In Michael Lewis expose the origins of the credit crisis from 2008 to 2009, "The Big Short: Inside the Doomsday Machine," we see how greed and ignorance created the perfect storm that led to the worst financial crisis since the Great Depression. As a financial professional who helps families and businesses plan for retirement, I help implement insurance strategies and planning. When we implement plans that often rely on third-party ratings of insurance companies and products that give us confidence that plans can be met.
In any case, the experience of the last three years should give us pause when taken for granted ratings companies such as Moody's and Standard and Poor. I'm not saying we should discard these classifications completely - instead we must carefully consider as a piece of the overall picture of financial strength. These organisms were wrong when they engaged in rating complex products, while relying almost entirely on the data supplied by the companies that have created the same products.
mortgage bonds account development and evolution of financial products such as credit default swaps Lewis is the opinion of a machine-readable insider money from Wall Street. Things went wrong when the rating agencies gave their seal of approval to these products for sophisticated investors such as hedge funds and institutions. Surprisingly, the creators of these products - Citigroup, Goldman Sachs, Merrill Lynch and other banks - often were not so sure of the value of home loans that were the foundation of the underlying bonds.
The basic problems are mortgages that formed the basis of the bonds after 2005 were subprime loans increasingly poor quality and rating models agencies do not consider that property values may decrease. Moreover, banks that create products tailored to their presentations to agencies so that the credit risk of the underlying bonds were not truly diversified and therefore more risky than it seemed. Indeed, the very risky bonds were rated AAA super-safe.
This is how the products were built and what went wrong:
1. Individual mortgages are grouped into mortgage bonds. Investors in these bonds backed by assets is paid off them as individual mortgages are paid.
2. Mortgage bonds are rated for the financial stability of the rating agencies based on their assumptions about default rates by individual mortgagees. The values of the underlying homes and FICO scores are two key measures that look.
3. Investors in bonds to buy insurance called "CDS" against the risk of these mortgage bonds will not bear fruit as expected (they will default). The price of this insurance is based on the rating of the mortgage bonds they received.
4. Big banks packet thousands of these smart investors bonds and swaps trading. Some banks generated many bonds they could not sell them all immediately so that they clung to them in their own accounts.
5. When adjustable rate mortgages began to reset in 2007 and 2008, the new higher rates forced many individual mortgagees to default. The cascading effect of high defaults and home values sink insurance plans triggered swap credit risk.
6. Banks were forced to pay in insurance and bonds held devalue their own books. Ultimately, banks were forced to come up with more cash to shore up their finances or go bankrupt.
As I walked away after reading this book with a clearer understanding of how Wall Street works, I'm not sure this knowledge makes me more confident with the capabilities of the different actors. Lesson learned: Be careful of the herd mentality in all forms of investment. Even the most sophisticated investors can get into trouble when they get greedy and too dependent on someone else to do your own homework.
"The Big Short: Inside the Doomsday Machine" is available on Amazon.com
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