Story on Shorting MBS Prior to Collapse - Why It's Not Interesting

Apr.15.10 | About: Fannie Mae (FNMA)

Propublica's has a big story on Magnetar, a company that actively shorted mortgage backed securities prior to the collapse, often encouraging the formation of securities they would then short. As this is a major theme in Michael Lewis's The Big Short, and was breathlessly mentioned by James Kwak, let me explain why this is not interesting.

People as a group generally disagree on everything. There will always be someone saying a price is too high, or too low. Over time, as the price moves one way or the other, those correctly calling the price move were either right, or lucky. In any case, the existence of this prescient group does not imply either 1) that it was obvious the prior price was too low/high, or 2) there was a conspiracy.

This is classic hindsight, and James Kwak and Simon Johnson, Michael Lewis, and Propublica may think it was all so obvious, but as prolific authors it would help their cause a lot if they had made unambiguous statements prior to the crash that we were in a bubble. Any idiot can say a historical event was obvious (indeed, I find the best history showing how while some event was inevitable, it was not obvious at the time). Further, even if some people were correct, they had to have been correct for the right reasons. If, like Nouriel Roubini, you were a permabear predicting a cataclysm for the same reasons as always, the fact of the credit crisis doesn't mean you called it. Or take my Nassim Taleb, who's called for a calamity, but when he points to his correct Fannie Mae (FNM) call, he notes an earlier criticism of the interest-rate Value-at-Risk methodology, an irrelevancy to their ultimate problems. Peter Schiff, in contrast, singled out the housing insanity and so he's a better candidate. But even so, it doesn't mean it was obvious, because the voices of those like Schiff were outweighed by those thinking everything was just fine.

It's important to remember that with so many people in the world, just calling a historical event is not sufficient because there are always people predicting massive failure or success to any policy. The key is whether they right for the right reasons, as in Schiff's case, or right for the wrong reasons, as in Roubini or Taleb's cases.

The problem was that given the historical national housing price index, nominal housing price declines over the prior 70 years were rather minor, and suggested little risk. This is why in 2003 Joe Stiglitz wrote Fannie Mae was overcapitalized and was of no concern. The fact that this assumption supported efforts at increasing home ownership, and helping minorities, was a plus in the way that any assumption that supports what we want to do is taken less skeptically than otherwise. That's human nature. There's no conspiracy there, and while there were some general errors of repetition, it was also in many ways a singular crisis (the repo bank run accelerator, the historic decline in housing prices).

For about 50 years, the definitive understanding of the depression was John Kenneth Galbraith's The Great Crash. He outlined the delusion of investors, but also highlighted the nefarious insider trading and financial skullduggery by those puppetmasters, the Captains of Industry. Charles E. Mitchell of National City and Andrew Mellon at the Treasury, in the 1930s, were in highly public tax evasion trials and were popular scapegoats, as if the recession was caused by greedy people with top hats.

Alas, this highlights that 'for every problem there is a solution which is simple, clean and wrong.' The 1929 stock market crash did not cause the Great Depression--ten years of weak performance--and while there was much financial skulduggery, no more than usual, and Mellon and Mitchell were hardly symbolic of some essential prime mover in the whole mess. Like most bad theories, this one died a slow, unpublicized death. Economists might seriously reference Galbraith to explain the death of animal spirits prior to the Great Depression in prior generations, but after 1987 the nexus between the stock market and the economy was shown to be not so clean, and the whole narrative became suspect, a classic 'just so' story.

So the current journalists that are now highlighting that various people actually shorted frothy sectors prior to the collapse, is really just another spin on the 'speculators caused the crisis' theory of the Great Depression. Greed, like lust, is pretty much in a steady state. Anecdotes of greed do not lend any more evidence that the national greed-o-meter was especially high in 2006, because with 300 million Americans I could read 100 anecdotes a day and it would not add up to anything significant.

I heard Propublica's story in a very well produced NPR radio story this past weekend. A lot of work went into it, with dramatic narrative, and the kind of suggestion that, like The Matrix, you would at the end find some truth so large and shocking you would leave forever changed. Unfortunately, the fact that there were shorts during a market decline, and all that is associated with such shorts (eg, they wanted to make a lot of money, they encouraged people to buy from them, they got rich), is simply not news.