Under the Kimono: The End of Wall Street

This is a stellar Friday afternoon read, with many thanks to Incline Jim for forwarding the link. It’s a behind-the-scenes look at how our financial castle crumbled, some ordinary folks who saw it coming, and stories of those clever enough to profit from the fall. I swear Reno Ignoramus or Bantering Bear could have written portions of this very sobering tale. Still upset about Mike’s cash contractor just trying to survive in our current crappy climate? Well grab your heart medication for this one because he’s not the real villian… these guys are.

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24 Responses to Under the Kimono: The End of Wall Street

  1. Avatar Phil says:

    You know what bothers me about this whole mess, is that they are both to blame. He was right in feeding the monster until it blew up was a part of the problem as well.

    What do you do to make the world a better place?

    I wonder what the players in this article including the author can say about making the world a better place?

    This article just shows me that greed is truely EVIL!

  2. Avatar MikeZ says:

    AWESOME link! A compelling read … all TEN PAGES of it! Thanks, Diane.

  3. Avatar Reno Ignoramus says:

    Yes, Diane, much of what is said in this article was indeed discussed right here on the humble Reno Realty Blog. In many ways, if one was willing to do the research, much of this “writing on the wall” was ascertainable by 2005-6. I do find one part of this article extremely valuable if it is in fact accurate. It provides an answer to a question that I have heretofore not seen explained. That is the explantion of how the default swap market grew to be in the tens of trillions of dollars when the underlying CDO market was “only” in the hundreds of billions. If in fact the default swap market was predicated upon CDOs that never even existed, or so-called “synthetic” bonds, that is truly ……well, I’m not sure what the word is for it.

  4. Avatar smarten says:

    Great link Diane. I thoroughly enjoyed the reading. What is explained in the article really has very little to do with sub-prime lending and borrowers defaulting on mortgages they could never afford.

    RI states “much of what is said in this article was indeed discussed right here on the humble Reno Realty Blog.” Well, not really but one thing that was…

    Do you remember the heated discussions had on this blog about investing in the stock and bond market [versus real estate] when Derrick couldn’t keep his mouth shut about all the gains he was allegedly realizing “playing the market?” I argued he was playing in the largest gambling casino in the world. He and quite a few others countered that the market was the greatest and safest investment vehicle ever invented. Well with that said, I find the following language from the article to be most revealing [hope you’re reading this Derrick]:

    “Wall Street…f—ed people. They built a castle to rip people off. Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience…The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The…psychological foundations of Wall Street shifted from trust to blind faith…The main effect…was to transfer the financial risk to the shareholders. When things go wrong, it’s their problem…When a Wall Street investment bank screw[s] up badly enough, its risks bec[o]me the problem of the U.S. government.”

    As much as it hurts good, innocent people, the melt down isn’t over. And it won’t be over until every sane person understands first hand that never, never, never again will he/she ever, ever place his/her life savings/retirement in such a rigged ponzi scheme. If you disagree, then you haven’t bled enough [and stay tuned].

    And as you can see, none of this is directly related to sub-prime lending and borrowers defaulting on mortgages they could never afford. The greed, fraud and deception goes far deeper.

  5. Avatar BanteringBear says:

    My apologies in advance for such a long post, but I feel these are very important pieces of the story.

    Smarten posted:

    “What is explained in the article really has very little to do with sub-prime lending and borrowers defaulting on mortgages they could never afford.”

    “And as you can see, none of this is directly related to sub-prime lending and borrowers defaulting on mortgages they could never afford. The greed, fraud and deception goes far deeper.”

    I think you need to re-read the article, Smarten, and perhaps review your interpretations of this entire meltdown. This has everything to do with sub-prime lending, and sub-standard mortgage loans in general.

    From the article:

    “In 2000, there had been $130 billion in subprime mortgage lending, with $55 billion of that repackaged as mortgage bonds. But in 2005, there was $625 billion in subprime mortgage loans, $507 billion of which found its way into mortgage bonds.

    Here’s where financial technology became suddenly, urgently relevant. The typical mortgage bond was still structured in much the same way it had been when I worked at Salomon Brothers. The loans went into a trust that was designed to pay off its investors not all at once but according to their rankings. The investors in the top tranche, rated AAA, received the first payment from the trust and, because their investment was the least risky, received the lowest interest rate on their money. The investors who held the trusts’ BBB tranche got the last payments—and bore the brunt of the first defaults. Because they were taking the most risk, they received the highest return. Eisman wanted to bet that some subprime borrowers would default, causing the trust to suffer losses. The way to express this view was to short the BBB tranche. The trouble was that the BBB tranche was only a tiny slice of the deal.

