I’m pretty sure it was bundled mortgages (MBSs) with shit lending standards that blew up the economy. Credit default swap was the vehicle that people like Burry (sp?) used to short the MBSs
Leave our beloved CDSs out of this! :). Yeah the ratings agencies certainly deserve a lot of blame and they didn't get flamed nearly enough as they should have. They were just one piece of a pretty corrupt and broken system however if they had done their jobs it probably wouldn't have happened.
They didn't even really get any serious regulatory changes. It's maddening that the system we still use to assess the risk of assets is paid for by fees from the people creating/ selling those assets.
At the very least they should have established a government funded third party rating agency to go along with the shitty ones.
"Shit rating agencies" gives me a fantastic visual, excellent comment to set my mood for the day. People in suits and ties rating other people's shit for living 🤣
Came to say this. If ratings agencies can be bought so easily, then there's literally no way to make a rational decision on any item's financial safety. Doesn't matter what market.
This is why the professional money managers only take in what a credit ratings agency says with a grain of salt. When its their bonus on the line they will do their own due diligence on a company.
Sub-prime mortgages generally... especially large mortgages with low money down (little equity stake at inception)... especially with balloon payments that were specifically designed for flipping and extreme speculation - and imagine lousy underwriting standards for these riskier mortgages... driven in part by the fact that you could originate and dump/sell without repercussions.
And by the way - all of this were designed at least initially to promote home ownership by people previously locked out of home ownership.
Pool those mortgages together.. .and have a nation-wide property bubble burst - so geographic diversification doesn't help
Now combine this with rating agency models that could be gamed - and historical default and delinquency models not calibrated to
You end up with "senior AAA" tranches of CMOs of subprime mortgages that were far from AAA.
Are there reasons tobe concerned today? Yep.
The private credit market is REALLY concerning.
So are the macro stresses from tariffs and oil price shocks. The high stock of US government debt is a serious problem, and is unsustainable.
A potential AI bubble popping could also trigger recession.
Blaming credit default swaps for the financial crisis is just idiocy - and throwing this in a headline is lazy and poor analysis.
Correct, and it only blew up the American economy. THAT is what affected the global economy. Here in Canada our dollar hit par with the US, after 2008, due to money fleeing the US into Canada. I have multiple family members who bought cheap real estate in 2009 to go south for the winter. It was almost a half price sale for us! (all sold last year due to Trump's threats btw)
Sort of, but largely in the sense that they were a stepping stone to create Synthetic CDOs. There were effectively 4 difference derivatives, MBSs, CDSs, CDOs, and Synthetic CDOs. The Synthetic CDOs were the biggest problem.
An MBS is what everyone thinks of, which pools mortgages underwritten by a bank and sells them to investors. They can be pretty complicated though. These have existed forever, and continued to exist post-GFC, and a largely actually a good thing for the financial system. However, they do need to be well regulated since they do pose a moral hazard if banks can sell off their entire mortgage portfolio as MBSs, since banks would no longer care about the quality of the loans they underwrite, just the quantity of them. This was problem number 1.
A CDS is effectively insurance on an MBS, and are also helpful for the system as they can help further de-risk an MBS (typically an MBS will have credit enhancements such as tranching, but that mightn’t be enough on its own). Again, this is largely fine, it does expose insurance companies to the system, but they’re designed to be exposed to risk so it’s okay. However, the issue with these is that banks and insurers started selling naked CDSs, meaning you didn’t need to own the underlying asset to insure it, which allowed people to use them to speculate on the MBS market.
A CDO is simply a pool of MBSs, and this is where the real issues start to come into play. What this allowed banks to do was to start pooling together low quality MBSs and CDOs that investors didn’t want, and then they pooled them with a few higher quality ones to hide the junk and not make it look too bad. Credit rating agencies overlooked this as well, and continued to give these CDOs good ratings which they shouldn’t have been doing. This is what then allowed a lot of the junk to start going through the system.
