Some Ramblings - The Big Short (2015) by Srinivas Kanchibhotla
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In computer terms, it is called recursion, a mechanism whereby a larger task can be accomplished by performing a smaller function over and over, like finding out the sum of first 100 natural numbers, wherein the first number is added to the the third...and so on until the limit is reached. The power of recursion can quickly turn on itself unless a proper exit strategy is provided, failing which the program would enter what is known as an infinite loop from which the program can never recover, like in this example, terminating the addition upon reaching 100 is the exit strategy. If no such break out condition is taken care of, the function performs endlessly gobbling up all the resources and sometimes even brings down the system to a grinding halt.

Here's a harmless statistic at the beginning of the crisis in 2008 from which some of the global financial systems have yet to recover from completely - there were a few hundred million dollars in the market riding on the risky sub prime mortgage loans (loans that have been disbursed with lax standards) sliced diced and repackaged into what were known as, quite ironically, securities. So far so good. The securities had a combination of good, bad and worse (more of the last 2) mortgages (the degree depending on the borrower's financial wherewithal to pay the loan back in full) that were sold in the market by the investment banks to clients, both domestic and foreign. Had there been a default of payments on those mortgages, owing to a sluggish economy that hasn't completely recovered post 9/11 in 2001 where demand was flaccid and supply outpaced the requirement, the securities would have failed, just like any other failed stock of a belly-up company, and the ones invested in it would have suffered losses to the tune of the original few hundred million dollars, which, though a considerable loss to the investors, wasn't a staggering enough amount to cause a worldwide financial calamity. So what, where and how did that harmless amount end up wrecking the whole system?

'The Big Short' is a sharp, caustic, sad, incisive and morbidly funny observation of the birth of greed, avarice, gross oversight and unethical collusion of the mortgage companies, commercial and investment banks and insurance companies that unleashed the power of recursion into quickly turning an otherwise failed financial instrument (securities) into a juggernaut of unparalleled financial havoc and destruction. Based on a non-fiction book and in the able hands of reputed comedy writer/director, 'The Big Short' translates the painfully funny and mockingly sad tale of the impending doom as the key players in the market march head on towards the eventual collision, all the while amping up the hoots, whistles and merriment. The movie does a great job simplifying the arcane market talk/speak into more user friendly language to lucidly explain the sheer audacity and the incredulity of how the banks doubled down on what were clearly (at least to them) losing propositions, in the hope that they are all rescued by that one Hail Mary clause that insurance companies use quite frequently to turn down even legitimate claims - act of God, where God indeed blesses America for its mortgage market to never ever go down, economic slowdown or other logical reasons notwithstanding. From the current RBI governor, Raghuram Rajan, who has written a position paper on how unsustainable the system was back in 2005, to quite a few unsung heroes (whom the movie follows, and some even benefited greatly from that foresight to the tune of $269 billion dollars (yes, that's right, that a "b"), by betting against the market), who were able to pin point, not just predict, with quite some accuracy the systemic risk and the instability, there have been a few voices of reason that saw the inevitable crash and tried to warn the world in their own ways, all when the market was turning red hot by the hour. But then again, the world was getting richer and richer by the minute, the individual stocks and portfolios, pension funds and 401(k)s getting fatter by the day, even the governments around the world were self congratulating themselves for their windfall profits that would soon fill up their coffers betting on the American housing market, and those voices of reason were dismissed away as false prophecies of doom; after all, for all his fame, even Nostradamus was wrong about a few things, wasn't he? And then, destiny came calling.

So what was that math that turned the few hundred million dollars into financial equivalent of a nuclear bomb? First, there were 'Credit Default Swaps' (CDS). As the name indicates, if someone defaulted on their credit, this instrument offered a hedge to cover for that loss. These kind of hedges have been a part of the system to cover for risky positions for long. So no problem there. The issue was not these CDSs. The real atom bomb was the CDO - Collateralized Debt Obligation, which is another instrument that offered another hedge against the CDS, like betting on a bet. And whenever such instruments were created and traded, money immediately changed hands in fees, commissions and premiums (almost incentivizing the creation of such instruments). So until the bet failed (mortgage was defaulted) and it was time to collect the insurance claim (underwritten by major insurance companies, like, AIG), the premiums ran up the tab and the banks and the insurance companies were happily being forked over the money for essentially doing nothing. That might have taken the original amount of a few hundred million dollars and made it 50 fold, what with all the bets and the side bets. And this is where greed enters the scene. The banks flush with all the monthly premiums on the CDSs and the CDOs, allowed for multiple bets on the same instrument raising the risk to astronomical levels. So a security has a CDS, a CDS has a CDO, and that CDO was allowed to have multiple (hundreds and thousands) of 'synthetic' CDO's riding on that one single security. Now imagine a few million securities in the market, based on a few million actual mortgages taken out on a few million homes in the country. The math simply recursed from that point on - million securities X associative CDS X supplemental CDO X CDO X CDO X CDO X CDO.....and before anyone knew a few trillion dollars of the world economy were riding precariously and obliviously on a few million mortgages and on the eternal hope that the housing market doesn't go bust. And when the hiring slowed down and the economy cooled down and people could no longer afford the million dollar homes that they got themselves in at bargain basement move in costs, the tiny snowball from up above started to roll on to quickly gather steam and momentum and size gobbling up everything within its path. Care to hazard a guess on what percent of the actual loans were these sub prime mortgages that brought about the greatest crisis since the Great Depression in 1929? Ans: 6%. What would had happened had that number been 15 or 30% even? End of Days? Apocalypse? Judgement Day?

From out of the ruins, comes rumination first, pondering on how come the system was allowed to bet against its own well being in the first place, and recrimination next, trying to find the heads to lay the blame on, from the mortgage companies who were making thousands of dollars on each closure and so threw (financial) caution to the wind and dropped down their award criteria to mere pulse, breath and a heart beat and not to any repaying abilities (there's even a category for such loan, it is called NINJA - No Income No Job), the commercial banks which were forcing the mortgage companies to sign up more and more people to quickly pocket the setup fees and transfer the loans (risk) to the market, where the investment banks grabbed the ball to create incestuous financial instruments for the sole purpose of making commissions on every deal that traded these securities, and the rating agencies (the S&Ps, Moody's, Fitch's) that hid the inherent risk of those loans and awarded stellar ratings on even the risky securities, again, earning filthy amounts on each transaction, all the way up to the Federal Reserve Chairman, Alan Greenspan (the once poster child of deregulation and 'market is always right' policy and philosophy) who made public statements about how sound the American housing market was, which further contributed to the steaming up of the market.

Crisis is when things go out of hand on actions not intended to cause it. However, if all the signs, history and math point to the inevitable doom and yet actions are performed, decision are taken to either cause it or hasten it, it is no longer called Crisis, it becomes fraud, 'The Big Fraud'


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