    But the scarcity of truly crappy subprime-mortgage bonds no longer mattered. The big Wall Street firms had just made it possible to short even the tiniest and most obscure subprime-mortgage-backed bond by creating, in effect, a market of side bets. Instead of shorting the actual BBB bond, you could now enter into an agreement for a credit-default swap with Deutsche Bank or Goldman Sachs. It cost money to make this side bet, but nothing like what it cost to short the stocks, and the upside was far greater.
    More generally, the subprime market tapped a tranche of the American public that did not typically have anything to do with Wall Street. Lenders were making loans to people who, based on their credit ratings, were less creditworthy than 71 percent of the population.

    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.

    There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them…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?”

  6. Avatar Sully 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.

    Thats the part our new treasury sect was warning Wall Street about in 2005 (even before it got as big as it is now) and the part Greenspan couldn’t see coming………

  7. Avatar Sully says:

    BTW – for those who like zeros and commas the total “at risk” for these listed derivatives and side bets are in the neighborhood of 1.1 Quadrillion.

    The side bets are slightly more than 50% of the total amount. Walking on eggshells doesn’t come to these moronic bets!

  8. Avatar BanteringBear says:

    Two things I wish this blog had: an edit button, and an expanding comment section.

    In an effort to keep my post as short as possible, I have jumbled a bit of the information, and omitted too much. My post doesn’t read well as a result.


    I think it’s fair to point out that historically, the default rate for derivatives is quite low, and though Systemic Risk is a concern through a potential for a domino effect due to “netting”, the central bank has, or is in the process of creating, a clearing house for Credit Default Swaps to prevent such a thing. I’ll need to research this as I’m going by memory.

    Furthermore, “The ISDA reported in April 2007 that total notional amount on outstanding credit derivatives was $35.1 trillion with a gross market value of $948 billion (ISDA’s Website). As reported in The Times on September 15th, 2008, the “Worldwide credit derivatives market is valued at $62 trillion”.

  9. Avatar Sully says:

    Yeah BB, thats the same article I read. But here is another one:


    This is not the one I received, but its similar in content. Additionally, AIG is on board for some 50 trillion worth just by themselves. At some point in time this will be made public, just as their failure came to light a few days after I posted the scenario of a major bank, brokerage or insurance company failing.

    I prefer to get my info from the inside sources.

    Think of yourself as a carrier pilot, on deck in the catapult.

    The “cat” is released and in 3 seconds you’re at 130 Knots. What you do next is your business.

  10. Avatar BanteringBear says:

    Thanks for the link, Sully. Some useful information in there, but some extremism as well. What is not much talked about in any of these articles, is the fact that CDS’s have an effective date, and a termination date. Many, if not most do, and will continue to, expire without a “credit event” taking place. We can only hope that with every passing day, more have expired, and the same garbage isn’t created. Nobody can predict what the carnage may be. We’ll just have to take it day by day, and hope that these @ssholes in charge do something right for a change.

  11. Avatar Sully says:

    Before anyone runs off to join the New World Order, keep in mind these mind boggling numbers are based on notional value of the derivatives.

    In other words, paper money. The point is (besides the new world order, sorry about that) the public is not being told how severe this problem is. And, as BB said, the greater majority of these have expiration dates. The CDS, on the other hand, depend on being renewed.

    This, I think, is what got Citigroup in trouble when AIG said “mea culpa” we can’t renewal these CDS because we are on the verge of bankruptcy.

    Then Citi had to put these toxic debts on their books (wait til Goldman does it too)and showed a greater loss then the market was expecting.

    So, now we have the worlds largest bank, brokerage and insurance company reduced to peanuts.

  12. Avatar Incline JJ says:

    That book Liars Poker is an excellent book..

  13. Avatar GreenNV says:

    I’ve designed space for many of the firms we are talking about, and have personally met many of the protagonists in this saga. More in Barbarians at the Gate, but here are my impressions:

    Bear Stearns – absolutely everyone I ever worked for or met there were complete and total A**hole captain of the universe types. This includes the parties who cleared deals through them: PKP (Bob K. Pryte), the first hedge fund to loose them $1,000,000,000) and Furman Selz (aka furball smells) and all their little hedge fund genius subtenants. Good riddance, Bear.

    Lehman – I only worked worked the Shearson end of the operation. They were always professional and seemed to have their act together. Who knew they would be the sacrificial lamb?

