At reckoning day, the bill was footed not by rich, dumb investors but (in part) by the failed investment banks’ shareholders and (the majority) by the U.S.When teaser rates ended in a real estate market that had ceased to grow, debtors defaults increased and a whole avalanche of bets became due.At this point, the very banks who originated the instruments forgot (or maybe did not understand really) that the rate upgrades were based on the unproved assumption of a very weak correlation between real estate markets in different part of the country, and started treating them as “true” triple-A bonds: instead of dumping them on “dumb money” (as was the original plan), they started accumulating them.Think of shorting as purchasing an insurance policy against the security not reaching maturity. Each of these bets (alongside the stocks of all players) could be shorted in fixed-income parlance, shorting is done with credit default swaps (CDS) which, due to the high rating of the bonds, costed very little.The rate upgrades were largely instigated by the investment banks who created the instruments, as the rating agencies did not have adequate models of their own.Depending on the pecking order of repayments, MBS could be sliced in tranches, the worst of which got shuffled up again to create CDOs and again these got upgraded thanks to the further distribution of risk.BBB-rated loans got securitized as bonds (MBS) representing bets that “no more than (say) 5% of this loan pool will default” by pooling them together in large numbers they earned an AAA rate upgrade because “at no time in history house prices went down across the country at the same time”.A booming real estate market made it easy for borrowers to refinance when the teaser rate expired, on the back of an appreciated asset (the house) and un-scrupulous lenders took the opportunity to increase the loan amount to totally unreasonable levels.The teaser rate mechanism made those loans very attractive, even though a 6% “teaser” rate seems sky high now that we are dealing with ~1% rates.very likely to pay back the loan) expands the pool of loans enormously, expanding therefore the profit of those who lend. Lending money to people who do not qualify as “prime borrowers” (i.e.Here is what I understood, even though I am ready to stand corrected. However I must say I expected a little more both in terms of explanation of the underlying mechanisms and in terms of what actually went wrong. In a nutshell, this is the story of four people who made a fortune betting against the market that in 2005/2006 was generating the bulk of Wall Street’s profits, subprime loans. And “The Big Short” even has its own star-studded casted film coming. In fact his only book I am missing is “Liar’s Poker” which I surely will read next.
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