Michael Lewis on the Financial Crisis

By now these articles have almost certainly made the rounds, but just in case you missed them Michael Lewis’s articles on the financial crisis are must-reads: The End of Wall Street’s Boom, The End of the Financial World as We Know It, and How to Repair a Broken Financial World.

Nobody else has done a better job of describing the lunacy that brought us to this in such a vivid and gripping way.

Some choice bits, starting with Steve Eisman’s description of the engine of doom:

“You have to understand this,” he says. “This was the engine of doom.” Then he draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranche—the bonds Eisman had shorted. But Wall Street had used these BBB tranches—the worst of the worst—to build yet another tower of bonds: a “particularly egregious” C.D.O. The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities. “I cannot fucking believe this is allowed—I must have said that a thousand times in the past two years,” Eisman says.

Eisman knows enough to short the BBB tranche, but then he has dinner with a C.D.O. scumbag who reveals the gruesome twist, “I love it when you guys short my market. Without you, I don’t have anything to buy.” And that is why we’re so screwed:

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. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. 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?”

I had like 10 other passages I was going to quote here, but really, go read ‘em all. Those bits are from the first article. Wait until you get to the others and you read about how Paulson has been spending the bailout money.