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Got an economics question:
I was watching 'Margin Call' the other day, and there is a scene where two day traders are lamenting the (then incipient) 2008 financial crisis. The senior of the two gives his justification for existing to the other:
Is there anything to this? if so, how does that work? I always assumed that day traders basically created no value and just shuffled wealth around to nobody's benefit.
Margin Call is a great movie but it’s even less realistic than the average Wall Street film, in part because most tend to focus on people more interesting / more on the fringes of finance (like The Wolf of Wall Street) rather than the comparatively more staid PMC culture that exists in bulge bracket investment banking and even increasingly (probably since about 2000) on the trading floor. The bank in Margin Call is based on Goldman Sachs, which partially hedged some of its exposure to the mortgage crisis. But the real life story (and there is some reporting on it) is less exciting than the movie, the events took place over a much longer time, and the drama with the board in the movie was fictionalized. I hope someone makes a similar movie fictionalizing the Credit Suisse collapse though, I think that’s a more fertile ground for storytelling although it would work best as a miniseries that takes place over maybe 3-5 years.
On one hand, the US did and does have an addiction to cheap credit. The housing crisis was spurred in large part by the Bush administration’s relentless push to ‘end the legacy of redlining’ by pressuring banks into lending to just about anybody without much consideration of their long term ability to pay, and many mortgage salesmen and retail banking compliance/KYC deliberately looked the other way as people lied and were coached to lie on application forms to borrow even more money. A movie about mortgage salesmen in Arizona in 2007 could include this line and I think it would be a fun (and accurate) description.
On the other hand, the credit traders in Margin Call aren’t mortgage salesmen. They have little to nothing to do with the provision of credit. The securitization of mortgages was not primarily responsible for the housing boom and collapse, even though that crash subsequently caused the financial crisis in part because of said securitization. You can twist the words into making a point that credit would possibly have been slightly more expensive if the MBS market had been less developed, but the reason for the housing bubble was primarily the fault of governments and retail banks, not investment banks.
So as a statement, it doesn’t make much sense, no. The thing is that traders at big banks aren’t really cowboys, for the most part these are people who make what they believe to be very predictable, very safe moves to hedge clients’ money. They’re not at a hedge fund or a hotshot at a small prop trading firm. They’re not Jordan Belfort type boiler room operators. They’re not Glengarry Glen Ross salesmen. They’re doing what is, almost all the time, a very low risk job where doing very well means making the bank a very small amount of money on the work they do for clients.
Good explanation, thanks. I thing along these lines I've always wondered:
My impression is that a substantial amount of the financial shenanigans that led to the crisis were based on all of the various actors who make up the pipeline of financing mortgages trying to figure out some way to themselves not lose their shirts in the environment of all of these sketchy mortgages the banks were forced to make. Where "forced" is not in the sense of "you will go to jail if you don't do this", but a more subtle indication that "we will audit and regulate your bank out of existence unless you do this". So essentially, deep down everybody knows it's going to collapse somehow eventually, and they're all trying to arrange things such that they're not the ones holding the bag when it does, which involves never acknowledging that to anyone else. Do you think this is accurate, or off-base?
It's hard to say, there's probably a few million pages of congressional testimony in which various people might or might not hint at this obliquely, I actually have no idea. I don't think there was any major effort by the majority of loan originators in middle america to limit their exposure to the subprime mortgage market. There were some smart people who did, especially from 2006 onwards, just like there were some smart hedge funds who made the same play, and just as Goldman eventually realized it themselves (as fictionalized in Margin Call). Obviously there were people who predicted the housing bubble bursting more generally, but we're 400 years on from Tulip Mania and there are always Cassandras preaching about imminent doom. It's very hard to tell who got lucky and was neurotic at the right time (like the hypochondriac who finally catches a terrible disease very early) and who knew the whole thing was really a sham.
I'll say that my impression from old hands in investment banking rather than trading is that most did not expect a crash in 2007. The market had barely recovered to dotcom levels, it had only been 6 years since the last crash and 4 since the trough of the 2001-2003 recession, M&A activity was hot but not shockingly so, the housing market was the only red-light indicator, if it even was.
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Peter Wallison says that (1) Fannie Mae and Freddie Mac misleadingly categorized mortgages as subprime only if they were issued by a small category of "subprime lenders" (rather than the more typical definition of any mortgage made to a person with FICO score worse than 660), so (2) the banks never even knew that the situation was in the toilet.
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