Interesting interviews with anonymous hedge fund manager

[ladelfina]

http://www.nplusonemag.com/interview-hedge-fund-manager

http://www.nplusonemag.com/financial-meltdown

People have made fun of my ideas about debt and the financial system. These interviews are worth reading for a variety of reasons, but I would like to highlight phrases from both articles:

[HFM:] It's kind of an interesting interaction in the sense that a lot of this mortgage project was almost created by the bid for the CDO paper rather than the reverse. I mean, the traditional way to think about financing is "OK, I find an investment opportunity, that on its face, I think, is a good opportunity. I want to deploy capital on that opportunity. Now I go look for funding. So I think that making mortgage loans is a good investment, so I will make mortgage loans. Then I will seek to fund those, to fund that activity, by perhaps issuing CDO paper, issuing the triple-A, double-A, A, and down the chain." But what happened is, you had the creation of so many vehicles designed to buy that paper, the triple-A, the double-A, all the CDO paper... that the dynamic flipped around. It was almost as if the demand for that paper created the mortgages.

n+1: Created the loans?

HFM: Called forth the loans, because it became a really profitable business. You saw where you could issue these liabilities.

[HFM:]...what happened is this machine—let's call it, it's a big machine that wanted to gobble up, you know, rated paper—needed to be fed. So there were people who could make a lot of money feeding the machine, and they were like, you know, "We need to keep originating mortgages, and feeding them to the machine," and if you have a robot bid, you tend to get a bubble. Someone is hungry for paper, paper will be created.

And that's almost never a good thing that lending decisions are being driven by the fact that many, many steps down the chain there's just someone who wants to buy paper.

I told you all I thought there was a VORTEX of debt created at the top of the system that sucked retail-level people in from below. The debt engine has not been not created by Joe Sixpack "demanding" this or that loose credit, as you may have been led to believe.

Anonymous HFM confirms this.

 

[haha]

...that the dynamic flipped around. It was almost as if the demand for that paper created the mortgages.

n+1: Created the loans?

HFM: Called forth the loans, because it became a really profitable business. You saw where you could issue these liabilities.

Don't be too sure that this isn't more common than this guy is letting on. Money earmarked for some category of spending very commonly creates product. It creates bridges to nowhere in Alaska, it creates teacher performance evaluation consultants, and not surprisingly it created CDOs.

It is frequently easier to cobble together the mousetrap that people think they want than to create a better mousetrap and then be faced with convincing someone to buy it.

ha

 

[ladelfina]

How am I showing myself to be unsure that this is common? Ha, maybe you have not been paying attention, but I have already taken a lot of heat, here, for trying to expose this structure, which I think is pervasive. Do you see me being a shrinking violet?

With AK/Stevens you address that in one way. [That's just a straightforward corruption case.] Teachers' unions and their "clientelismo" you may be able to address in another.

This is far beyond any of that.
We are talking about essentially ALL US banks and many if not most foreign banks that have bought into the US SIVs/CDOs/MBSs that were on offer.

The inverse debt pyramid requires ever larger debt. Please, someone, deny this. The NEED for debt creates a need for debtors. Debtors were duly found.

 

[soupcxan]

You are laying all the blame on the supply side of the equation but the situation can't be understood without considering demand as well. The system really has three parts that interact with each other. I worked at a company that did a lot of loan securitizations (not mortgages, but close enough). They liked secz because it reduced their cost of funds (the debt they would have to borrow from the market to make the lown) and thus, it increased their return on equity (which was their measure of profitability based on how much leverage they put in). If they were levered 10-to-1, then a 0.5% reduction in their cost of debt would increase their return by 5%. The result of all this was that they could offer the customer (to whom they were making the loan, planning to secz it later) a lower rate. This is obviously an advantage over other lenders, who were after the same customers, primarily competing on rate. So then the other lenders have to get into the secz game if they don't want to be priced out of the market. That's the supply side.

