Movie Review: Inside Job

The message of Inside Job, told through Matt Damon voiceovers, is that deregulation causes financial crises.

The movie blames Wall Street - which certainly had its share of crooks and incompetents -  but ignores little guys like mortgage brokers, subprime home buyers, appraisers, and cash-out HELOC borrowers who blew their illusory home equity in Vegas. It also ignores the systemic problems that prevent incentive alignment, like deposit insurance.

One of the insights in Panic is that cash-out refinancings, like a HELOC, entail greater moral hazard than new home purchases. The borrower and mortgage broker both want the appraisal to be as high as possible, and since the property doesn't actually trade, there is no buyer on the other side of the transaction to provide a countervailing market force to the valuation. They liken these mortgage credits, where homeowners are borrowing money because they cannot support their lifestyles with there incomes, to failing businesses. They note that businesses that cannot service debt out of operating income are junk credits and have very high default rates.

If I was going to pin the crisis on one thing it would be: moral hazard. I remember, well into the crash, people buying high yielding CDs in banks that were going to fail. Who cares? The FDIC made them whole. But it gave the bankers consequence-free money to gamble with on building condo towers.

Falky says it best: "'Predatory' lending is when a bank gives a loan to someone who can't afford it, and then has the gall to ask for their collateral after 500 days of non-payment."

Rating: 1/5

Allied Irish Banks (AIB) Credit-default Swaps Trading With 60 Points Upfront!

AIB has something like $250 billion in assets - a really big bank.

Credit-default swaps on subordinated debt of Allied Irish Banks were 60 per cent upfront and 5 per cent a year, meaning it costs €6 million in advance and €500,000 annually to insure €10 million of the bank’s debt for five years. CDS on the subordinated debt of Bank of Ireland cost 33 per cent upfront and 5 per cent a year.

Credit default swaps will start to trade with points (percentage points of the notional) upfront when there is a risk that a credit event would take place before the protection seller has received any income from the CDS. In late October 2008, protection on AIG was costing 42 percentage points upfront and 5 percentage points a year.

This may not matter to U.S. markets right now, but it will.

More Evidence that the Market is Broken

WSJ has a lengthy article on trading in AIG, the zombie stock whose CEO admits there is no equity in the company.

American International Group Inc., a symbol of the financial crisis, has morphed into a playground for speculators. At a traders meeting before the market opened on Monday, Scott Redler, chief strategist at hedge fund T3 Capital Management, noted that AIG's stock hadn't moved much for days and was ripe for a breakout. Whether it headed up or down, he said, the traders should be ready.

AIG shares, trading below $40 at the opening bell, climbed within 15 minutes to $41, then above $42. "This thing's going to $45," T3 President Marc Sperling said, watching his six computer monitors. "It's on every trader's radar screen across the country."

[...]
Alex Herrera, head of Soldier Capital LLC, a 26-member day-trading firm in Ramsey, N.J., has been among those buying and selling AIG. A former floor trader on the New York Stock Exchange, Mr. Herrera says he often trades blocks of 100,000 shares, using funds he borrows through the firm to make bets of as much as 15 times the size of his portfolio.

On some days during the past month, AIG trading volume topped 130 million shares [the entire float]...

These people need to have their ass handed to them in order for the market to work again. The purpose of the market is to allocate capital to productive enterprises. This type of activity is like a video poker room or a Chinese retail stock brokerage (but I repeat myself).

Bears are patriots right now.

The Market is Now a Zombie Movie

Here is the zombie movie all star cast, roughly in order from most to least outrageous:

General Motors - hovering at a half-billion dollar market cap, even though the stock is worthless.
Lehman Brothers - up 200% on Friday, even though it faces $100 billion in claims.
AIG - up over 5x since beginning of July, even though the CEO admits there is no equity in the company.
FNM - up hugely. But the preferred stock still less than 10 cents.
FRM - same as FNM,
Washington Mutual - up 35% on Friday. Why not buy the holding company notes for 70 cents?