The Global Financial Crisis in 2008: Blame of Wall Street and Insurance Companies
In 2008, a global financial crisis began and generated companies such as Lehman Brothers, one of the biggest investment banks to declare bankruptcy as well as forced Merrill Lynch to sell its company. AIG the largest insurance company also collapsed at this time. The United States faced a worldwide collapse causing the economy to tank and embarked into what was pronounced “The Great Recession.” People around the world were affected in many ways, for some, the loss of trillions of dollars, a weak economy, massive amounts of people without jobs, and the increase of national debt. During this time, six million people lost their homes in which trillions of dollars in consumer wealth vanished. This crisis extended until 2012, as economies globally decelerated, stock markets fell, and international trade weakened. To better understand how this global financial crisis unfolded the book “The Big Short” expands on the insider’s perspective on how the downfall of the United States housing market was prophesied before anyone could even speculate there was a problem going on. In the world of corporate finance, the book shows how several businessmen involved in wall street shorted securities within the housing bubble and in turn, came out on top making themselves filthy rich. Before the crisis, banking was dubbed as lackluster up until the 1990s when mortgage-backed securities were created by a man named Lewis Ranieri, a former bond trader turned chairman of Salomon Brothers. Ranieri developed securitization which allowed numerous cash flows to be pooled into bonds. Firms were then free to put thousands of home mortgages into one securities basket and sell them to investors and banks. Historically homeowners had seldom failed to pay on their home loans which considered them as safe investments. At this stage though, mortgage bankers were lending money left and right to individuals who were not seen as financially fit allowing them to take out loans in order to buy homes. This became a dangerous move as additional mortgages were being placed into the same basket of securities. The rating agencies such as S&P and Moody’s were to ethically rate and be unbiased gave these securities top scores. The fraud of Wall Street firms is revealed in the book showing how companies such a Lehman Brothers and Bear Stearns blindsided the market. True colors of the real estate industry are revealed exposing just how greedy mortgage bankers had become. These bankers understanding they were in the wrong still willingly offered loans to individuals knowing well they would never have the means to pay them back.
When the mortgage bond market was created everything was underway by the Salomon Brothers, this meant that the bonds were backed by real estate holdings. On the off chance that there would be a default, mortgage bondholders were able to sell the property backing a bond to counteract for the default. The Salomon Brothers also devised a solution calling them tranches, in which they split large pools of home loans and distributed the payments made by the homeowners into different portions. The concept of tranches was made to provide dissimilar levels of investment for different estimated mortgage prepayment schedules, each of which had proportionate interest rates calculated to compensate for varying levels of risk. In 2002, a man by the name of Steve Eisman went in opposition to the Household Finance Corporation, in which he recognized that they were misleading individuals by offering them a 15-year 12.5 percent interest loan under the facade of a 30-year 7 percent interest loan. Unlike fixed interest rates, they became floating rates where the interest rates moved up and down the market. The same bond market that Eisman had been obsessing over became a topic of investigation for another gentleman by the name of Michael Burry. He too had similar apprehensions about the quality of the loans. Burry comes up with the idea of “shorting” subprime bonds, which no one has ever done before, thus making it harder to crack this case all on his own. In the end, he leverages a credit default swap by buying $60 million of credit-default swaps from Deutsche Bank. Burry’s investors are displeased about the bets because, in turn, they are losing a good deal of money within a short period, making the investors want to withdraw their funds indefinitely. Greg Lippmann, a bond trader who is affiliated with Deutsche Bank gets in touch with Burry asking to buy back his credit default swaps. Not long after that Goldman Sachs gets on Burry’s case asking to buy back as well. This proves that mortgages are plummeting.
Steve Eisman and a man by the name of Vinny Daniel met up with Greg Lippman in February of 2006. Both were cautious because they normally did not trust anyone from the bond market. Lippman was intrigued by the idea of short-selling subprime mortgage bond credit default swaps. He too wanted to implement this idea and get other parties on board so he could profit the extra fees that accompany it. Lippman generated a presentation in which he entitled “Shorting Home Equity Mezzanine Tranches.” Lippman uses a Chinese analyst named Eugene Wu to additionally confirm the idea that the subprime mortgage market is on the rise. With the help of Wu, he forms a sales pitch in which he attempts to persuade other corporations to buy the credit default swaps from him. He also is assembling the credit default swaps for himself. Unfortunately for Lippman, no one is convinced, and he starts to get frustrated by his rising losses. He decides to present the same pitch to AIG FP, they state that they may be interested in buying some credit default swaps. Lippman sought to show prospective investors that low-income homeowners in the United States would be unable to grasp these true interest rates when they eventually emerged.
