Last week, Reason.com published my review of Michael Lewis’ The Big Short: Inside the Doomsday Machine. As is the nature of articles like that I wasn’t able to include all of my thoughts on the book. Here is one of those that was unfortunately left on the cutting room floor, and it is relevant to the Goldman/Abacus saga unfolding in today’s political theater.
One of the really fascinating aspect of Lewis’ book is the subtle morality tale that sits in the background of the book. Or perhaps, the lack thereof. Lewis offers his characters up as courageous, cunning, and ultimately successful investors. They accurately saw the house on fire (confidence in housing was excessive, and MBSes were packed with crap) and went out to buy fire insurance (CDSes that would pay out when troubles eventually hit the housing sector). What they didn’t do is make it their sole cause to stop the fire from destroying the house.They didn’t try to shout if from the roof tops—though Lippmann wasn’t exactly quiet when trying to draw other investors into the same side of his trade. They didn’t set out on an Al Goresque campaign to alert the world that the financial markets were burning to the ground. And they even contributed to the severity of trouble for financial giants by being buyers for ill-placed bets from sellers of credit default swap insurance. Does this make them heroes or villains?
It is an unavoidable fact that Eiseman, Burry, and Cornwall Capital contributed to making the market meltdown a bit worse by buying credit default swaps that Goldman, A.I.G., and others were willing to sell. They certainly didn’t set the fire. But its like they were willing to sell firecrackers to people who were unwittingly thinking they were buying wood to make the house bigger. They didn’t speak up and say, “Hey! You’re going to make this worse.” In buying credit default swaps on self-identified weak mortgage debt, they didn’t stop the problem from getting worse.
However, they are not the villains here. Claims that they are—or that John Paulson, Goldman Sachs, and anyone else that made money on the crisis—are a strange view on justice. Something akin to blaming weathermen for Katrina. Weathermen couldn’t stop the storm even though they saw it. They could warn about it, but some people simply wouldn’t listen. And in the bubble period of irrational exuberance, no one was listening.
If there is any villain it would be the regulatory structure that allowed so much faith to be put in the ratings agencies. In this metaphor, you could imagine the ratings agencies labeling boxes of firecrackers as timber for building a home. Simply because guys like John Paulson were willing to make a bet that the housing market would collapse doesn’t make them a villain. They looked inside the boxes (MBS pools) and examined the material (weak loans).
Specifically on the Goldman/Abacus saga, IKB and ACA say Paulson was a villain because he knew the mortgage debt he picked was going to go bad. They say Goldman was a villain because they didn’t make it clear that Paulson was cherry picking crap on the other side of the trade. But beyond whether or not Goldman did say that (tho if Fabrice Tourre broke an SEC rule that should be prosecuted), it shouldn’t matter who was on the other side of the trade, and Goldman shouldn’t have had to tell IKB and ACA that. ACA—a self-labeled sophisticated investor—should have looked closer at the investment it was insuring. IKB should have done their research. If they had, then they would have discovered what John Paulson found: there was a lot of crappy mortgage debt being labeled AAA and it wasn’t worth the risk.
Lewis’ characters—Eisman, Burry, Lippmann, Charlie Ledley, Jamie Mai, and others—all did their homework too. This might not make them heroes to anyone other than Ayn Rand and followers, but it doesn’t make them villains either. It was not their job to alert the world that IKB/ACA and others were making stupid bets with their money on housing investments. The government claimed that it was it’s job, and whether or not that is philosophically the role of government, regulators failed miserably. If there is a collective villain, the regulatory structure would be a ring leader. Investor stupidity would be a trusty henchman.