"The Federal Reserve engineered
a private bailout of LTCM, but Greenspan resisted derivatives
regulation. The derivatives lobby, led by Senator Phil Gramm and his
wife Wendy, who initially had deregulated swaps in 1993 and had been
a director of Enron since then, waited out the storm of criticism. Then,
in late 2000, as the country rubbernecked at the Bush v. Gore election
results, they and Greenspan persuaded President Clinton to perform his
last official act, signing the Commodity Futures Modernization Act of
2000. Greenspan, Rubin, and Levitt all supported this sweeping deregulation
of derivatives. It was one the greatest mistakes in the history of
financial markets."
" According to the math, huge amounts of risk disappeared when you
pooled risky assets together in a CDO. As a result, a large share of the
pooled investment could be rated AAA. Word spread about this result
like a game of telephone. Mathematicians explained the model to
derivatives structurers, who explained the model to rating agency analysts,
who explained the model to salespeople, who explained the
model to investors. By the end, the message had warped from logarithmic
functions and negative infinity symbols, to fat tails and low correlations,
to simply âAAA, pass it on.â
Wall Street derivatives arrangers trolled for risky assets to pool using
the new methodology. Banks created hundreds of billions of dollars of
new CDOs backed by low-rated corporate bonds, emerging markets
debt, and subprime mortgage loans. They split the CDOs into levels, or
tranches, based on the seniority of claims. The tranches were like the
floors of a building built in a flood plain. The lowest floors were the
riskiest and would be flooded with losses first. The middle levels were
protected by the lower levels. The highest floors seemed very safe. It
would take a perfect storm to flood them. Or at least that was what the
mathematical models said.
The rating agencies, primarily S&P and Moodyâs, were willing to
rate many CDO tranches AAA, even though the underlying assets
already carried much lower ratingsâfrom them. In their eyes, the models
could magically transform a pool of BBB-rated subprime mortgage
loans into a somewhat smaller pool of AAA-rated CDO investments.
These AAA ratings were nearly as preposterous as the AAA ratings for
FP Trust, but the rating agenciesâ mathematical models, including a
264 F. I. A. S. C. O.
version of Liâs copula, better hid the dubious nature of the ratings. The
crap had become cake. Investors either believed the ratings or ignored
the ratingsâ unreasonable bases (as well as the fact that the banks paid
the rating agencies triple their usual fees for these ratings). The CDO
business boomed and became the most profitable part of Wall Street.
When mortgage lenders such as New Century Financial Corporation
and Countrywide Financial saw the insatiable demand for risky loans,
they began making too-good-to-be-true loan offers to anyone they
could find. Many people have criticized these lenders for unscrupulous
practices. Others have criticized borrowers for taking loans they couldnât
possibly repay. Much of that criticism is fair, but it ignores the big
picture. The driving force behind the explosion of subprime mortgage
lending in the U.S. was neither lenders nor borrowers. It was the
arrangers of CDOs. They were the ones supplying the cocaine. The
lenders and borrowers were just mice pushing the button."
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AGAIN:
"Wall Street derivatives arrangers trolled for risky assets to pool using
the new methodology. Banks created hundreds of billions of dollars of
new CDOs backed by low-rated corporate bonds, emerging markets
debt, and subprime mortgage loans. They split the CDOs into levels, or
tranches, based on the seniority of claims.-----------------------------------------------------------------------------------------------------------------
http://www.frankpartnoy.com/_/F.I.A.S.C.O._files/Fiasco_AFTERWORD.pdf
"