    KKR – I was the drafter on their NY HQ, and met both Kohlberg and Kravis during the process. Kohlberg was always the ultimate gentleman, and left his own firm when the other partners when malignant on their greedy LBOs. Kravis was a flashy new money dick-wad, though a genius. George Roberts was one of the most intelligent, soft spoken, and decisive people I have ever met, and I admire him greatly to this day. I once had a 10 minute meeting where he bought several hundred thousand dollars in antiques to furnish the corporate offices. He listened to our presentation, and without fail, purchased the primo items presented to him. I also was in charge of installing the ventilation shafts to allow KKR’s private chefs to cook fish in their private kitchen. Money was no object. Long John Silver’s was not a choice, even with the hush puppies. Every fillet cooked their probably cost over $1000.

    Citibank – What a bunch of wankers. Clueless.

    Except as noted, I only know these firms from the facilities point of view. But I think how the treat their facilities echoes their corporate philosophy. It is sort of a scrape your shoes before entering scenario. yuck.

  14. Avatar smarten says:

    I continue to be of the opinion the root of the worldwide economic collapse we’re seeing unfold are these credit default swaps [“CDS”]. Apparently in many cases, CDS contracts were not purchased as genuine “insurance” by the holder of a bond but rather, as nothing more than a naked, speculative investment that would pay off if the underlying bond defaults. With all due respect, this is a subject never discussed on this blog until relatively recently.

    As reported this morning’s Yahoo News, “CDS obligations could become a black hole for the banking system…These things are like land mines says Michael Greenberger, a former regulator of derivative contracts at the Commodity Futures Trading Commission [an oxymoron, wouldn’t you say?]. Every indication is that they are at the heart of the financial crisis“…[fueled by the fact poor regulation has made this market opaque].

  15. Avatar Incline JJ says:

    Of course it was all OPM..Other people’s Money

    I have gone to many secondary conferences and meetings and have wondered sometimes how some of these people running the mortgage divisions even got out of high school..

    This is on the mortgage side of the business:

    Lehman Brothers..Acted like they where the smartest brightest and most pompous guys in the room..Thru huge parties and loved to brag and throw out big numbers..

    Goldman Sachs..Acted like they invented the mortgage business..same very pompous..looked down on everyone else in the room including Lehman..

    Citibank..Very Clueless

    Wells..Azzholes..major jerks..enough about them cause I never liked them

    BOFA..pretty cool actually..maybe I am biased on this cause I have always had a good working relationship with BOFA

    Bear Stearns..I have the feeling they knew the end was near 2 years before they crashed..Scared rabbit mentality..In fact the guy who ran the mortgage division looks and has the same facial expressions all the time as the author Bob Woodworth

    A friend of mine, who worked in Secondary the other day asked me, how many of them loans that I sold off do you think went into Foreclosure..I said well you guys did stuff that WAMU did..Lots of stated..Probably 80% of the stated loans will go under if they haven’t already..

    silence…on the phone..

  16. Avatar DonC says:

    I think I’m with Smarten that the big problem was with the credit swaps. Yes BB is correct that the subprimes are at the heart of the meltdown, and he’s doubtless correct that there would have been massive defaults, but they would have been a smaller problem, adjusted for inflation, than the bad commercial loans we had to deal with from the S&L fiasco of the 80’s. The swaps took a big problem and multiplied it by a hundred, making it a huge problem.

    The answer to “how the rating agencies justified turning BBB loans into AAA-rated bonds” is computer modeling using historical data — in this case the maxim that all real estate is local. Bundle lousy bonds from many areas and the risk of default on the group drops, or so the historical data would tell you.

    JJ is also right that a root cause was OPM. Keep in mind that Long Term Capital Management almost ignited a WS meltdown ten years ago. It didn’t trade subprimes. But it did use computer models to manage risk and it did use OPM — about the same ratio as all those now going under, or about 30:1 to 35:1.

    There are two problem here. One is the debacle with subprimes. The other is the structural problems on Wall Street based on leverage, faulty risk management, mis-alignment of management and shareholder interest, and lack of regulation.

    I wouldn’t say that all trading on WS was, is, or should be suspect. All the losses at AIG came from one very small group – the one that dealt with credit derivative swaps.

  17. Avatar Sully says:

    Well to give you an idea how much further we have to go to fix this mess:

    Today the new president introduced his economic team. Also, he said he was going to create 2 1/2 million new jobs over the next 2 years (out of thin air, great magic act).

    The stock market (still believing in Santa Claus) was up 5% for the day. This had to be the smart money buying, as every one else is broke by now!

    I suppose the next thing we will hear, is how all those new jobs are going to pay for all the bailouts.

  18. Avatar BanteringBear says:

    I never once stated that Credit Default Swaps weren’t a problem. I agree that they’re a huge problem, and have no doubt exacerbated things. But to argue that the housing bubble, and the subsequent crashing of housing prices has less to do with this meltdown is delusional as far as I’m concerned.

