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in Real Estate Finance Professors Oler and Korologos Name: Joshua Kogan Date: December 13, 2010 Assignment: Lessons Learned from Michael Lewis The Big Short Chapter 1 1. Vincent Daniel, while working for Eisman in 1997 concludes that subprime lending companies were growing so rapidly, and using such goofy accounting, that they could mask the fact that they had no real earnings, just illusory, accountingdriven ones. They had the essential features of a Ponzi scheme. A year later Eisman issues a report to this effect. Less than a year later, LTCM crisis occurred the early subprime lenders were denied capital and promptly went bankrupt en masse. 2 By 2005 the subprime mortgage machine was up and running again as if it never broke-down in the first place, and in even more unsustainable ways (e.g. with floating-rate mortgages, to the tune of $625bn. 3. The lesson learned from the LTCM crisis was that those making subprime loans had to keep them off their books.
Chapter 2 4 . Michael Burry looks for ways to bet against subprime mortgage lending, and solicited the interest of major banks in credit default swaps on subprime mortgage bonds. He was able to cherry-pick some of the banks worst bonds to bet against, as the banks didn t realize that the underlying value of these bonds could be worthless.
Chapter 3 5. AIG was found to be on the other side of Burry and Lippman s bets against the bonds. AIG felt that they figured out a way to insure subprime mortgage loans without having to disclose to anyone what they had done. 6. Goldman Sachs devised a CDO to disguise the risk of subprime mortgage loans, thus allowing them to be re-rated as triple-A. 7. In a matter of months AIG FP bought more than $50bn in triple-B-rated subprime mortgage bonds by insuring them against default through CDO securitization.
Instead of feeling qualms. . Eisman learned that there were 7000 people in attendance making money off of subprime mortgages. Eisman hosts a conference call predicting larger losses creating frenzy and shorts Merrill Lynch. The assumption was made that one pile of subprime mortgage loans wasn t exposed to the same forces as another that a subprime mortgage bond with loans heavily concentrated in Florida wasn t very much like a subprime mortgage bond more concentrated in California. Cornwall Capital. the other major banks felt shame that Goldman Sachs had been the first to find this particular pay dirt . The financial engineers crate the illusion of security. Greg Lippman led 10-20 people to bet against the entire subprime mortgage market and. but the dictatorial CEO of AIG. Eisman and Daniel found this out and said nothing. Big positions against CDO were accruing. by extension. Chapter 6 13. The industry was growing rapidly. Gene Park figured out that the credit default swaps AIG was buying were 95% prime. Chapter 5 12. the global financial system. 11. 15. so they too began the same process. Chapter 4 10. and a subsequent run on the bank . etc. FICO scores were being manipulated by lenders for home mortgages. Bear Stearns collapsed after mortgage defaults that backed the bonds. These people (including John Paulson. Joe Cassano. In a 1997 conference in Las Vegas.8. 9. CDO managers like Wing Chau were securitizing their CDOs to create more triple-A CDOs (CDO-squared). Chapter 7 14.) were looked at as odd by other investors. resisted the news.
25. Nearly everyone involved was ignorant of the process. 17. Rating agencies were accepting explanations for rating complicated CDOs from Wall Street banks. like a black swan. 18. . The reining model at the time of how the market worked precluded the possibility of such a calamitous event. the heroes could not figure out why there was an insatiable demand for the other sided of their trade why they continued to lose on daily mark-to-market in face of a deteriorating housing market. Hubler trusted the ratings of the ratings agencies and gambled that slightly better mortgages would remain sound. and embedded in the American financial system. For quite some time. The essence of the scheme being that the pretense that the subprime mortgage loans were not all essentially the same. Howie Hubler creates the essentially fraudulent credit default swap. nonetheless there were CDO managers. further accelerating its collapse. General 23. Wall Street failed to realize the correlation of the entire market to the subprime market. Hubler loses more money than any trader in the history of Wall Street (about $9bn) and did not violate any laws. John Mack (CEO of Morgan Stanley) demonstrates on a conference call that he didn t know the market well enough to describe what happened to his company.Chapter 9 16. 20. they were designed to be bets almost certain to pay billions of dollars. Nor did it understand the effect from a confluence of events too specific and improbable for anyone to predict. and thus not all likely to default at the same time. The CDO market came to dwarf the actual market for loans subprime or otherwise. In 2007 Goldman Sachs makes a large bet against subprime market. 19. 26. 21. 24. 22. out of whole cloth. 1 Trillion dollars in losses had been created by American financiers. They didn t even know what a CDO was.
. many traders went from dealing stocks to being active in the bond market. 38. they started buying insurance policies that protected their bets and this created a huge reinsurance market. U. 29. As a sales strategy. Regulators have consistently failed to recognize or to prevent bubbles. Although this provides diversity.S. During the boom.S. The prospectus for each bond was very large and essentially nobody besides the lawyers who wrote them and a handful of investors actually took time to read through it to understand what they are investing in. but The Big Short shows that for those who recognize that a bubble is developing credit default swaps can provide powerful incentives to speculate against bubbles. 39. it is makes things more complex and heavily skews the projected returns from the realized returns. Even though clients may lose money. and/or property level was simply not completed by the purchasers of triple-A rated subprime mortgage bonds. 40. 30. 35. Millions of people with shaky or nonexistent credit histories were seduced into accepting adjustable-rate mortgages with very low teaser rates at initiation. Wall Street and the SEC did not listen to warnings from Eisman. 28. regulators did not act to arrest the largest housing bubble in U. 33. The associated skills are not easily transferred with regards to making investment decisions. the employees of various financial firms are still being paid heavy bonuses. 32. When hedge funds started to realize that home owner would at some point. 34. Lippman and others when alerted about the potential catastrophe on the horizon. 37. history. 31. sub-market. default on their loans. The rating agencies were being paid by the banks that were making the loans. The complexity and the pace at which these bonds were created made it impossible for accountants to value the loans. Many of these bets were dependent on historical information and the idea that home prices will never go down in the US. consumer loans were mixed with corporate loans and bundled together to reduce risk. 36. Creative financial engineering was utilized to inflate bank balance sheets to show that their company was performing healthy and making huge profits.27. Due diligence on a market. and the outcome was a worldwide financial crisis. or their associated CDOs.