BEAR on 26/3/2009 at 04:50

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It was almost laughable how fast it happened. Thats one of the reasons I love watching the daily show so much. Even if they do acknowledge it, they mostly find more humor in the incredible rabid populism that has reared up than the actual bonuses.



I'm jealous. If I ever get to come to new york, thats on my list of things to do (I'd love to go to the colbert report too, but with the daily show its a matter of history. I've been watching it as long as I can remember at this point).



True, but Stewart did try to make it clear that he didn't think Cramer was really responsible (or, more responsible than anyone at CNBC as he saw it). He seemed rather ambivalent and bemused by the whole "feud". He was pretty rough with him, but it was very much in the spirit of the daily show (ie methods he used), even if it was harsher than usual. I think he had more of a problem with CNBC pretending to be an authority (albeit more on trading, but a lot of the people who watch the network might not be able to draw that distinction), rather than what they should have been doing or should have known.

Good to see you back. I wondered how long you could resist this thread. I hardly had the heart to even look at it. Your commentary is as enlightening and easily understandable as usual (in before thief13x accuses me of sucking your cock).

Also did anyone else actually laugh out loud when he said "rejection of capitalism in favor of (usually) socialism."? Well, it was more of a muffled chortle because I was stuffing my face at the moment, but still.

I'm not even sure if he's being serious at this point. I feel bad about insulting him (I'm not half as bugged by people being "stupid" as I try to seem), but sometimes I just can't help it. I really think he's goading me at this point.

Rug Burn Junky on 26/3/2009 at 15:18

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That's just it, who's to say what they should have been doing? It's like getting upset at traffic reporters for not knowing enough about urban planning. Sure, it should somewhat inform how they do their job, but when you're listening to the radio to find out if there's a 20 minute delay on the GW bridge, you don't expect the guy in the traffic copter to give you a soliloquy on the advantages and drawbacks of congestion pricing in lower Manhattan. There are other avenues for that, and they did and do exist. I’m not going to clear CNBC entirely, there’s a lot of what Stewart said that was right on the money, but there’s also a fair share that was colored by his own misconceptions.

There’s a lot of misinformation here that’s difficult to fully explain.
First of all, anyone who goes out and buys $20k of stock on the basis of “some guy on TV told me to” is a sap, professional trader or not. But this little canard about just trading contra Cramer has been going around for a while, and it’s hyperbole – exaggerating both his effect on the market, and other people’s responses thereto. He highlights many different stocks, for different reasons. These stocks have different timeframes. You can analyze the financials, and say “this is intrinsically worth more than the current price, if I buy it now eventually it will be worth as much as I think.” That’s value investing, and it’s what Warren Buffet does. But that implies a long timeframe – you have to be patient.

That’s not what Cramer always recommends though, and why you can’t just point to a stock that was X value one day, and (1/10)X six months later and say “See! He was wrong!” especially if that stock was at 2X at some point in between. A lot of his picks are based on short term technical analysis. If he highlights a stock that has significant upward momentum, you can easily pull up the analyses and see whether there’s a legit trade for yourself – Is it trending up? Can you rely on that trend? Is there a good price point to get in? The real pros are making their trades on this basis, ignoring Cramer’s analyses entirely, but that doesn’t mean he can’t unearth something that makes them or anyone else consider a trade in the first place, but ultimately, he’s illustrating aspects of trading, not giving instructions to trade, and a professional trader isn’t going to need that illustration. So yeah, he’s not offering strictly serious useful commentary, but that’s pretty obvious from his show. He’s a clown.

But regardless, it’s never as simple as just shorting a stock that he recommends, that’s no more reliable than just buying everything he says, and there are significant obstacles to doing so. You’d have to fight whatever initial upward momentum there is, which most short sellers don’t do (follow a trend, or stand aside, don’t fight them). Besides which, if this were a legit strategy, there’d be enough competition for the shorts that the carrying costs of borrowing the stock would minimize the strategy very quickly. So it’s a cute thing to say, but at the end of the day, it’s all wrong.

Again, this is where things get twisted by repetition and the message that gets out to the lay public does real damage. It’s easy to parrot in hindsight “obviously they were shit, look at what happened.” But that’s not really true, and it’s lazy thinking.

They are very definitely NOT shit, but the models need to be refined. CDO’s were worth what they were made out to be – under normal market conditions. They are also what people expect them to be worth under extreme market conditions, such as we’re in now. What people misunderestimated (;-)) was the likelihood of the extreme market conditions – the “fat tail” or, to use the now suddenly popular Nassim Taleb’s term, the “Black Swan.” They failed to see not only that it was more likely than they thought, but that the very ubiquity of the structures in place increased the likelihood of this failure. That’s a systemic problem, and you’re blaming the trees for the forest fire.

