"a sense that unhealthy things were going on in the U.S. housing market": And It's Not Mold

Michael Lewis with a post that got a lot of attention on Portfolio:

"At the end of 2004, Eisman, Moses, and Daniel shared a sense that unhealthy things were going on in the U.S. housing market: Lots of firms were lending money to people who shouldn’t have been borrowing it. They thought Alan Greenspan’s decision after the internet bust to lower interest rates to 1 percent was a travesty that would lead to some terrible day of reckoning. Neither of these insights was entirely original. Ivy Zelman, at the time the housing-market analyst at Credit Suisse, had seen the bubble forming very early on. There’s a simple measure of sanity in housing prices: the ratio of median home price to income."

Poor loans. Spigot Theory, useless.

"By the spring of 2005, FrontPoint was fairly convinced that something was very screwed up not merely in a handful of companies but in the financial underpinnings of the entire U.S. mortgage market.

"Unhealthy things". "Screwed up". Don't blind me with science.

"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.

The arrangement bore the same relation to actual finance as fantasy football bears to the N.F.L. Eisman was perplexed in particular about why Wall Street firms would be coming to him and asking him to sell short. “What Lippman did, to his credit, was he came around several times to me and said, ‘Short this market,’ ” Eisman says. “In my entire life, I never saw a sell-side guy come in and say, ‘Short my market.’ ”

I've already used the football and betting analysis in my losing debate with Derivative Dribble.

"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."

Poor loans. Over and over.

"In retrospect, pretty much all of the riskiest subprime-backed bonds were worth betting against; they would all one day be worth zero. But at the time Eisman began to do it, in the fall of 2006, that wasn’t clear."

This is called regret. It doesn't occur only in finance.

"The funny thing, looking back on it, is how long it took for even someone who predicted the disaster to grasp its root causes. "

Highly comical. If someone predicts something but not for the right reasons, it's called a lucky guess. It certainly doesn't qualify as prescience.

"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."

It's called alchemy. Even Newton believed in it.

"Eisman, Daniel, and Moses then flew out to Las Vegas for an even bigger subprime conference."

Next time fly to Bakersfield. You'll get more done.

“Would you say that 5 percent is a probability or a possibility?” Eisman asked.

A probability, said the C.E.O., and he continued his speech. "

Pardon me? This is just a confusion of words.

"That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. 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."

Poor loans.

"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."

Sorry, if done right, these can be useful for determining the likelihood of default. It's not the product. I wouldn't do it, but I'll use the info.

“We have a simple thesis,” Eisman explained. “There is going to be a calamity, and whenever there is a calamity, Merrill is there.”

Is this a priori or what?

"There was only one thing that bothered Eisman, and it continued to trouble him as late as May 2007."

He's a hell of a lucky guy. I'm troubled but hundreds of things daily.

“The thing we couldn’t figure out is: It’s so obvious. Why hasn’t everyone else figured out that the machine is done?”

Strangely, he's Heideggarian.

“When I read it, I thought, Oh my God. This is like owning a gold mine. When I read that, I was the only guy in the equity world who almost had an orgasm.”

I wouldn't brag about almost. It's not terribly satisfying.

"Outside it was gorgeous, the blue sky reaching down through the tall buildings and warming the soul. "

This sounds like my Fuld parody.

Let's end it here. Too much pathos, not enough satire.