    It’s obvious that the over-levered banks ARE the problem. I don’t care if we’re talking about CDS’s, mortgage loans, credit card loans, car loans, or any other financial dealings, these scumbags were feeding at the trough WAY too often. Now there’s hell to pay. Unfortunately not for them, but for taxpayers, and the public in general.

  19. Avatar BanteringBear says:

    These “bailouts” are doing nothing but stealing money and prosperity from future generations in order to satisfy the bets of these Wall St. pigmen. It’s more disgusting than I can convey. I had a hard time sleeping last night after seeing that Citibank was the next to benefit from a policy of “privatize the profits, socialize the risk”. God help this country.

  20. Avatar Marla says:

    This is a very fine article and all the comments are quite fine as well. But folks, does it really matter how this disaster came about? It is more than apparent that the Fed and the Treasury, no matter who is President, are going to spend TRILLIONS (not hundreds of billions)of dollars bailing out and propping up and keeping alive every company deemed “too big to fail”. By the time this disaster is over, the “original” $700 billion bailout is going to look like a piss in the bucket. The true cost of this is going to truly unfathomable. If we ever are told the true cost.

  21. Avatar DonC says:

    Marla, it matters because if you don’t know the root cause the solution proves elusive.

    BB, keep in mind that TARP is not likely to be “stealing money from future generations.” The government is not using taxpayer dollars, and it’s not consuming, it’s investing.

    Right now the Treasury is borrowing funds at .02%. Hows’ that for a rate? LOL It just loaned to Citi at 8%. Borrowing at .02% and loaning at 8% is not a recipe for losing money. It’s a recipe for making a lot of money. If you remember, the Treasury made a bundle off Chrysler in the 80’s. It’s highly likely we’ll see the same result here, and rather than stealing money from future generations it’s giving money to future generations.

    You have to distinguish this from things like military spending, which is more raw consumption in that after you’ve spent the money you just have to spend more.

  22. Avatar smarten says:

    FWI, I’m a long time Citibank customer.

    Last week it became apparent to me [I’m certain it was apparent much earlier to many of you] that MY bank was going to fail. Although I was concerned, I was not frightened because my deposits are insured by the FDIC up to $250K.

    But after the latest bailout I received an e-mail from Citibank. My bank wanted me to know that under the Temporary Liquidation Act [or something similarly named], ALL deposits, whether more than $250K or not, were now fully insured by the FDIC.

    Stupid me thought the FDIC was only on the hook for a maximum of $250K/customer. Now I see the hook goes far, far deeper and I suspect extends or will shortly extend to customers of other troubled institutions as well.

    And I agree with DonC. I think it’s important to understand how we got into this mess and once we understand, to take action designed to punish those responsible and prevent any reoccurrence. “Punishment” need not be criminal [although I think it should be] – it could be failing to bail out troubled wrongdoers. It could be preventing those who profited from CDS investments from realizing that profit. It could be letting Wall Street [IMO the true cause of the problem] melt into oblivian.

    If we give these wrongdoers a “pass” and don’t learn our lessons, then I am confident these people will resurface under some new costume so they can consummate new sophisticated frauds in the future upon we lemmings.

    I do not mean to minimize the effect sub-prime borrowing played in all of this. However, if we were just talking about mortgage defaults I am of the belief the market would be able to absorb it. Today there’s essentially no credit available for anyone to absorb anything.

  23. Avatar Marla says:

    DonC, I didn’t say that it does not matter if we don’t know the root cause. Please read my comment. I said it does not matter how all-knowing we are now about how this disaster came to be, and that, whatever the cause, this is going to cost us trillions of dollars.

    I find your spin on it all quite interesting. You make it sound like this is the greatest deal in history for the Treasury. Borrow at 0.2% and get 8% back. Why, DonC, I guess at you might suggest that with a little luck the Treasury can find hundreds of other failing businesses to loan money to. Maybe, if there are enough fraud-ridden, greed-based, failing companies out there that the Treasury can rescue, we might even be able to balance the federal budget with the windfall profits as all these companies begin to thrive again and pay back their debts to the Treasury. Gee, how can we not when the treasury has a 7.98% spread going for it.

  24. Avatar Perry says:

    I saw Smarten’s comment about the FDIC and it reminded me of this article I read. I am by no means a financial wizard but I’ve definitely become financially skeptical. The article talks about Citi’s failure and towards the end the FDIC specifically. I’m not so certain the FDIC gives me solace anymore. http://www.moneyandmarkets.com/citigroup-collapses-banking-shutdown-possible-28325

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