Anatomy of Stupidity: The End of Wall Street's Boom

If you are still operating under the illusion that Wall Street is rational (even Alan Greenspan now has his doubts), then you owe it to yourself to read The End of Wall Street's Boom. The author is Michael Lewis, who chronicled its excess in Liar’s Poker. (I need to read this book!)

The protagonist is Steve Eisman, who had anticipated the implosion for two years -- who made a lot of money over the implosion, but felt no glee.

This article goes deeper into the machinations -- and utter lack of due diligence and foresight -- that I hinted at in September with The ABCs of CDOs: How We Got To Today's Financial Mess. Read this and tell me if you still think Obama has picked the best minds in the country to advise him on the economy. Here's an excerpt:

The funny thing, looking back on it, is how long it took for even someone who predicted the disaster to grasp its root causes. They were learning about this on the fly, shorting the bonds and then trying to figure out what they had done. Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.

But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says...

Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. “They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford,” Eisman says. “They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?”

Yes, Mr. Eisman. It was allowed. And the players included Goldman Sachs (current Treasury Secretary Henry Paulson was Chairman and Chief Executive Officer of Goldman Sachs before taking the job) ... Merrill Lynch... J.P. Morgan Stanley (see Obama's economic advisors) ... Salomon Brothers. Eisman traces the cancer back to his days on Wall Street, when Salomon Brothers went public:

No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.

Read this article. And just say no to bailouts without penalties or restructuring. As the former CEO of Salomon Brothers notes:

When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle.