Magnetar Again

A few days ago I showcased Yves Smith's admirable account of Magnetar, the ultimate in bet-against-the-box hedge funds. Comes now a much more detailed account here.

Death Ships

In B. Traven's novel The Death Ship, a misbegotton sailor finds himself cast out to sea on an old scow whose purpose, as he learns, is not to reach port, but to sink--the owners having decided that it is worth more at the bottom of the ocean while they disport themselves with the insurance money. So, a death ship born to die.

I've been reflecting on death ships lately as it dawns on me that they may be more common than we think. Specifically I've read two accounts of the late financial uproar, in which the authors identify transactions which, as they argue were designed to fail. I choose my words advisedly--designed not just with reckless disregard of their prospects, but with failure as the end in view, and design feature and not a bug.

One is Yves Smith's account of Magnetar which (per Yves) designed investment vehicles with such a high probability of failure that the promoter could make money by shorting its own creation. That is, designed to fail.

The other is Gary P. Gorton in Slapped by the Original Hand, where he makes a comparable argument about the adjustable. Recall (forget so soon?): in the ARM, I take a 30-year mortgage at a two-year teaser rate. At the end of the two years, the rate adjusts up--but not adjust "up;" rather, up so far that I can't come close to servicing the old debt. So I have two remaining choices. One, default. Two, cut a new deal, perhaps with the same bank--which the bank, perhaps surprisingly, is happy to do because the property has gone in value and under the new deal, the bank effectively captures the new equity.

Per Gorton, this "new deal" scenario is not just a happy accident. Rather, he argues, the deal was structured that way from the start--the bank foresaw default and wanted default, because that was the bank's route to the ballooning equity stake.

So now I'm up to two now in my count of financial death ships--devices designed to screw up the economy not just by accident but on purpose and as a matter of policy.

Are there more death ships on Wall Street? I wouldn't be surprised; once you start looking for death ships, you see them everywhere. Consider Mel Brooks' The Producers, where the naughty boys undertake to get rich by producing a show that will fail: the comedy is that they fail to fail, and wind up in jail. Hell, consider the chicken: the fastidious among us may cringe at the thought that we get our dinner by breaking the neck of an innocent creature. The Marengo-and-Tetrazzini crowd will say: hey, the chicken wouldn't have been born to begin with if we hadn't intended to kill him. So, we did him a break. Or, a death ship.

I would want to distinguish those activities that harm others by fatal indifference as distinct from general plan, though the distinction may be hard to isolate. For example, I assume the tobacco companies know that they are in the business of killing people, but I assume this counts more as an unfortunate side effect than a settled business purpose--if they could make all that money through a non-lethal form of addiction, they'd be perfectly happy to do so. I would also distinguish those who make money off the misfortune of others. As a bankruptcy lawyer, I hear a lot about that, but I don't know of any bankruptcy lawyer who structures deals so he can profit from the debtor's bankruptcy.

I hesitate to include the Republican Party, because its nihilistic behavior has become something close to a meme. But I think you'd have to concede that the Republican campaign against Obamacare was more about destroying Obama than it was about his plan--and that, indeed, there must have been Republicans thanking their lucky stars that they President wanted something so bad that they would have the opportunity to try and destroy it. Query, was there ever a case where an entire economy, an entire polity, counted as a death ship?

It is dangerously tempting to raise this whole analysis to a higher plane--to consider whether we are all characters in somebody else's drama where we have no idea of the plot, nor least of all the denouement. Or as I say on my Facebook page (though the line is not original with me)--perhaps the rapture has already happened and we are the ones left behind. Or perhaps it is all just a giant rust-eaten garbage scow, on which somebody else hopes to collect the the insurance.

Yves Smith on the Truck that Hit Us

The best thing about Yves Smith's formidable new account* of the late meltdown is her gritty and granular narrative of how banking went from being a somewhat pampered and overpaid service industry into being a gang of pirates. By all appearances, Yves was there for much or most of it; she saw investment bankers get sucked away from partnership into corporate form; she saw the market-driven pressures that drove them into sussing up the M&A market; she witnessed the silent but ineluctable shift from investing to proprietary trading, and the rise to dominance of the risk-taking animals, to the point where the animals ran the zoo, and where they lost all contact with any exterior reality as they came to play the game for the game itself as a contact port where nothing counted for so much as winning for its own sake.

Almost as good is her detailed insider of account of the rise of the non-bank transactions: securitization, repos and (particularly) "insurance contracts" aka "swaps"--including the fullest account that I have seen of Magnetar, the arsonist who learned how to build structures of dfry sticks so they could burn them down and collect on the underpriced insurance. Smith is particularly good at picking up on insights that would have been obvious to alert insiders, though not so visible from without--as for example, how much the debt market was driven by the near-insatiable appetite for triple-A paper which inevitably led more and more suppliers to try to produce product for the market.

She leads off with an extended narrative o n the rise of "mathematicization" in finance. It's well done and mercifully accessible, although the typical reader of this book is likely to have encountered a version of the story (perhaps in more abstruse form) elsewhere. I think she is less successful in tying the "excess of math" meme into her "corruption of the market" mantra. That is, having shown how mathematicized economics tended to sand down all the rough spots, she goes on to describe a pattern of market behavior in which economics, mathematicized or otherwise, is little more than a bit player. It's a world where institutional incentives drive greed and competitive bravado, and where the economic models are at best an excuse, not a real driver of behavior.

In the same vein, she doesn't seem to have fully worked out her own notion on the place of "the market" in the economy. Apparently she's lived all her life in a world of banks and transactions and in so many ways, she seems to be comfortable there. She thinks we've overdone it on free trade, and she has some kind words to say about unions. Well enough, but does she really want to go back to the days when protected car companies and protected unions colluded to sell us crap cars while they split the profits? To printers who sat up all night setting bogus?: To railroad crews who drew a days' pay for taking a nap? To a steel industry who deferred the inevitable for two or more generations with evasions and excuses for which the rest of us had to pay?

I think these questions are merely rhetorical. And the corollary is that this book is not a grand design for a new economy. Probably a good thing, that; we've had more than our share of grief from grand designs. It is a splendid insider account of our recent financial past, from an alert insider with a developed sense of decency and a fine sense of balance. Highly recommended, put it on the short list.
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*ECONned (2009). The silliest thing is the title, but maybe we can blame that on the publisher. And FWIW, the book is not just a rehash of her must-read blog, Naked Capitalism, although nothing in the book will come as a great surprise to faithful readers of the blog.