Lastly, you then have Synthetic CDOs which is what really magnified the loss. A Synthetic CDO doesn’t actually own anything, but instead is designed to try to replicate another CDO without owning the underlying assets. These were created by buying naked CDSs which were structured in a way to replicate other CDOs. This allowed the speculation in this credit derivative market to not only be leveraged to extreme levels, but also meant that those on the other side of the trade (the banks and insurance firms) didn’t actually have any of the capital on hand to fulfill their obligations if things went belly up. That’s why the whole financial system was brought down when things made a turn for the worse.
Now, obviously there were other things at play too. Namely, there was huge demand in these assets since they had pretty high returns for supposedly very low risk. Financial institutions wanted to capitalise on this demand by finding new ways to sell more of these products (hence the creation of naked CDSs and Synthetic CDOs), which made banks start lending money to anyone to fulfil this demand. This easy credit then led to property prices taking off since it was so easy to get a mortgage, which then fuelled a lot of speculation over property prices, which in turn not only meant that there was more demand for home loans, allowing the banks to sell more of their credit derivatives, but it also drove up the value of the credit derivatives to since they are in turn also collateralised by the underlying properties. That then fuelled speculation on the credit derivative side, beginning a positive feedback loop since it made banks start lending even more aggressively, fuelling more speculation on house prices and demand for home loans, causing even more speculation on credit derivatives and so on. CDSs actually play a pretty small part in this whole aspect of it too, yes they help fuelled demand by allowing pension funds to insure the MBSs and CDOs, but pensions could still buy less risky ones and it likely wouldn’t have made a huge impact.
The big issues were the Synthetic CDOs causing financial institutions to have more exposure than they could handle, and the positive feedback loop where the credit derivative bubble and property bubble helped fuel one another. The biggest learnings are to make sure banks hold a large portion of their own MBSs to avoid them having a moral hazard, and to also ban naked derivatives which are only used for speculation.
Damn, this write up is great! 10/10 explanation.
One thing I think The Big Short (the movie) did poorly was to explain what a synthetic CDO is/was - though I highly rate the movie overall.
I’m still not exactly clear on what synthetic CDOs are from your explanation.
> “These were created by buying naked CDSs which were structured in a way to replicate other CDOs.”
What does this mean? How do you structure MBS insurance to replicate a pool of MBSs?
Meanwhile, people like Tony Robbins are pitching to the public the other side of this potential disaster - that there's an opportunity of a lifetime to "get access" to PE investment vehicles that they claim were only available previously to insiders. That is false. Pension funds throughout the world have had made PE investments for decades. Isn't it a bit suspicious that these "opportunities" are coming at the same time when stability of the investments are increasingly a concern? I guess it's better and easier to try selling risky products to gullible people before asking for and likely receiving government bailouts or more protection beforehand. A market solution?
Can any politicians actually say no to a bribe anyway? Or would there be consequences if they did? They seem okay with bombing, poisoning, and starving children, so calling PE "too big to fail," (or another country's resources too important not to take or control) and securing their 10th home and claiming disaster aversion seems like the easy lay up. Why bother with accountability or compasion? Those are things only poor people and fools should concern themselves with, right? How would the public respond anyway? By wasting time and energy venting on social media like me?
It's unfortunate that deceit and division for the purposes of exploitation are completely on-brand in nearly every aspect of most peoples' lives now. I don't think it's some coincidence that public trust and consumer sentiment are at all time lows, while corporate profits, corruption, and inequality are at all time highs. These are opposite sides of the same coin. I think this is why the wealthy chose fascism over democracy - to protect themselves, the opulent from the majority (James Madison). But they aren't just protected. They seem untouchable, lavish, and insatiably greedy. If only the working class had the class solidarity of the capital class.
It's always credit, in one form or another. Whether it's CDS or CLO, or just the bonds, the worst crises are credit crises.
If you buy a bunch of equity, you think of it as a punt. Maybe I'll make 10x, maybe it goes to zero. I won't lose much. I can leverage it, but taking leverage for equity is something you do because you're conscious of the risk. You also can't borrow terribly much for equity leverage, normally.
If you buy a bond, you are thinking of it as not really risking the principal. I mean if course, some bonds default. We'll diversify away that risk. But really, you are farming money.
