Betting against the American Dream

      17 Comments on Betting against the American Dream

NPR’s Planet Money and This American Life, in collaboration with ProPublica, have once again produced a brilliant piece of journalism about the financial crisis, this time focusing on the machinations of an evil-genius Wall Street hedge fund that made a killing by deliberately inflating the housing bubble while simultaneously betting that it would pop, thereby helping wreak incalculable havoc on countless people’s lives, and the economy and financial system at large. The hedge fund’s hilariously appropriate name: Magnetar, which sounds like a Decepticon from Transformers, or perhaps Skeletor’s accomplice on He-Man. (“I shall defeat you, Magnetar!”)

Anyway, you should really listen to the whole thing. But if you don’t have 40+ minutes to spare, here’s the 90-second, Producers-inspired show tune version:

Heh. (And, ugh.)

P.S. If I could make a humble request… please don’t argue that this is a financially ignorant liberal-media hit job against businesspeople who followed the rules and did nothing wrong unless you’ve actually listened to the whole segment. I’m very interested in hearing intelligent counterarguments, but the obvious ones (like “but there’s nothing wrong with short selling!”) are pretty well addressed in the piece — which, by the way, does NOT let other, non-Magnetar actors off the hook, by any means. Blame is most certainly spread around. Anyway, seriously, give it a listen. It’s really good.

17 thoughts on “Betting against the American Dream

  1. gahrie

    I wonder what George Soros thinks about this company? You know, the man who made his fortune by doing the same thing with currencies?

  2. kcatnd

    More importantly, would you really care about this if Soros backed political candidates you agree with?

  3. dcl

    That’s what happens when you vote for crap regulation, or no regulation. In other words, that is, in a nutshell the problem with what Bush did, and to a certain extent the Ron Paul libertarian argument.

    If you assume good actors, you are going to get royally screwed.

  4. Brendan Loy Post author

    Gahrie, did you listen to the piece? And if so, can you explain how exactly Soros “made his fortune by doing the same thing with currencies?” Unless he was somehow creating foreign currency for the express purpose of reaping a windfall from its failure, I don’t see how that can be true.

    If you’re simply saying that Soros made his fortune by “shorting” certain currencies, and you think that’s “the same thing” as what Magnetar did with CDOs, you either didn’t listen to the piece, or didn’t understand it — nor, apparently, did you read my last paragraph, which specifically called out the fact that this isn’t just a matter of “shorting.” What Magnetar did is far more ingenious and insidious than that. Regular “shorting” has the effect, at least potentially, of deflating a bubble. Magnetar actually played a highly significant role in inflating the bubble, while simultaneously setting itself up to profit handsomely from the bubble’s catastrophic collapse — a collapse that had an enormously negative impact on countless people and institutions that, also in pursuit of profit of course, made decisions that were influenced by the frenzy that Megnetar helped feed, all without disclosing the double game they were playing. Did Soros do that? How? (I don’t know much about Soros, so it’s an honest question; I just don’t understand how one could possibly do something similar with currency.)

    In any event, despite my feeble effort above, I’m not clever enough to correctly explain in detail what Magnetar did, nor am I qualified to really discuss the complex ethical and legal issues it raises. (If it sounds like I’m trying to portray Megnetar as a cardboard villain, I’m not — there are certainly some real ethical questions, but there’s also an argument that, within the parameters of the f***ed-up financial system circa 2006-07, their actions were totally legitimate, and it’s the system that’s to blame. The NPR piece teases out both of these perspectives.) So I’ll just again encourage you, and everyone else, to listen to the whole thing. Those Planet Money people have an amazing knack for explaining complex financial concepts in plain English without overly dumbing them down, and this piece is another example of that.

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  6. Alasdair

    This supports what I have learned so far in various areas …

    And dcl happily blames Bush – and ignores Frank and Dodd who prevented Bush doing anything to correct the selling of mortgages to people who aren’t likely to be able to repay the loan …

    Yet, by simply following the money, one finds “But the sponsors of this toxic trade did bother to make sure they had a powerful friend. The head of the firm in question gave substantial amounts of money by political contribution standards to Rahm Emanuel’s PACs, and only his PACs, over the period when these transactions were in play.