Here’s a simplified primer on CDO’s for those unaware, rather than the hyperbolic descriptions in the conventional wisdom.

Suppose you have 100 people that each want to borrow $10, and they’re willing to pay you back $12 in a couple of weeks, because they know people don’t think that they’re reliable, but they all think they have great business ideas. You don’t have $1000, but you can rustle it up from your friends, because you have up to an extra $200 to offer.

You have 1 friend Andy, who’s a little skittish, but has $100 to lend. You tell him great, we’ll use that, and I’ll pay you first, out of all of the money that comes in, but since we’re paying you first, I’m not going to give you 20% interest, instead, you get 3%, because let’s face it, the odds are, 90% of the people are not all going to default. What’s more, we’ll take a little bit of that 17% that’s left over and give it to our friend Izzy over here, and he promises that if the borrowers don’t pay, he’ll give you your money back, deal? This is your AAA tranche.

You have another friend, Mike, who has about $890, and is ok with taking a little risk, as long as he’s rewarded. So you say “I’ll give you the 20% cut, plus a little sweetener on top out of the money that would have gone to AAA above, let’s make it 21%. But you have to get paid after Andy. If everybody pays? Mike makes a killing. But as long as 85% or so pay, he’ll still get his money back. This is your mezzanine tranche.

So there’s another $10 to lend, and you put your own $10 in, at 30% interest. If even 1 person doesn’t pay, you get wiped out. But if not, that $10 you risked becomes $13, not a bad ratio. This is the residual.

That leaves about $7 left over. $2 goes to Izzy, your insurer. He’s taken a look at this, and thought “These are pretty safe, so if I do a lot of them, and only one in a blue moon totally fucks up (I mean, really 90% default rate? That’s unheard of!), I’ll come out ahead.”

Out of the last $5, 2 goes to the lawyers, the trustees, the underwriters and everyone else that set up the deal, and you keep the last $3 for yourself as payment for putting it all together. Everybody walks away happy, and usually they work swimmingly. Now, is it really obvious that these are, as you say “shit?”

In theory, these work. A paper written in the 50’s that analyzed non AAA debt at the time showed that investors overstated risk. You make 1 or 2 risky loans on their own, and there’s a good chance you go bust, so no amount of interest is worth it. But if you make 100, or 1000? Enough of them pay off that the high levels of interest more than make up for the ones that go bust. It’s an effective investment strategy, and the basis for most securitizations, as well as high yield bonds of all sorts.

The problem, of course, is correlation. When the likelihood of 1 of your loans going bust is not independent from all of the others. That’s what happened here. Not only did all of the borrowers use the money for risky purposes – they used it for the SAME risky purpose. It’s like they all decided to invest in Beenie Babies at the same time, with predictable results.

The Residuals and the Mezzanines were risky going in, we knew that, that’s not the problem. The problem is that AAA’s suddenly seem riskier than they were supposed to – not because of the CDO, but because of the market supporting the CDO – and the guys holding the AAA’s aren’t allowed to hold anything that’s rated less than that. So all of these Andy’s out there, have to sell them at the same time. There’s an artificial glut, because there aren’t enough buyers, but Andy still has to sell them, so the price goes down. Way down, because you have forced sellers who have an incentive to get cash, even if it’s less cash than they’ll eventually get from their investments if they held onto them.

Is that the fault of the CDO? Well, only marginally. As long as Beenie babies are worth something, this will work for a time. The first guy to do this just financed the Beenie Baby trade, and probably makes a killing. The 2nd through 10th see this, and do the same thing. All of a sudden, 100 more people put together a CDO, and there’s a glut of beanie babies, and the whole thing comes crashing down. They ruin it for everyone.

Each of these vehicles are looking at it through their own prism, and are not really able to be responsible for the actions of others. The problem was that there’s no guy on the outside watching the whole thing and going “whoa, slow down there pardner, we’re in trouble if this all fucks up.” Changing the requirements (the guy putting the deal together has to put more of his own money in? You need to make the AAA tranche smaller and smaller?) changes the incentives, and the economics. This is where regulation and oversight come in, you’re right, there needs to be more, but not in the way you think. But again, that’s the weakness of the system, not the product.

Again, it’s not insane. It’s just that small fluctuations can have large effects that weren’t accounted for, but that doesn’t mean that the rationale is entirely wrong, just its implementation.