When you buy an equity, you look at the price every day, and when the pain gets too much, you lock in your losses by selling it.
When you buy a bond, you think of it as theoretical that you might sell before the term. So what if it's trading at 90 now? It will pay me the full amount later, no problem.
So when the bond market dies, a lot of investors have a rude awakening.
The reason a bond market crash is far more severe than a share market crash is because they signify a much bigger problem.
If companies are all suddenly struggling a lot, or it turns they’re all overvalued, their share prices will crash but they will keep operating and being productive. Meaning that once the crash has occurred and people catch their breath, the economy will recover as businesses continue doing what they were doing. The bonds will largely be fine, they’ll lose some value due to heightened default risk, but they won’t crash as companies continue to pay their debts.
However, when a bond market crashes, it’s because companies are suddenly no longer able to pay their debts, which only happens if the companies are going bankrupt. Share prices will almost certainly crash as well since the companies aren’t simply struggling, they’re looking like they’re about to no longer exist. This spells much bigger concerns for the economy too since a recovery will be much further down the line considering you will now have to rebuild from scratch these productive entities rather than simply getting them back on track. It doesn’t help that the liquidation process to repay bond investors also destroys the productive capabilities of these companies. Then you have other ramifications, namely that bond investors are largely risk averse investors who need that cash (ie a bank or insurer needing capital to repay deposits or insurance claims, or a pensioner who relies on bond yields to cover their living costs).
That’s for bonds, but other credit crises are worse because they can bring down the entire financial system. Banks are the traditional lenders, and they control the financial system. If you have a non-bond credit crisis, it’s going to hit the banks hard, and in turn that will have huge ramifications on the whole system.
The company sells autos to sub-prime borrowers and packages the loans into ABS (asset backed securities) Trusts. There are ~20 Trusts that publish data on the SEC website showing size of 300M-1B. The average monthly payment on these used cars is 470-530 dollars per month, avg principal 26k, loan terms 73 months plus. There are also many private trusts with no available public data.
The ABS trusts are showing significant and accelerating financial stress. Many have delinquency triggers at 2.2%. Just like we saw in 2008 the Trusts have about 50% Senior A level debt that is generally good, with several tranches below that going down in debt quality. The lower tranches have significant losses, ex: Carvana Auto Receivables Trust 2021-N4 has a 20% loss rate on 460 M. This is off balance sheet debt. But the company still has loss positions across all of these trusts that could trigger during a liquidity/debt crisis. This hits the company twice because it doesn’t get the money from the interest payments and also has to make the senior debt holders whole.
Additionally the company is heavily leveraged.. balance sheet shows 5.5 billion in debt, 3.384 tangible book value for a net debt of 2.788 billion. The company will need to refinance significant portions of this debt in the near future.
The whole business model depends on predatory lending, selling people cars that will almost immediately be under water with terms >6 years. If the credit markets seize up the whole model of packaging bad loans with good to sell whole package as high quality seizes up and goes away overnight. Almost exactly analogous to the 2008 mortgage crisis.
Thats_So_Ravenous | 11 hours ago
I’m pretty sure it was bundled mortgages (MBSs) with shit lending standards that blew up the economy. Credit default swap was the vehicle that people like Burry (sp?) used to short the MBSs
SunshineSeattle | 11 hours ago
Dont forget the shit rating agencies - they also helped 🤷
arun111b | 11 hours ago
And many economic experts (like Larry Summers) and financial media (print and digital) too.
MeanCryptographer585 | 10 hours ago
You mean “went to Jeffery Epstein for dating advice” Larry Summers
imtourist | 11 hours ago
Leave our beloved CDSs out of this! :). Yeah the ratings agencies certainly deserve a lot of blame and they didn't get flamed nearly enough as they should have. They were just one piece of a pretty corrupt and broken system however if they had done their jobs it probably wouldn't have happened.
SunshineSeattle | 11 hours ago
Its amazing to me they were allowed ro continue running without censure or anything. Like ... This is your whole job.
