The Big Short: Missing the Most Important Part of the Story.

The Big Short: Missing the Most Important Part of the Story.


By Dr. Phil Taverna


It is a great fairy tale, but it is missing the foundation. I have written several times about this, but the big Obama crash of 2008 was caused by the banks, not the housing market.


It is a great story told by Michael Lewis. And he must be a liberal. When you need to place an f-bomb on almost every other page, it is time to break out the soap.  When he hears it for the first time from his kids, he has no one else to blame.


When you hear about the bursting housing bubble of 2008, it was all political. And was timed in such a way that the Democrats could make a clean sweep of the Whitehouse and congress. In hindsight Bush should not have bailed out anybody. And we would not be reading this book.


But The Big Short missed the most important part. The bubble never burst.  In the real world a bubble is caused to burst when the demand to pay the big bucks lessens or vanishes. That never happened. There were plenty of buyers who would pay the “inflated price” but there were no banks that would loan the money to the average buyer.


And Mr. Lewis hints to this, but misses the most important part of the story.


But the fairy tale as told goes like this. Clintons wanted poor people to buy a house. So the subprime industry was created. Allegedly these loans were 2 years fixed at about 6%. Then went to 12% or more as a variable rate after 2 years.


Does this mean no other types of mortgages were included in this batch. The fairy tale also had loans that had no docs. And the author mentions a crop picker making $14,000 a year buying a $750,000 building. And another person buying 5 condos. Now when you apply for these loans there is an application. There is an underwriter. And there is a building and an appraisal.


Now if this is true, we are no longer looking at home mortgages but investment properties. Be that as it may, an underwriter is going to approve a loan for $750,000 for someone making $14,000? The monthly payment would be about $4,500 per month for at least the first 2 years. I am going to make a guess that the app never got past the front door. So lets say the property was appraised for one million dollars. It doesn’t matter. No loan! So are you telling me that millions of applicants lied on their applications. So instead of $14,000 he threw in a zero to make $140,000. I want to see it and the underwriter that bought the story.


I stated years ago that this is impossible, Don’t get me wrong, after Obama and Clinton, people today lie more than tell the truth, but the average person would not lie to that extent on the application. It states right on the bottom if you lie like a lawyer, you will go to jail. Or they will take the building away from you.


The story also mentions that there were folks who did not make any payments and the broker or bank allowed the borrower to roll the interest into the principal. That sounds like an investment. Would a bank allow that for 2 years? Not likely unless there was a lot of collateral/skin involved. So it sounds more like a fairy tale and you need to wait for the frog to kiss the prince and turn him into Baloney.


Basically folks took all these mortgages and put them into bonds. And people bet on the value of these bonds going up and down. And remember all these loans were backed by collateral in the shape of a building. So there was absolutely no way you could lose in a normal world. These  story tellers will tell you that each mortgage was backed by a building worth at least 90% of the value of the loan.


The author claims that these bonds can default and if a certain % of the loans in the bond defaulted if they were of similar types, they all would default. So these bonds were worth millions. Now they are worth nothing???


So these geniuses came up with derivatives that they called CDS. Credit default swaps. So generally you can’t go short on a bond. But you can buy insurance to bet for the default. In other words if the bond defaulted, and lets say the bond was worth zero, which would be impossible in a real world. The CDS holder would make the millions. The CDS holder basically bought insurance from places like AIG. So for nominal amounts, you could bet on the bond defaulting. This was a premium you paid every year. It could be long term and the author never said what would happen if the CDS holder stopped paying for the insurance. I would assume nothing. The policy/contract would be cancelled. So AIG took all the risk and the reward would be fantastic if someone could make the loans default.


So even if someone walked away from the building. The building still had value and the bond still should have value. Some how the story tellers are saying the bonds are worth nothing.


Back to the appraisal. Keep in mind if all the houses in the bond burned down and there was no insurance and all the land became swamp land, the asset would be worth zero. That is a lot of ifs. And it is not clear who owned all the CDS’s by September 2008. And that is what the Feds should be investigating. If you are sitting there holding all those CDS’s and you could cause the housing bubble to burst, you would make billions without any effort. Here is where people get confused. This is not capitalism.


So what the underwriters did was they began to downgrade all appraisals. About 25% to begin with. In Wilkes-Barre the appraisals and the assessment came in at about $130,000 dollars. Chase would not accept it. They ordered another appraisal as a drive by and accepted an appraisal of $97,000. So it was Chase who burst the bubble. There were plenty of buyers willing to pay the price. It was the bank that interfered with the process and reduced the appraisals by about 25%. It happened about the same time that McCain and Palin were ahead in the polls. You know the rest of that story.


So lets be clear that the collapse of the bond market was brought about by the owners of the CDS’s.   This was big money to be had with little money down. But this would have no effect on the housing bubble. Did you hear anyone being foreclosed because the bond holding the mortgage was worthless. I will betcha a big bank swallowed that up for pennies on the dollar. And they get the building for collateral as well. It was a win win win for the big banks.


So it is clear that Mr. Lewis thinks that the bubble burst because of the bond market. That is not so. It burst because the appraisals controlled by the underwriters were reduced by almost 25% in 2008. That means you could not refinance. Could not get out of a variable mortgage with an interest rate over 15%. Could not sell your house for a fair price. That is what burst the bubble. There were plenty of buyers to pay for a mortgage with a fair appraisal. The home owners/investors were being screwed by the banks.


The end of the book points out that all the losses of the CDS’s were reimbursed by the taxpayers via TARP. He also indicates that some of the bailout was such that it was not paid back. Otherwise known as a gift by the taxpayer/ politicians.


That is the rest of the story. Lets make sure we are clear, the housing bubble was not affected by the bond market, not by the credit default swaps. It was caused by an intentional reduction of appraisals by the underwriters.


Quick example: In the old days a comparative appraisal was done. And houses were compared to your house and a fair price was arrived at. And usually decent houses were used in comparison. In 2008 they did not do that, even though that was the standard. They changed the standard and compared the house to the worse houses in the neighborhood. And they would pick the worse appraisers in the area to produce the low balled numbers.


Some would argue that the houses would not sell for more. That was not true. Remember this house was assessed as well. Once they low balled all the appraisals, then of course the house could not be sold for more. If the appraisal was low, the mortgage would not be for the full asking/selling price. The seller would have to reduce the asking price. And that is what burst the bubble! It was not the housing market.

Also note that there is no mention of Fannie Mae or Mac. And by lowering the appraisals the banks made less on each mortgage. In hindsight the Democrats thought the housing would return to normal in less than a year. But Obama never signed an executive order bringing the appraisals back to the 2007 levels. That is probably the main reason that Obama’s economy is putrid. But remember someone made lots of money. And so far they have not been prosecuted.


Betting millions to make billions. And guess who paid the billions? You did!


Merry Christmas and Happy Holidays


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