And that’s, again, where perception come in, people hear the words “risk” and “bets” and think “Oh no, they’re just gambling like this is blackjack,” when that’s patently untrue. Investments are risks. They’re gambles. There is no getting away from that. You don’t, and can’t, know for a fact that when you loan someone money, they’re going to be able to pay you back. So there are people out there that need money and financing, and people that have money and can offer financing, as long as they’re compensated for their risk. Wall Street brings them together. The industry has spent a lot of brainpower analyzing these risks, and putting together formulas that approximate how much they’re worth, and how to spread them around. These aren’t perfect models, and can’t be. It’s not an exact science, and things go wrong, but that doesn’t mean they don’t have value. And if you eliminate the taking of risk in the financial markets, you eliminate the financial markets, and that will be to the detriment of all of us, because things will just grind to a halt (ie. like right now).

Rug Burn Junky on 26/3/2009 at 16:18

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Don't get me wrong, I actually also think that AIG should "fail," and it is in the process of doing so. And I think as an institution, they are dangerous and provide (and respond to) unhealthy incentives. However, that doesn't necessitate a hard landing that causes more pain than necessary in order to correct these incentives.

Another take (with which I actually agree in principal, but disagree with in practice for the same reasons I outlined here), is from (http://blogs.harvardbusiness.org/haque/2009/03/heres_why_we_should_let.html) Umair Haque, one of my favorite business theorists.

Rather than approach it from a hard-line laissez faire libertarian viewpoint, he's coming from the other direction - practically a commie - but I think he's ultimately making the same point that you are. ;) He diverges however, at the critical point that he doesn't agree with the idea of backstopping the counterparties. This is a critical point that leaves him with intellectual consistency, but ignores the short term drastic effects.

That said, he's also not a mainstream economist - he's on the fringes, and his goals are not really aligned with what most people would take as a priority. I ultimately think he's right in the long term, but the short term costs are too much to bear.

Rug Burn Junky on 26/3/2009 at 19:35

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1) I'm not your monkey, sitting here just for your amusement, ask an actual question rather than just throwing out subject matter.

2) He's a bit of a cunt, but a good mayor, and

3) Black-Scholes is a wonderful, but flawed, heuristic.

Morte on 26/3/2009 at 21:10

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No, and that's the problem. Certainly the ratings agencies didn't see it. But if you repackage a bunch of housing mortgages who only have a chance of getting paid if the market continues to rise (I wouldn't call the housing bubble normal market conditions though), it's shit, even if someone points to a nice mathematical formula that says otherwise while trying to hide a smirk. Clearly a CDO isn't terrible by necessity, but if all that goes into it is the worst of the worst it's not going to be worth much. And because it's a bunch of loans in there, it makes it that much harder to judge exactly how safe an investment it is.

If the rating agencies had been capable of assessing those instruments, this wouldn't have been nearly as bad.

(Have you read The Black Swan incidentally? Over-reliance on bad models making people fail to see that high-risk events are not only more likely than people think, but radically increase their exposure to those events is pretty much what he spends the entire book railing against. Taleb's insufferably arrogant at times, but it's hard to say that he doesn't have a point. Especially in the light of what's just gone down.)


Even if you buy a CDS, it's not the same as having a cash reserve - as AIG have aptly illustrated, you might run the risk of them not being able to cover it - and it's pretty crazy to be able to pretend it is.

Please correct me when I go hilariously wrong here, I've just recently started digging into this, but a CDS is basically insurance, yes? Company A buys a loan, and wants to guard agains a default, so they pay company B X amount of dollars so that company B will pay the full amount if the debtor defaults. Which seems perfectly cool.

However, as I understand it company B doesn't have to show any money if its credit rating is sufficiently awesome. Which seems less cool. You can't do that with most other things. And if a bank can lend money on the basis of a CDS being just as good as real money, it seems really not cool.

And then there's the "naked" CDS, where noone has anything to do with the original asset. Company C is paying company B the same X dollars company A is, against the promise that company B will pay company C the same money it pays company A in case of a default. Which is just betting, really.

And because you can treat a CDS as any other asset, you can dump them together, carve them into tranches and sell it as a CDO.

So you could have people dumping BBB loans together into a CDO, and have part of it come out smelling of roses, and be grade AAA paper. And then someone could take out a CDS - or a ton of people could, since anyone can bet on the outcome - on the BBB tranches of that CDO. Which could be dumped in amongst another bunch of crap and turned into a CDO with part of it rated AAA. Repeat ad naseum.

If someone can see that whole picture (and I haven't gotten things completely wrong), it's not hard to see how misjudging the risks will have a big outcome, because there's much more than that one CDO riding on the underlying loans.



I don't disapprove of all things Wall Street does. As you say, there's a need to bring financiers and those in need of financing together, and it can perform that function perfectly well. But when you introduce instruments like naked CDS, you're just running bets, and it turns into a casino that does nothing useful for the economy while creating risk.

Mix in structural flaws like lack of oversight and perverse profit incentives for individual traders leading them to actions that go against shareholder interest and you get things like 400 idiots in AIG underwriting half a trillion of CDS without anything to back it and breaking the economy.