At the start of 2006, there seems to be a low number of people who are betting against the subprime market. Although they didn’t deal with loans, Capital One, a credit card company that was known for lending money to Americans with weak credit scores had clients from the same socioeconomic class who were headed towards an unfortunate disaster. After being successful for many years, their stock crashed in 2002 due to issues concerning risk management and the fidelity of their CEO. Ben Hockett, a former trader of Deutsche Bank persuades them to issue an ISDA license, which they use to buy credit default swaps from Greg Lippman. They actually end up buying just the top tranches from subprime mortgage bonds. This is because the cost is inexpensive, but in return, there is a high payoff. They end up purchasing $7.5 million in credit default swaps from Lippman, in which they are told by a former analyst that they undoubtedly selected the best tranches to bet against. By the year 2007, they end up purchasing over $110 million worth in credit default swaps. Major subprime companies are failing all over the place, and the markets no longer thriving. A new subprime index entitled the TABX opens less than a week later, this gives analysts the ability to see the authentic prices of CDOs. Unfortunately, it turns out that they are actually lower than what Wall Street has been estimating. Prices start plummeting on the TABX instantaneously, soon after almost every bank halts the selling of credit default swaps excluding Wachovia. The market of subprime loans rapidly goes back to running normally as before transferring billions of dollars worth of CDOs. Bear Stearns CDO division declares that they have lost countless amounts of money within the subprime market within the month of June. The loans that are offered have impeccable rates for a two-year, fixed period after which the interest rates skyrocket. Bonds are starting to decline making Eisman questionable that the banks and finance firms have been taking it upon themselves to invest in CDOs. This suspicion is confirmed when HSBC declares that they have also lost much of its invested funds in the subprime market. The probability that a crash is about to happen intensifies.
At this point, everyone is frantic that they must cash out before the market entirely crashes. If they do not act fast, they will be left with nothing if the firms they purchased credit swaps from end up going bankrupt. Panic is abundant because they must act quickly to sell before they are unable to and end up losing everything. Eisman is invited to give a speech in March of 2008 for Bear Stearns investors. Another man, Alan Greenspan who is the former chairman of the Federal Reserve is also going to present. During Eisman’s speech stock for Bear Stearns starts to nosedive more than twenty points. By Monday, Bear Stearns is sold to J.P. Morgan at $2 a share. The news keeps streaming and by September, companies such as Lehman Brothers and Merrill Lynch no longer exist. The men at Cornwall are angry with what’s happening but come out rich. Eisman gets a call from Danny about his “heart attack” and discovers that he’s sitting with Vinny and Porter outside on the steps of St. Patrick’s Cathedral. They feel remorseful, as their actions rushed the process. As they watch people walk by, the wondering when everyday people will comprehend how they are personally impacted by the operations of Wall Street.
In conclusion, I believe that Wall Street and the organizations involved such as the insurance companies, as well as rating agencies should be held to blame. After reading The Big Short, I feel that they as professionals and experts should be held to a higher standard since they were giving financial advice as well as soliciting predatory products and dabbling in risky business. At the same time, the homebuyers shared the responsibility as consumers to be held accountable at some fraction because they were knowingly buying houses they knew they couldn’t afford. From the outside looking in its hard to understand every element, a professional may know so as consumers they put their trust in the professionals within their industries. Much of the blame can be put on the mortgage lenders since they produced such problems. It was the lenders who decided to grant funds to people who they recognized to have poor credit scores and were at high risk of defaulting on repayment. These lenders had more than enough money to contribute and like investors, an increased willingness to accept further risk to magnify their investment returns. At the time there was a surge in demand for mortgages, and the prices of housing were increasing because of the significant drop in interest rates. In the end, Lenders more than likely saw subprime mortgages as a lesser risk than what they were perceived to be, at that time the economy was strong and healthy, buyers were making their payments and the chances of defaulting were low.
