01. The subprime mortgage crisis ten years ago and "The Big Short"
In September 2008, Lehman Brothers, the fourth-largest investment bank in the United States, declared bankruptcy, and the subprime mortgage crisis became a wildfire and spread across the world. Time is in a trance, 10 years have passed since now.
Ten years of life and death are boundless.
In 2015, the movie "Big Short" was released, depicting the various living creatures in the subprime mortgage crisis with cold, heavy brushwork. Taking the four-way big shorts to see through the property market bubble as the main line, tell the story of them shorting the property market and making huge profits. The four short positions are:
Short number one: Michael Burry, the fund manager of the same name of ScionCapital, because he always isolates himself from the outside world with heavy metal rock music, we call him rock Burry ;
Short No. 2: The prototype is Deutsche Bank trader Greg Lipppmannt. He was inspired by the rock Burry and started to promote CDS transactions on a large scale. His way of making money comes from recommending short-selling tools CDS to investors to earn commissions. A total of 35 billion US dollars of CDS were sold (5 billion of which were held by Deutsche Bank's own account), we call him the intermediary Lipppmannt ;
Short No. 3: Mark Baum, the helm of a private equity fund, directly led a team to conduct research on the property market, and even went to nightclubs, and finally believed that there was a huge bubble in the property market, and we called him Mark the doer ;
Short No. 4: Hedge funds CornwallCapital’s Jamie Mai, Charlie Ledley, and retired trader BenHockett, their investment strategy belongs to a very niche investment genre-constructing long-tail strategies, looking for asymmetric transactions, betting on small probability events that are underestimated, In the movie, they only have a capital of 30 million U.S. dollars, so we call them grassroots Jamie and Charlie .
02. Is it possible for the mortgage to default overall?
The background of the story is based on the belief that house prices will always rise. According to historical statistics, the mortgage default rate has always been low, and housing prices have been rising. How can a large-scale default break out? Federal Reserve Chairman Ben Bernanke even directly declared in public: "We'venever had a decline in house prices on a nationwide basis" (We have never experienced a nationwide decline in house prices).
The so-called "good swimmers drown, good riders fall", before those big crises appeared, these "good swimmers" and "good riders" were confident enough to laugh at those who smelled the breath of crisis.
The first person to smell the crisis in the movie is Rock Burry. He shut himself in a small room to read the original materials of the buyers behind the MBS. After reading a lot of boring materials, he found that in most of the materials, 50% of buyers have no information. This means that either these people are completely ineligible for the loan, or the bank does not require them to provide any information when lending, so as long as the lender fails to repay the loan, a large-scale default is possible. He analyzed MBS one by one and found out those without any income proof + extremely high loan-to-value ratio (high leverage) + floating interest rate (more likely to be cut off due to the Fed's interest rate hike) + relatively recently issued mortgages (comparison of issuance time) The long subprime mortgage has a certain buffer after the appreciation of the mortgaged real estate, so the probability of withdrawing is relatively small.) He decided to short the bonds of the worst quality.
Since in a bubble, everyone uses low-interest loans to bet that the property market will "forever rise", so it is particularly important to confirm the property market bubble. Rock Burry came to the conclusion that "the property market has a bubble" through rigorous data analysis. The agency Lipppmannt overheard the idea of Rock Burry shorting the property market in the bar and confirmed the same conclusion. After being promoted by the agency Lipppmannt that there is a bubble in the real estate market, the doer Mrak chose to directly investigate the real estate market. Two scenes in the movie are particularly interesting:
One is that when Mark asked the tenant if the landlord was at home, the tenant told him it was the name of a dog. In other words, the bank even gave a loan to a dog!
Also, in a nightclub, Mark found that even a stripper had bought five houses and an apartment with a 5% down payment, finally believing that there was a huge bubble in the property market.
03. A short-selling tool with optionality: CDS
The obstacles in reality are obvious. In addition to the ridicule of short-selling the property market, the lack of tools for short-selling the property market is also an important part.
Rock Burry's approach is to request a customized insurance from an investment bank. This type of insurance is CDS. CDS is a financial derivative product similar to debt default insurance. The purchase of CDS transfers the default risk of the purchase of debt to the selling institution of CDS (usually an investment bank or insurance company). The CDS in the movie means that when the MBS bond defaults, the seller of the CDS (can be understood as an insurance company) has to settle all the principal and interest of the MBS. Assuming that the principal and interest of a US$1 million loan are US$1.1 million, then if the person who repays the mortgage does not pay the debt, the insurance company will have to pay US$1.1 million. Of course, in normal times, CDS buyers have to pay premiums (premium) regularly.
It can be seen that the content of this CDS transaction is that when the real estate does not collapse, insurance premiums need to be paid on time every month, and only when the real estate collapses can compensation be received. Therefore, unless the real estate crashes, Rock Burry is giving money to investment banks.
