Question(s) about the 2008 crash

[snot]

I recently saw The Big Short (https://www.amazon.com/Big-Short-Christian-Bale/dp/B01995O5OS ) for the first time. I'd thought I had a pretty good understanding of the causes of the worst of the losses in the 2008 crash, but this film portrayed an aspect or two somewhat differently than I expected – in particular, it portrayed the big banks, including e.g. Goldman Sachs, as just plain stupid, and if I understood the movie correctly, it suggested that banks like Goldman only bought the shorts AFTER the MBS mortgage bonds were already seriously cratering.

I find it hard to believe that banks like Goldman were so clueless about how risky the mortgage bonds were – I always assumed they were placing their own bets against them before it became obvious to everyone else. (Granted, there may well have been situations where the right hand didn't know what the left handwas doing; but I always assumed that the left hand, at least, knew perfectly well that the right hand was selling sh*t bonds, and started betting against them from earlier on than the movie suggests. And I would have assumed that some banks, e.g. perhaps Deutschebank, WERE that stupid – but not Goldman). Does anyone here have any inside scoop on that? Did the big banks really not purchase any shorts until things were already, obviously falling off the cliff?

Also, as I understood, the bailout of AIG was key – I thought it was the issuer of many of these shorts or bets against the bonds, and that our bail-out of AIG made it possible for it to make good on the shorts, thus saving/enriching the big banks who'd bought them. But the movie never mentioned AIG at all. I expect the filmmakers may have felt that AIG could be eliminated from the narrative without greatly impairing viewers' insight into the causes for the crash; but I just wonder if anyone here knows more about how central AIG's role really was or wasn't.

Any other comments re- the accuracy/inaccuracy of the movie are also welcome.

If you happen to have saved links to any sources backing up your answers, that would be really great.

Fwiw, if you haven't seen the movie, I highly recommend it – I wish more people had seen it, because it looks to me like we're approaching a similar crisis.

[genxlib]

1. I was a pretty close follower of it at the time.

I also predicted it in real time and stayed months ahead of crisis as I foresaw it clear as day as it played out.

In a nut shell, I would describe it as "Make the profit but pass the risk"

These assholes thought that they were so smart that they had figured out a mathematical way to eliminate the risk. All they did was create a system that was so complicated that it gave the appearance of shedding risk while hiding the real problems.

They were essentially buying insurance in case things went sideways. They made up fancy names for it was essentially like an insurance. My perception of it is that what they were doing would have worked at the micro level the same way most insurance works. But they were all doing it and no one was asking whether it made sense at the macro level. There was extraordinary systemic risk because they were all counting on the insurance to pay off. At the end of the day, the insurers (with AIG being the biggest) didn't have anywhere near enough capital to cover all the risk that they insured.

The idiots thought they were just making the risk disappear. Which led to the reckless loaning habits. They saw profits and believed they couldn't lose. They were making loans that no one ever had a chance in hell of repaying and did not care because they were insuring the risk and selling the loans to other investors. And then they were dicing them up and selling them again and again and again. And every layer was tapping into the same insurers to make the risk disappear. I saw figures at the time that the volume of insurance vehicles written were exponentially larger than even the loans themselves because they were insuring every layer of the business. Once it went sideways, they owed everyone and were upside down immediately.

In the end, the insurance model doesn't work because it is founded on disbursed premiums covering isolated losses. But in this case, the damages were self inflicted and spread across the entire industry. It collapsed like the house of cards it was.

[genxlib]

2. And definitely a good movie

Worth the watch.

It would seem like fiction if I didn't live through it.

[3Hotdogs]

3. I look forward to responses.

One hand -- other hand -- I believe is quite realistic.

The mortgage market was going along, swimmingly. You are talking about a 150 year old bank with, probably thousands of employees, And they don't work in the same building.

An anecdote about the crash of '29 and the beginning of the Great Depression. Everybody was either in the market or going to be in the market. Groucho Marx had money in it or was about to. Then he had second thoughts.

(Paraphrasing) My shoeshine guy is giving me stock tips. What source of information does he have that everyone else doesn't.

Groucho pulled his money out -- or didn't invest -- or whatever.



Then there was the time I had inside information. My M-i-L was executive secretary to the president of a small company in Fairfield, N,J. The company was growing and she was getting regular raises. Not Mercedes type raises but enough to buy a good Chevy Bel -Aire.