    The moving force behind a brilliant and devastating subprime short strategy was a heretofore unknown Chicago hedge fund, Magnetar, headed by Alec Litowitz, formerly of the hedge fund behemoth Citadel. Our studies indicate that Magnetar alone accounted for between 35% and 60% of demand for subprime mortgages in the year 2006.” – from this source

    So it becomes the fault of the Evil Bankers and the Eeeevil Booosh ™ – and the politicians who made the “risky stuff, very risky stuff, extremely risky stuff” possible are able to walk away with contributions to help keep them in office and get more of them in office …

  7. Brendan Loy Post author

    That’s fascinating, Alasdair. I’d love to know more about the Rahm Emanuel angle. Seems a bit odd, since the Democrats were the minority party in 2006! But perhaps Magnetar, in addition to foreseeing the collapse of the housing bubble, also foresaw the coming Democratic landslides in November ’06 and ’08.

    Hey, wait a minute… are we sure Magnetar is not actually staffed by TIME TRAVELERS FROM THE FUTURE?!?!?! 🙂

  8. Alasdair

    Brendan – I doubt if Magnetar’s folk gave the proverbial flying fornication about the future elections – as long as they had their tame pols keeping regulators harmless/neutralised (can you say “Keating”? (as an example from recent history)), that’s all that mattered … to do business, various institutions were forced to set up mortgages (“extrememly risky stuff”) for folk who could not afford to pay back the money, thus setting them up for failure, setting Magnetar up for major profits, and setting a bunch of pols up for contributions (and great interest rates on mortgages) from grateful Magnetar and others …

  9. Brendan Loy Post author

    But my point, Alasdair, is that having a friend in the minority party doesn’t really do much in terms of “keeping regulators harmless/neutralised.” What regulatory power did Rahm Emanuel have, or have the ability to influence, in 2006? The Dems controlled literally nothing in the federal government at that time.

    I’m not saying this to discredit the report you linked, which you may notice I’ve published a whole new tweet about. It’s very intriguing, and potentially damning or at least embarrassing. I just don’t exactly understand the logic of giving to Rahm, and only to Rahm, at that time. Maybe because the Republicans were already so solidly in the tank for deregulation, there was no need to make contributions to keep them in line?

  10. Brendan Loy Post author

    By the way, the notion that the Community Reinvestment Act and its progeny, “forcing” “various institutions” to do “extremely risky stuff,” has any place in this particular conversation, is pretty nutty if you understand what we’re talking about here and what the incentives and financial realities were by 2006. What the CRA, etc., may have done is provide the initial catalyst for banks to try this stuff, at which point they realized how damn profitable it was for them. But once they realized that, surely it was irrelevant whether or not the governments continued to “force” them to do it. “Forcing” them to do it would’ve been superfluous, like throwing Brer Rabbit into that briar patch. They now wanted to do it, because it was making them billions. The free market, not the government, is what “forced” them to continue doing it, even if it might have been the government that initially gave them the idea, 5 or 10 or 20 years earlier. They did this stuff because it was incredibly profitable for them. This is especially true insofar as we’re talking about investment banks like Bear and Lehman, who were never covered by the CRA and similar gov’t subprime mandates. They were motivated purely by profit, not forced into this kicking & screaming by the highly visible hand of Barney Frank.

    In other words, take that talking point somewhere else. It doesn’t belong in this conversation. Not saying it’s an invalid point (overblown, perhaps, but not invalid). But it belongs in a different conversation than this one.

  11. James Young

    I’d heard all about this. There’s something fundamentally wrong with a system where this is possible. No, I’m not arguing for regulation, I am arguing for _abolition_. It is also why I think, yes, there needs to be a clause in any new bill that says bailouts are utterly verboten. “No public funds may be transferred to a private banking entity other than to meet FDIC obligations. No exceptions.”

  12. Brendan Loy Post author

    “No public funds may be transferred to a private banking entity other than to meet FDIC obligations. No exceptions.”

    This is both emotionally satisfying, and batshit crazy as a matter of policy. Had such a law been in place in 2008, we could very well be in Great Depression II right now. And had it been in place in 2003-2007, there is absolutely no guarantee the banking activities that led us to the 2008-2009 crisis wouldn’t still have happened. It even seems fairly likely that they would, because I really don’t think your average mortgage broker or hedge-fund manager or Lehman trader was thinking, “This is all OK because the government will bail out AIG and Citigroup in the end.” That doesn’t even make any sense.