Wind_Yer_Neck_In | 10 hours ago
They didn't even really get any serious regulatory changes. It's maddening that the system we still use to assess the risk of assets is paid for by fees from the people creating/ selling those assets.
At the very least they should have established a government funded third party rating agency to go along with the shitty ones.
IosifVissarionovichD | 11 hours ago
"Shit rating agencies" gives me a fantastic visual, excellent comment to set my mood for the day. People in suits and ties rating other people's shit for living 🤣
sirlapse | 10 hours ago
Shit rating agency outta Zurich
ActualSpiders | 7 hours ago
Came to say this. If ratings agencies can be bought so easily, then there's literally no way to make a rational decision on any item's financial safety. Doesn't matter what market.
imtourist | 3 hours ago
This is why the professional money managers only take in what a credit ratings agency says with a grain of salt. When its their bonus on the line they will do their own due diligence on a company.
jfrankparnell85 | 6 hours ago
It's a very specific set of products:
Sub-prime mortgages generally... especially large mortgages with low money down (little equity stake at inception)... especially with balloon payments that were specifically designed for flipping and extreme speculation - and imagine lousy underwriting standards for these riskier mortgages... driven in part by the fact that you could originate and dump/sell without repercussions.
And by the way - all of this were designed at least initially to promote home ownership by people previously locked out of home ownership.
Pool those mortgages together.. .and have a nation-wide property bubble burst - so geographic diversification doesn't help
Now combine this with rating agency models that could be gamed - and historical default and delinquency models not calibrated to
You end up with "senior AAA" tranches of CMOs of subprime mortgages that were far from AAA.
Are there reasons tobe concerned today? Yep.
The private credit market is REALLY concerning.
So are the macro stresses from tariffs and oil price shocks. The high stock of US government debt is a serious problem, and is unsustainable.
A potential AI bubble popping could also trigger recession.
Blaming credit default swaps for the financial crisis is just idiocy - and throwing this in a headline is lazy and poor analysis.
Tribe303 | 10 hours ago
Correct, and it only blew up the American economy. THAT is what affected the global economy. Here in Canada our dollar hit par with the US, after 2008, due to money fleeing the US into Canada. I have multiple family members who bought cheap real estate in 2009 to go south for the winter. It was almost a half price sale for us! (all sold last year due to Trump's threats btw)
Baxter9009 | 10 hours ago
But not many people would touch any of those bonds if they weren't insured in the first place?
OK_x86 | 10 hours ago
The CDS were instrumental in magnifying the losses though. But that's also on the companies who issued them without doing their due diligence.
big_cock_lach | 8 hours ago
Sort of, but largely in the sense that they were a stepping stone to create Synthetic CDOs. There were effectively 4 difference derivatives, MBSs, CDSs, CDOs, and Synthetic CDOs. The Synthetic CDOs were the biggest problem.
An MBS is what everyone thinks of, which pools mortgages underwritten by a bank and sells them to investors. They can be pretty complicated though. These have existed forever, and continued to exist post-GFC, and a largely actually a good thing for the financial system. However, they do need to be well regulated since they do pose a moral hazard if banks can sell off their entire mortgage portfolio as MBSs, since banks would no longer care about the quality of the loans they underwrite, just the quantity of them. This was problem number 1.
A CDS is effectively insurance on an MBS, and are also helpful for the system as they can help further de-risk an MBS (typically an MBS will have credit enhancements such as tranching, but that mightn’t be enough on its own). Again, this is largely fine, it does expose insurance companies to the system, but they’re designed to be exposed to risk so it’s okay. However, the issue with these is that banks and insurers started selling naked CDSs, meaning you didn’t need to own the underlying asset to insure it, which allowed people to use them to speculate on the MBS market.
A CDO is simply a pool of MBSs, and this is where the real issues start to come into play. What this allowed banks to do was to start pooling together low quality MBSs and CDOs that investors didn’t want, and then they pooled them with a few higher quality ones to hide the junk and not make it look too bad. Credit rating agencies overlooked this as well, and continued to give these CDOs good ratings which they shouldn’t have been doing. This is what then allowed a lot of the junk to start going through the system.