I told a few friends about the stock. None of them had money to invest so they didn't get in on the gravy train. The more fool, them.

The company was International Controls and the president was Robert Vesco.

[k55f5r]

4. I only got about 1/3 of the way

into the movie before I turned it off. It was either turn it off, or shoot the screen. Never has a movie so pissed me off. Not the movie's fault, totally the subject matter.

[progree]

5. What struck me most was that issuers of CMOs paid ratings agencies to rate their issues.

I don't know if that's in the movie or not, but I read a couple books on the 2008 crash, and that struck me as the most wrong-headed thing about it all.

CMOs are collateralized mortgage obligations -- bundles of mortgage-backed securities that are diversified as far as risk ratings and geography.

On the geographic diversity, the thinking was some housing markets occasionally had significant downturns, but, overall nation-wide, there's never been a severe housing market downturn (or not since the Great Depression or whatever and supposedly regulations since made a re-occurance of that almost impossible), so they were considered safe investments by apparently a lot of professionals who should have known better. (Or as the proverb goes, there are none so blind as those who refuse to see).

They got AAA ratings or whatever very high ratings from rating agencies like Moody's, S&P, and Fitch. Part of the reason for that is that the issuers of CMO's paid the rating agencies for their ratings. So, to keep the issuers' business, the rating agencies had a strong incentive to provide good ratings.

I remember also some very well known person (at the time) at Merrill Lynch (Henry Blodgett) who was pushing mortgage funds that he and the analysts knew were crap (according to internal emails), onto individual investors. That's how I remember the story anyways. Afterwards, he started Business Insider.

[Warpy]

6. Some of the "financial instruments" that institutions were being sold

were so exotic that even the guys who dreamed them up weren't quite sure if they could explain them and if you can't explain something, you don't understand it all that well, yourself.

Most of them were tied in one way or another to home mortgages or, to a lesser extent, commercial property. As time went on and the housing bubble grew in "hot" markets, the loans started getting shakier and shakier to lure people who didn't know what they were doing but jumped at the chance of owning their own homes took on obligations they didn't understand and had no way of meeting. Those loans were then chopped up, repackaged, and sold as income generating securities under various names.

A few people noticed what was going on, but most stopped at the projected return on investment, the name of the issuing institution, and thought they couldn't lose, a sure sign that they'd lose.

So that's basically it, nobody really knew what was going on and most of them didn't want to know. They just wanted a sure thing to generate income so they'd be closer to getting that corner office. When the For Sale signs started to outnumber the fdesperate fools and suckers by a significant amount and people had taken out risky loans in the hope of turning a quick profit in an overheated market couldn't pay ythe loan or sell, the whole thing collapsed

[progree]

7. A lot of the new mortgages were Adjustable Rate Mortgages (ARMs). The economy was heating up and so was

inflation so the Fed started raising their rates and the market followed. ARMs reset to higher and higher levels (a friend of mine had her ARM rate tied to 6 month LIBOR rates). So what were once very low-interest rate mortgages were no longer low interest rate. A lot of people could no longer afford their new higher and ever-increasing mortgage payments and went into foreclosure..

https://www.macrotrends.net/2015/fed-funds-rate-historical-chart

CPI: https://data.bls.gov/timeseries/CUSR0000SA0

[snot]

8. Clarification re- my questions:

(1) I thought that at least some people at banks like Goldman were betting against the MBS's EARLIER than the movie portrays. Not so?

(2) Was AIG (which was ignored in the movie) NOT one of the major issuers of the shorts?

(3) Adding one further question: near the end of the movie, the small-timers who'd understood the risks early on and had bought shorts were forced to sell them rather than collect on them. I assume that if they'd been able to wait until the instruments matured, there would have been an even bigger payout but felt pressure to sell them because -- why? On this I wasn't entirely clear. I gathered they were concerned that the institutions they'd bought them from might go bankrupt -- i.e., they were concerned about counterpart risk –– which makes sense; but then that risk should been reflected in a discount in the price they could sell the shorts for; i.e., if it was a big risk, why would someone else pay a lot for them? Should we infer that those who bought them paid a good price because they had greater access to government-internal info that the small-timers didn't and knew that the bailout was coming, perhaps even had a good idea about which institutions would get bailed out? Maybe I lost focus toward the end of the movie, but I'm a bit unclear on these points.