    “Moral risk” is a real problem, but setting crazy, potentially economy-destroying, no-exceptions policy is not the right way to address it. “Zero tolerance” is almost always a bad idea, and this is perhaps the worst iteration ever proposed.

  13. James Young

    Okay, when someone does something that nearly kills the economy, do you A. leave them the means to do it again by having a lawyer (sorry) parse the words of the law until they find a loophole or B. close the loopholes. Decisively. Because while the average trader may not have been thinking that, the person lending them money who knows, “Whoa, I go from penthouse to banging a cup if this falls through…” sure as hell does.

    Put another way, zero tolerance _is not_ a bad idea when the next time something happens means you’ll have all hell break loose. It’s sort of why we used to have that “any WMD means you become a glowing grease spot” in place–means there’s no quibbling. People realize they’re going to lose EVERYTHING, then you don’t get to slap a AAA rating on a steaming pile of poo and expect someone to give you large sums of money for it.

    Lastly, aren’t you the one always making fun of people for PANIC, yet you’re now throwing around terms like “Great Depression II” as a counterargument? Just sayin’, there’s a reason they passed a bunch of laws after the Great Depression that worked _just fine_ for many decades until everyone in Congress said, “Campaign funds? Sure we’ll get those pesky _good laws_ out of the way.”

  14. AMLTrojan

    What the CRA, etc., may have done is provide the initial catalyst for banks to try this stuff, at which point they realized how damn profitable it was for them. But once they realized that, surely it was irrelevant whether or not the governments continued to “force” them to do it. “Forcing” them to do it would’ve been superfluous, like throwing Brer Rabbit into that briar patch. They now wanted to do it, because it was making them billions. The free market, not the government, is what “forced” them to continue doing it, even if it might have been the government that initially gave them the idea, 5 or 10 or 20 years earlier. They did this stuff because it was incredibly profitable for them. This is especially true insofar as we’re talking about investment banks like Bear and Lehman, who were never covered by the CRA and similar gov’t subprime mandates. They were motivated purely by profit, not forced into this kicking & screaming by the highly visible hand of Barney Frank.

    Brendan, suppose I sprinkle a few granules of sugar across the kitchen counter in hopes some ants will show up. Now suppose I sprinkle a little more, and even more show up. Now suppose I leave the sugar open and unattended; how quickly until the kitchen is overrun with ants?

    Or take another, more natural example. Occasionally, there are “red tides” in which red algae bloom. These blooms can last for days or weeks, and quite often they end up killing a lot of the local shellfish and sea life. Because of this, the environmental authorities often shut down beaches and try to find ways to restrict the harm done by the toxic blooms. Still, it’s commonly understood that nitrates and phosphates in urban runoff exacerbates red tides.

    In both of the situations, who is more at fault: The ones who put out the sugar and the nitrates; or the ones who take advantage of the situation and end up causing suffering to others around them? If you focus your efforts on trying to modify the behavior of the ants and algae without first addressing the toxic market conditions caused by the humans, you will not permanently solve the problem, and the ants and algae will find some other way to take advantage of the next cycle of sugar and runoff.

    Bottom line: Focusing on regulation and rules, versus repealing the policies and incentives that provide the fertile ground for financial wizards to run amok unethically in the search for outsized profits, is a fool’s errand. Alan Greenspan and Barney Frank held out the sugar, and everybody screamed for them to continue doing so, because sugar is sweet. It’s not so sweet, though, when the ants take over the kitchen and destroy the rest of your food, and then you have to empty your cupboards, spray Raid everywhere, and put out ant bait all over the house.

  15. Jazz

    The other day I finally got fed up with springtime bugs in the house. I sprayed the kitchen, the bathrooms, the living room and play room where the kids are often eating, and then sprayed outside the entire damn house. Afterwards I put down traps behind the fridge, under the stove, under the bathroom sink, all the usual places. And damn if I didn’t see a fricking ant today in the kitchen.

    One doesn’t need to leave a bag of sugar on the kitchen counter for the ants to come back; this is essentially the reasoning behind Greenspan’s (and, more influentially, Graham’s) opposition to rules and regulations. Whether you make it easy or hard, the ants always find their way back.