But the key point behind this CDS is that the losses are limited and the gains are huge.
As Michael Burry said in an interview in reality, transactions should look for transactions with optionality. The optionality here is a transaction with option attributes. Your limit loss is clear. The maximum loss is the premium, and the gain is huge in theory. This is the asymmetry of this strategy.
In the movie, the grassroots Jamie and Charlie are also masters of such strategic elements as CDS. The two young men used US$110,000 as the principal to establish a fund company, which quickly rolled to US$30 million in three years. This kind of optionality strategy is also used: constantly buying out-of-value call options of the company in question.
Therefore, good fighters are invincible.
04. Wall Street resistance: both an athlete and a referee
Rock Burry prepared for a short position by buying large amounts of CDS from major investment banks such as Goldman Sachs. The agency Lipppmannt peddled CDS a lot in an attempt to earn commissions. Doer Mark bought a large number of CDS recommended by the agency Lipppmannt after investigating the property market. Grassroots Jamie and Charlie used the retired trader Ben to match up and finally met the ISDA threshold of investment banks and held long positions in CDS. The bears are ready to short the property market. They only need to pay CDS premiums to investment banks on a regular basis, waiting for the property market to collapse, and every day there are news that buyers are not repaying their loans. It seems that everything is as they expected and they will earn immediately. earned a lot.
They have constructed optionality strategies, but they have been losing money. Good swimmers and good riders are not paper tigers!
The whole system is resisting, and this resistance is so strong that the bears begin to doubt themselves: "Am I wrong?"
The intermediary Lipppmannt, as a "short advocate", naturally also underwent tremendous pressure. After being scolded by the doer Mark and employees for a long time, he decided to arrange these short sellers to go to the LasVegas Securities Industry Summit to directly meet with counterparties who have long house prices to strengthen their short-selling confidence.
At this securities industry summit, the bullish house price people reached a crazy climax.
In LasVegas, the agent Lippmann has contracted a Japanese food shop’s teppanyaki grill restaurant with a total of 4 barbecue stations. Each station has a short seller and an investor who sells CDS. The agent Lippmann hopes that customers will understand through direct dialogue. How crazy the whole system is.
Even, when the doer Mark took the information they collected and contained a lot of MBS information that did not have any borrower information to question Standard & Poor's why it rated these MBS AAA, Standard & Poor's replied: "If we don't give AAA , These companies will go to Moody's (S&P’s competitor) for rating."
This resistance benefits from investment banks' pricing power in the over-the-counter market. Products that are traded on exchanges, such as large stocks and bonds, are generally difficult to control due to the large number of participants and transparent prices. On the other hand, over-the-counter trading is another world, and it is usually a gambling between investment institutions and investment banks. After the transaction, it is usually the investment bank market maker that determines the price of the product. Therefore, the pricing power of banks is particularly important here. In other words, investment banks are both athletes and referees.
In theory, if the price of subprime mortgage bonds falls, the price of insurance purchased by big shorts should also rise rapidly, and short selling should make money. At that time, the price of subprime mortgage bonds was plummeting. Since investment banks did not empty their positions in subprime mortgage bonds, plus their pricing power, they all said with shame that the price at which they sold insurance had not changed. The core of the capitalist financial market is mutual trust. At that time, the lack of credit behavior of investment banks also became the last straw to overwhelm the market.
For the bears, waiting for the last straw to fall requires unparalleled paranoia to stick to their own strategies. There is this scene in the movie. Howie Hubler, a Morgan Stanley bond trader, was a tragic figure who was short-listed at the beginning but was blown out. He did not persist. The premiums required by CDS swallowed up Hubler's short-term benefits. In order to offset this part of the cost, he chose to sell part of the CDS. In the end, these transactions left $9 billion in debt-the largest single transaction in Wall Street history. Loss record.
Short selling is not so easy! If you want to cross the Yellow River, you will climb the Taihang and snow-covered mountains.
05. Are the big bears bloodthirsty devils?
The ending of the story is, what is the final benefit of these four big shorts? The short No. 1 rock Burry fund earned 750 million U.S. dollars for investors in 2007 with a scale of 600 million; the short No. 2 intermediary Lippmann received 47 million U.S. dollars in commission in 2007; the short No. 3 doer Mark earned no specific details. Disclosure, but his fund income should be similar to Burry; the short four grassroots Jamie and Charlie made a profit of 80 million US dollars, which is not large, but after all, they only have 30 million US dollars in principal, and this return is also very impressive.
On the whole, these four people earned less than 2 billion U.S. dollars. And another big bearer who is not described in the movie, John Paulson, made 20 billion U.S. dollars during the entire subprime mortgage crisis!