From the customer's point of view, he may or may not have known about the secz process, but he did notice that he was getting lower rates on his financing. He also noticed that as soon as he got one rate, he could go to another lender and demand that they beat it if they wanted his business. So the debtor played a role in encouraging banks to use secz. Lower rates also encouraged him to take on more financing than he might normally have, since it was cheap.

The third part of the system is the investors who bought these asset backed securities. They were happy to get slightly better yields over treasuries for what they thought was a very low risk asset (if they bought the AAA-AA rated tranches). The lenders were happy to pay these spreads since they were still cheaper than any other source of funds. And because lenders, borrowers, investors, and various other intermediaries (e.g. mortgage brokers) were acting independently, it was easy for things to get out of hand. Once the cycle started to snowball, the average joe realized that everyone around him was getting rich on real estate, so he jumped in too. This created more demand for cheap mortgages

The situation is much too complex to lay the blame soley on investors (the top of your supposed "vortex") who wanted to get a few more basis points over treasuries.

 

[ladelfina]

vortex:

"Our job is to create loans for securitization," said an official from Wachovia Corp. (WB) a few years earlier. "We're trying to manufacture the product that the investor base wants." And so they did.

How Could My Big, Beautiful Loan Go So Bad, So Quickly? - Seeking Alpha

 

[barbarus]

People have made fun of my ideas about debt and the financial system.

If you're referring to the over-achieving professionals who post on this blog ladelfina, you must keep in mind that they are quite uninformed of the current financial reality.

They have worked very hard to get where they are at and this has always payed off for them. They think that playing by the rules will inevitably result in economic success. After all, it has so far has it not?

Of course things have changed and they've got a whiff of fear in the air that tells them their world of comfort is sore threatened. There's more than a little whistling past the cemetery going on in many of these posts.

Think about it. For the uber-rich at he top to accumulate the vast amounts of dough we've seen in recent times, it takes an army of true-believing underlings to keep things going. You'll see much more self reinforcing posting over the coming months as these folks try to convince each other it's going to be OK.

I don't see the brickbat "tin foil hat" thrown around with nearly the same ubiquity as even a few months ago do you?

Consider the image of a flock of contented sheep moving down the slaughterhouse chute. Life has been good so far, but there's some kind of commotion going on ahead. There are some pretty awful sounds and smells coming from the direction the group is inevitably headed, but maybe if everyone just keeps his/her head down, it will be OK. Sure, a few ordinary sheep may come to a bad end, but they don't know medicine-law-IT-engineering-et al.

What do YOU think?

 

[CompoundInterestFan]

If you're referring to the over-achieving professionals who post on this blog ladelfina, you must keep in mind that they are quite uninformed of the current financial reality.

What I appreciate about ladelfina (and I hope she continues to do this) is that she makes substantive posts and backs them up with evidence.

Unlike you, who seem to just pop in randomly to blather on about doom-and-gloom scenarios and overused metaphors about sheep being led to the slaughter. And all the while, accusing anyone who doesn't see it this way of being a hopelessly naive optimist.

And yeah, "tinfoil hat" isn't thrown around as much probably b/c people get a little tired of repeating the same thing over and over.

Unlike you.

 

[CitricAcid]

Maybe tinfoil hat should be used more frequently. What makes it difference this time? Everything will not end within the next year. I think most people believe that the U.S. economy is somewhere along the spectrum between "Buy gold, ammunition and food because the economy will fall apart tomorrow... as barbarus believes" and "Leverage everything you own at any rate because the U.S. economy could never slow down and will continue to take off to the moon and beyond".

 

[kcowan]

Ladelfina
I think it is twofold. First the packaging of loans became easier because the rating agencies (and Fannie Mae) would buy them without doing any DD then the banks could make money writing up new loans without carrying the risk of loss. Everything else was just side effects.

Who will pay? Shareholders, taxpayers and pensioners.