    Having said that, from your last paragraph I find it unclear how (tongue planted firmly in cheek) Mr. Frank, as a legislator, can “pervert” the incentive for unethical thrust for profit by financial wizards without relying on “rules and regulations”. Perhaps if they are wizards Mr. Frank can use some sort of magic, outside of rules and regulations, to stop their chicanery.

    This conversation, and the inevitable finger-pointing it leads to, reminds me of something an accounting professor said many years ago: “Many people think accounting is boring and cut-and-dried,” he said, “and there’s a significant part of the field that is both boring and cut-and-dried. Its known as bookkeeping.

    The rest of the profession is basically art”.

    Its worth noting that the sources of the most financial outrage in the 21st century, whether it was Enron constantly re-stretching the boundaries of “revenue recognition”, or Waxman’s recent irritation at certain companies taking a “big bath” by being overly generous with their health care reserves, involves ‘accounting as art’ run amok. I suppose Barney Frank could have played a different role in all this by not pushing to have home ownership in the low 70%s, as opposed to the historic high 60%s, the result of which was to have relatively more mortgages in toxic tranches. The outcome of Frank’s intervention was surely to make the CDO/CDS debacle marginally more enticing, but those shitty mortgages were going to exist either way – the ants would still find their way in.

    This all got me thinking today about our historic defense against corporate malfeasance in the pursuit of accounting as (distorted) art: the audit function. Has any profession in America suffered a greater loss of prestige in the last generation than auditing? After Andersen imploded post-Enron, no one wants to do audits anymore, not that anyone really wanted to all that much before Enron.

    There was a time when an arms-length auditor took their job seriously to act as a (sort of) check on the Enrons of the world when they were pushing the revenue recognition envelope off the table, across the floor, out the door. Now, anyone stuck doing audit is often biding their time until they can jump to consulting, and they’re often loth to say anything critical because they’ll need the reco to get the heck out of auditing.

    So here’s a proposal: make the auditing profession matter again. Give auditors teeth and respect and an expectation that they will act as agents of the public, not buddies with management. And see a day where a story like the GS one leads to an instinctive question that would have been asked in the past, but is easily overlooked now: “Where the hell were the auditors???”

  16. AMLTrojan

    I don’t know about most of the accounting audit firms you speak of, but for us government contractors, the DCAA has plenty of razor sharp teeth still.

    I place primary blame with Alan Greenspan. The bottom line is, he knew that his job was to take the punch bowl away right as the party was getting started — that was his favorite metaphor. But instead, he found excuses to leave it out there longer: The Fed not counting commodities or real estate in their inflation indexes was like saying the party guests weren’t yet drunk because they could still walk.

    As for Congress and the policies around Fannie, Freddie, and subprime mortgages to low-income borrowers, I worked for a congressman who was hell-bent on reforming that industry back in the early 2000s and got nowhere. What people sometimes fail to understand is that, just a few extra % of borrowers qualifying at a higher % multiple of their income (due to interest-only ARMs and whatnot) helps skyrocket the demand for entry-level homes and in turn drive up the demand for everyone else on the real estate merry-go-round, particularly in places like Southern California where supply is very restricted. By pushing homeownership rates up just a few percentage points above the historical norm, housing prices were able to increase by absurd amounts in just a few short years. I still remember the bidding wars in the early 2000s — it was absolutely insane in Southern California! So you can’t paper over Congress’ role in this so easily.

  17. James Young

    The ants may come back–but if you use some of the insecticides that resemble p-chem, they don’t come back for a long, long while. As with regulation–if you make it extremely hard for folks to get stupid (one reason I applaud the “if there is nothing restricting derivatives I will veto this bill” (slight paraphrase) stance of the President), they generally don’t get _as_ stupid.

    That being said, I think the punitive side of the house needs to be far stronger. Some basically blasts the foundations of the financial artifice, they shouldn’t get away with a golden parachute. Indeed, they shouldn’t get away with any assets at all. (We may allow their spouse to have a Mrs. Madoff out. No reason for her to be on the street corner with a barrel just because her husband’s a jacka**.) This goes the same for government workers, btw. I know Congress is fundamentally unserious about really solving this when they A. reconfirm Bernanke, a.k.a. Captain Smith and B. don’t have Alan Greenspan, Hank Paulson, et. al. under serious investigation for what he knew and when.

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