Martin Fridson Embraces The Big Lie To Challenge The Big Short

Near the end of The Big Short, the Steve Carell character prophesizes that, "the banks will blame poor people and immigrants." More specifically, they will pander to class bigotry in order to reassign the failures of private label securitizations on to affordable housing goals and the GSEs. Which is exactly what Marty Fridson did in Barron’s a week ago. He writes:

In the accuracy department, however, The Big Short falls far short. The movie suggests that bankers securitized subprime loans and passed off this dross as gold simply because they ran out of higher-quality paper. But it ignores the fact that blame for the housing bubble begins not with Wall Street but with Washington—in particular, the Clinton administration, which sought to make mortgage financing “more available, affordable, and flexible,” thereby encouraging borrowing by people ill-equipped to repay their loans. Clinton’s policies were embraced by his successor, George W. Bush, who was equally intent on promoting “the American dream” of homeownership among minorities and the poor. 

Incredibly, those who lost their homes are represented in the movie by a family of renters; it’s their landlord who defaults on the mortgage. Evidently, Hollywood dares not suggest that people who bought houses they couldn’t afford were responsible, even in a small way, for their fate. The movie’s creators might argue that their aim is entertainment, not education. But they are shaping perceptions of historical events in ways that could produce inadequate policy responses to future crises affecting the economy and markets.

Let's be clear. There is zero data to support Fridson's thesis. A picture is worth 10,000 words, and here are two pictures that demolish much of his arguments.

The graph above understates the superiority in GSE loan performance, since the National Delinquency Survey does not disclose the percentage of GSE loans includes in its calculations.  In other words, the GSEs dramatically bring down the national delinquency rate. The nationwide rate exclusive of the GSEs would be much worse.. Over the last 13 years, GSE delinquency rates have closely tracked the delinquency rate for Prime Fixed Rate mortgages.

One reason that the GSEs demonstrated better loan performance is that, to a large extent, they avoided the worst of the real estate bubble. This graph, prepared by Trust Company of the West, compares home price appreciation for homes financed by the GSEs with the commonly-used Case-Shiller Index.

An Executive Summary of Financial Crisis: Here’s what really happened.

In the summer of 2007, almost immediately after the rating agencies began assigning long-overdue downgrades to subprime bonds, the market for private label residential mortgage-backed securitizations shut down. Trading in cash RMBS bonds almost ceased. Over the subsequent 14 months, a number of entities holding significant exposure to private label RMBS faced liquidity crises. Many of those entities collapsed. First it was some hedge funds. Then it was the $400 billion market for SIVs (structured investment vehicles), then it was some banks in Germany, then it was the broader ABCP (asset backed commercial paper) market, then it was Bear Stearns, then it was Lehman, then it was AIG. The near-collapse of all these institutions was exacerbated by the inconvenient truth about modern credit markets; credit default swaps have undermined, if not eliminated, transparency.

Mortgage loans did not cause the crisis. Mortgage securities caused the crisis. Specifically private label RMBS caused the crisis. Why? Because, as I’ve written before, the non-triple-A-rated tranches, which were subordinated to 95% of a 100% debt-financed capital structure, can get wiped out overnight. That’s not my opinion, that’s just math.

Moreover, those deeply subordinated tranches were not distributed broadly throughout the vast universe of institutional investors. There was a huge concentration of that toxic risk exposure held by a relative handful of global institutions. AIG, Citigroup, UBS, Merrill Lynch, MBIA and AMBAC all faced the specter of insolvency because their collective risk exposure to subprime CDOs exceeded $250 billion. The ripple effects were huge.

(It’s certainly true that mortgage loans did in Wachovia and Washington Mutual; though the law and, precedent set a clear path for the government takeovers of those banks.)

The foregoing summary is not my interpretation of events. That’s what happened. Anyone who says otherwise—anyone who says that New Century, or Bear Stearns, or the SIV market, or the ABCP market, or Lehman Brothers, or AIG, or Merrill Lynch, or Citigroup, or MBIA, or AMBAC faced collapse because of anything related to Fannie’s or Freddie’s business model—is lying. All of those companies faced collapse because of their holdings of private label RMBS. The September 2008 meltdown was not caused by mortgages; it was caused by private label mortgage securities. Anyone who fails to make that critical distinction is either ignorant or disingenuous.

Moreover, the GSEs never faced any kind of liquidity crisis. They continually had unfettered access to the unsecured debt markets, and their mortgage securitizations were continually sold without disruption. Anyone who says otherwise is lying.

Addendum: The class bigotry that underpins The Big Lie cuts both ways.

In the absence of any any evidence whatsoever, this bigotry is used to characterize loans made under affordable housing goals as reckless, imprudent and ultimately catastrophic. Because you know what happens when you start making loans to those people.

Conversely, this same bigotry is also used to excuse the ethical and criminal lapses of wealthy people. Take, for instance, this little gem by Tim Worstall in Forbes:

We even know that most of the people in the industry handing out the mortgages, selling the CDOs and all, actually believed in what they were doing: this wasn’t a cynical attempt to rip the rest of us off. We know this because most of the people in the industry were even more heavily invested in real estate themselves than people outside the industry. If you think it’s all a scam then that’s not what you do: that’s the action of people who truly believe. 

Apparently, Tim did not fully grasp the consequences of the originate-to-distribute model of housing finance. Again, an inability to distinguish between real estate and RMBS is fatal to any basic understanding of what went on.