Lastly, you then have Synthetic CDOs which is what really magnified the loss. A Synthetic CDO doesn’t actually own anything, but instead is designed to try to replicate another CDO without owning the underlying assets. These were created by buying naked CDSs which were structured in a way to replicate other CDOs. This allowed the speculation in this credit derivative market to not only be leveraged to extreme levels, but also meant that those on the other side of the trade (the banks and insurance firms) didn’t actually have any of the capital on hand to fulfill their obligations if things went belly up. That’s why the whole financial system was brought down when things made a turn for the worse.
Now, obviously there were other things at play too. Namely, there was huge demand in these assets since they had pretty high returns for supposedly very low risk. Financial institutions wanted to capitalise on this demand by finding new ways to sell more of these products (hence the creation of naked CDSs and Synthetic CDOs), which made banks start lending money to anyone to fulfil this demand. This easy credit then led to property prices taking off since it was so easy to get a mortgage, which then fuelled a lot of speculation over property prices, which in turn not only meant that there was more demand for home loans, allowing the banks to sell more of their credit derivatives, but it also drove up the value of the credit derivatives to since they are in turn also collateralised by the underlying properties. That then fuelled speculation on the credit derivative side, beginning a positive feedback loop since it made banks start lending even more aggressively, fuelling more speculation on house prices and demand for home loans, causing even more speculation on credit derivatives and so on. CDSs actually play a pretty small part in this whole aspect of it too, yes they help fuelled demand by allowing pension funds to insure the MBSs and CDOs, but pensions could still buy less risky ones and it likely wouldn’t have made a huge impact.
The big issues were the Synthetic CDOs causing financial institutions to have more exposure than they could handle, and the positive feedback loop where the credit derivative bubble and property bubble helped fuel one another. The biggest learnings are to make sure banks hold a large portion of their own MBSs to avoid them having a moral hazard, and to also ban naked derivatives which are only used for speculation.
tacoBrahe1 | 4 hours ago
Damn, this write up is great! 10/10 explanation. One thing I think The Big Short (the movie) did poorly was to explain what a synthetic CDO is/was - though I highly rate the movie overall.
I’m still not exactly clear on what synthetic CDOs are from your explanation.
> “These were created by buying naked CDSs which were structured in a way to replicate other CDOs.”
What does this mean? How do you structure MBS insurance to replicate a pool of MBSs?
LordOssus | 9 hours ago
Could an uptick in CDS's be a indicator in itself? Like a canary in the coal mine.
Thats_So_Ravenous | 8 hours ago
Oh, certainly. People are betting on default.
h4ms4ndwich11 | 9 hours ago
Meanwhile, people like Tony Robbins are pitching to the public the other side of this potential disaster - that there's an opportunity of a lifetime to "get access" to PE investment vehicles that they claim were only available previously to insiders. That is false. Pension funds throughout the world have had made PE investments for decades. Isn't it a bit suspicious that these "opportunities" are coming at the same time when stability of the investments are increasingly a concern? I guess it's better and easier to try selling risky products to gullible people before asking for and likely receiving government bailouts or more protection beforehand. A market solution?
Can any politicians actually say no to a bribe anyway? Or would there be consequences if they did? They seem okay with bombing, poisoning, and starving children, so calling PE "too big to fail," (or another country's resources too important not to take or control) and securing their 10th home and claiming disaster aversion seems like the easy lay up. Why bother with accountability or compasion? Those are things only poor people and fools should concern themselves with, right? How would the public respond anyway? By wasting time and energy venting on social media like me?
It's unfortunate that deceit and division for the purposes of exploitation are completely on-brand in nearly every aspect of most peoples' lives now. I don't think it's some coincidence that public trust and consumer sentiment are at all time lows, while corporate profits, corruption, and inequality are at all time highs. These are opposite sides of the same coin. I think this is why the wealthy chose fascism over democracy - to protect themselves, the opulent from the majority (James Madison). But they aren't just protected. They seem untouchable, lavish, and insatiably greedy. If only the working class had the class solidarity of the capital class.
lordnacho666 | 11 hours ago
It's always credit, in one form or another. Whether it's CDS or CLO, or just the bonds, the worst crises are credit crises.