These numbers are astronomical figures for us ordinary people. Many people call them shameless people who make a fortune and are bloodthirsty demons.
However, human nature is so greedy, and human memory is so short. At the end of the movie, it is described that the Federal Reserve provided assistance to financial institutions that participated in the crisis after the subprime mortgage crisis, and a new type of derivative called a customized CDO (BespokeCDO) soon appeared on the market, seeming to convey "Nothing changed" message.
The people of Qin have no time to mourn for themselves, and later generations to mourn; later generations mourn and fail to learn from it, which also makes future generations mourn for future generations again.
(The full text is over, thanks for reading)
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There are some unpredictable technical terms in the movie: "Wall Street loves to invent those very mysterious terms, so that they can show their awesomeness."
1. Housing Mortgage (Housing Mortgage), this term is very familiar to us. As a home buyer, we apply for a housing mortgage loan from the bank by paying the down payment, and agree to repay the loan every month, and the repayment will be completed in 30 years.
2. Mortgage Backed Security (Mortgage Backed Security, MBS), the bank has a mortgage loan that generates monthly cash flow, but the bank does not want to wait 30 years to recover all the funds. So they sold these loans to other financial institutions in the form of MBS. MBS is a type of Asset Backed Securitization, which aggregates assets with poor liquidity but predictable cash flow and transforms them into highly liquid financial products.
For example, if Bank A lends 1 million to a buyer, Bank A has a mortgage loan that the buyer will repay every month for 30 years. The total value of this loan, including principal and interest, is 1.4 million, but the bank does not want to After holding it for 30 years, Bank A packaged many loans in the form of MBS and sold it to Financial Institution B for a price of 1.2 million yuan. Financial institution B bought 1.4 million assets with 1.2 million, and bank A got a difference of 200,000 through reselling. Everyone was very happy.
So who will financial institution B be? In the US market, nearly half of MBS are sold to the famous Fannie Mae and Freddie Mac. However, in most cases, Liangfang is only a distributor of MBS. After they bought MBS, they sold them to the world-governments (sovereign wealth funds), banks, hedge funds, insurance companies, pension funds, Individual investors and so on. Under this circumstance, a complete chain of capital flow is formed: from the buyer who buys a house with a loan to the bank, to other financial institutions, and finally to investors all over the world.
3. Subprime Mortgage Loan (Subprime Mortgage Loan), Fannie Mae and Freddie Mac will purchase high-quality loans in MBS due to government supervision. So what is a subprime loan? Simply put, it is a loan provided by a bank to a low-credit house buyer.
But how to tell which MBS is priority and which are secondary?
This requires the adoption of the Big Three international rating agencies, Standard & Poor's, Moody's, Fitch and other rating agencies. For example, Bank A wants to sell MBS with a price value of 1.4 million US dollars, then how to price it? At this time, Bank A finds Standard & Poor's and provides the buyer's information. Standard & Poor's grades this MBS, such as AAA, which means that Standard & Poor's believes that this MBS has a very low default rate and is therefore a high-quality MBS. Or C level, also called "junk level", means that Standard & Poor's believes that the risk of defaulting on such securities is very high. The higher the rating, the lower the investment risk, and the more expensive the price; the lower the rating, the higher the investment risk, and the cheaper the price.
4. Collateralized Debt Obligation (CDO). Because loans are distinguished between high quality and low quality, a secured debt obligation (CDO) was created. CDO is a structured asset securitization product. Similar to MBS, investment banks will concentrate credit assets (such as housing loans and other loans, bonds, etc.) that can generate predictable cash flows to form an asset pool, and repackage these assets based on credit ratings to form different series (Tranche) products are sold to investors.
The structure of CDO is more complicated than that of MBS, and many investors have difficulty understanding its potential risks. Moreover, many rating agencies do not give credit ratings based on the credit risks of the assets that make up the CDO, resulting in some CDOs made up of subprime loans that can also receive AAA safety ratings. CDO conceals the credit risk of subprime mortgages to a certain extent, so it is also regarded as the culprit that triggered the subprime mortgage crisis in 2008.
5. Credit Default Swap (CDS), CDS is a financial derivative product similar to debt default insurance, and is the main tool for short selling in movies. The purchase of CDS transfers the default risk of the purchase of debt to the selling institution of CDS (usually an investment bank or insurance company). The CDS in the movie means that when the MBS bond defaults, the seller of the CDS (can be understood as an insurance company) has to settle all the principal and interest of the MBS. Assuming that the principal and interest of a US$1 million loan are US$1.1 million, then if the person who repays the mortgage does not pay the debt, the insurance company will have to pay US$1.1 million. Of course, in normal times, CDS buyers have to pay premiums (premium) regularly.
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