a second edition of the book with a chapter on the housing market in which he very soberly demonstrated that homes were overvalued and that this was another huge bubble waiting to go snap, crackle and pop. Do you know what happened to him? He got canned as an adviser to the New York Federal Reserve (which, by the by, was then chaired by Tim Geithner; Shiller got his revenge, though, but he did not plunge the knife half as deep as I would have).

This quote from his description of the book tour is fairly typical of bubble mentality:

I remember appearing on a radio talk show and hearing a woman tell me that she just knew I was wrong: the stock market has a pronounced uptrend; it has to go up generally. The tremor in her voice made me wonder what accounted for her emotions. I also recall seeing a man who came to two of my book talks, each time sitting in the back and looking agitated. Why did he come back a second time and what was agitating him so? (p. xiv)

If decent people like Shiller were treated like unpatriotic Cassandras, how far can we condemn the Goldman piranhas? If they had gone on national television to explain the Big Short in 2005, my guess is that not only would they have been able to continue selling crap securities to all and sundry, but the tone of the commentary would probably have been that “the cowboys have lost their touch and their nerve” (wink, wink, nudge, nudge). In fact, although they did not go on television to describe the big bet, word got around the market that the firm was going short the mortgage market and as late as 2006 competitors were still loading toxic assets on their balance sheets:

What made the bet so heroic—and risky—was that the rest of the market… still had not come around to this way of thinking and were only too happy to bet against Goldman. (Cohan, p. 506)  

Which isn’t to say that Fab Tourre and his posse aren’t a bunch of slimebuckets. What I’m saying is that perhaps we as a society enabled them a little bit more than we like to think.

So was the “Big Short” moral? To be honest, I don’t know. I think the only flaw in Michael Lewis’s incredible book of the same name is that he doesn't even come close to addressing the issue. And none of his subjects do either. But this week the book version of Lewis’s financial disaster tour of Greece, Iceland, Ireland, Germany and California came out and one sentence from the latest piece indicates that he has begun to ponder the issue:

It's not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They'd been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans.

Miguel Llorens is a freelance financial translator based in Madrid who works from Spanish into English. He is specialized in equity research, economics, accounting, and investment strategy. He has worked as a translator for Goldman Sachs, the US Government's Open Source Center, several small-and-medium-sized brokerages, asset management institutions based in Spain, and H.B.O. International. To contact him, visit his website and write to the address listed there. You can also join his LinkedIn network or follow him on Twitter.


Rob said...

Interesting thoughts. You have nicely highlighted the fact that we are unknowingly all so interconnected that no one has any idea who is to blame for the financial mess we find ourselves in. Asking whether the Big Short was moral is really the same question as asking whether it is acceptable for most Western fashion retailers to indirectly employ third world labour at poverty-maintaining rates. At a rational level, we might find the behaviour morally repugnant, but it's our collective thirst for ever newer, cheaper, trendier clothes that allows (causes?) it to happen. (The big difference, of course, is that one could argue that we the people trusted our governments to effectively regulate the finance industry so as to prevent something like the big short from happening.)

I read and thoroughly enjoyed Lewis's The Big Short, though you're quite right: it's compelling because it's a human drama peopled by larger-than-life characters doing extraordinary things; what it doesn't really do is raise any serious moral questions. For example, Steve Eisman is painted as a good guy because he saw the lunacy of what was happening with subprime CDOs; but in the end, he was prepared to make massive personal gains from an abhorrent situation – and there are, of course, no winners without losers.

I wasn't aware that Lewis had released another book. Boomerang looks like being another fascinating read. The only problem is that the Kindle version costs more than the hardback!

Miguel Llorens M. said...

Hey, Rob. Thanks for reading and leaving the comment. You are right that the government is actually there to regulate stuff like what the “Big Short” shorted. If you read Nocera and McLean’s book on the crisis, the regulatory breakdown happened at several levels. The mass sale of subprime mortgages never should have occurred (a lot of fraud occurred there). The bundling of these bad mortgages also should have been closely watched. And then the creation of synthetic CDOs should have been the subject of some debate among regulators: to what extent is something as abstract as that good for anyone? One thing that doesn’t get said: when houses were rising at 20% a year, why didn’t the Fed raise interest rates? In my view, inflation is inflation.

By the way, you can read all of the Lewis book for free on Vanity Fair as separate pieces on Ireland and Greece, etc. I think the only new text Boomerang brings to that series of articles is a foreword. Happy reading.

Rob said...

Hey Miguel – thanks for the pointer to Vanity Fair :)

Gueibor said...

This was a great read, Miguel, but then again, all your posts are.

I may be a bit over the top with cynicism, but I'm puzzled by how the general population never stops to ponder on the very nature of private financial institutions. This crisis is only the biggest ad most recent, but financial bubbles are nothing new, and there is no shortage o background information about them. Sadly, my view is that stupidity and greed will always trample caution and effort — work ethic doesn't even come into the equation, Protestant or otherwise.

Financial matters should be a byproduct of actual physical industries producing goods and services. Whenever banks tend to grow bigger than their clients, Governments should intervene (I feel stupid by even having to type this… water should be wet, duh). Instead, for most of the last century we've had banks outgrowing their own governments*, then entire regions, and all the while people were going “Weee, I'm their client LOL!”.
Now those same people are scratching their heads at the shocking realization that their financial gurus have been putting their own interests above theirs. Entities championing greed have out-greeded me? How can that be possible?

I don't think this crisis will change things in the long run.
In our lifetime, maybe. Perhaps even for the next generation or two. But given enough time, human greed will rear its ugly head and people will conveniently forget history, or twist it to justify their current flawed decisions.
I mean, none of us are nearly as stupid as those cigar-chomping bastards back in 1929, right?

(*I’m aware the US still manages more cash than, say, GS; otherwise the bailout would have been a physical impossibility. When I say “outgrowing” I’m taking power and influence into account.)

Miguel Llorens M. said...

All of the points you make are part of the political debate now. Let me throw out a bunch of (perhaps) related observations:
1.- There is this recent book called "This Time is Different" that chronicles 800 years of financial crises, so, yes, eventually similar episodes will recur. That is just a fact of economic life.
2.- However, these crises can perhaps be delayed by a few decades by introducing stopgaps. Many think that the period devoid of major crises after the Great Depression was due to stricter regulations.
3.- Two regulations that I favor (and rules that existed until very recently): don't let any bank have a market share higher than 10% and Glass-Steagall, which separates casino and investment banking from deposit institutions.
4.- Global megabanks scare the crap out of me. The British know that they can't bail out their own banks because they are larger than their own economies, which is scary, as the Irish and Icelanders found out to their chagrin. Could Spain bail out Santander and BBVA if they blew up? (I don't know if anyone has done the arithmetic on that one.) You simply can't let banks get that big, as former IMF chief economist Simon Johnson never gets tired of repeating.