If you buy a bunch of equity, you think of it as a punt. Maybe I'll make 10x, maybe it goes to zero. I won't lose much. I can leverage it, but taking leverage for equity is something you do because you're conscious of the risk. You also can't borrow terribly much for equity leverage, normally.
If you buy a bond, you are thinking of it as not really risking the principal. I mean if course, some bonds default. We'll diversify away that risk. But really, you are farming money.
When you buy an equity, you look at the price every day, and when the pain gets too much, you lock in your losses by selling it.
When you buy a bond, you think of it as theoretical that you might sell before the term. So what if it's trading at 90 now? It will pay me the full amount later, no problem.
So when the bond market dies, a lot of investors have a rude awakening.
big_cock_lach | 8 hours ago
The reason a bond market crash is far more severe than a share market crash is because they signify a much bigger problem.
If companies are all suddenly struggling a lot, or it turns they’re all overvalued, their share prices will crash but they will keep operating and being productive. Meaning that once the crash has occurred and people catch their breath, the economy will recover as businesses continue doing what they were doing. The bonds will largely be fine, they’ll lose some value due to heightened default risk, but they won’t crash as companies continue to pay their debts.
However, when a bond market crashes, it’s because companies are suddenly no longer able to pay their debts, which only happens if the companies are going bankrupt. Share prices will almost certainly crash as well since the companies aren’t simply struggling, they’re looking like they’re about to no longer exist. This spells much bigger concerns for the economy too since a recovery will be much further down the line considering you will now have to rebuild from scratch these productive entities rather than simply getting them back on track. It doesn’t help that the liquidation process to repay bond investors also destroys the productive capabilities of these companies. Then you have other ramifications, namely that bond investors are largely risk averse investors who need that cash (ie a bank or insurer needing capital to repay deposits or insurance claims, or a pensioner who relies on bond yields to cover their living costs).
That’s for bonds, but other credit crises are worse because they can bring down the entire financial system. Banks are the traditional lenders, and they control the financial system. If you have a non-bond credit crisis, it’s going to hit the banks hard, and in turn that will have huge ramifications on the whole system.
Cybertronian10 | 5 hours ago
> If you have a non-bond credit crisis, it’s going to hit the banks hard, and in turn that will have huge ramifications on the whole system.
Would the private equity situation be a risk to banks?
AMCorBUST2021 | 3 hours ago
I have been researching Carvana.
The company sells autos to sub-prime borrowers and packages the loans into ABS (asset backed securities) Trusts. There are ~20 Trusts that publish data on the SEC website showing size of 300M-1B. The average monthly payment on these used cars is 470-530 dollars per month, avg principal 26k, loan terms 73 months plus. There are also many private trusts with no available public data.
The ABS trusts are showing significant and accelerating financial stress. Many have delinquency triggers at 2.2%. Just like we saw in 2008 the Trusts have about 50% Senior A level debt that is generally good, with several tranches below that going down in debt quality. The lower tranches have significant losses, ex: Carvana Auto Receivables Trust 2021-N4 has a 20% loss rate on 460 M. This is off balance sheet debt. But the company still has loss positions across all of these trusts that could trigger during a liquidity/debt crisis. This hits the company twice because it doesn’t get the money from the interest payments and also has to make the senior debt holders whole.
Additionally the company is heavily leveraged.. balance sheet shows 5.5 billion in debt, 3.384 tangible book value for a net debt of 2.788 billion. The company will need to refinance significant portions of this debt in the near future.
The whole business model depends on predatory lending, selling people cars that will almost immediately be under water with terms >6 years. If the credit markets seize up the whole model of packaging bad loans with good to sell whole package as high quality seizes up and goes away overnight. Almost exactly analogous to the 2008 mortgage crisis.
Who will be left holding this bag?
AMCorBUST2021 | 3 hours ago
CVNA is 15B in ABS. Small potatoes. Easy to dismiss as one badly run company.
Or with this public data its possibly a rare window into a $300B+ private credit system with the same rot. Bear Stearns was a small company too.