The big short basically painted it as a naked cash grab by cackling Wall Street traders. My experience was it was fairly prosaic at the banks, essentially trying to construct products our customers wanted to buy. There was a lot of stuff that was going wrong, a lot of it was at:
At the micro level:
* local and regional banks stuffing mortgage pipelines with garbage, colluding with appraisers and others to make outrageous loans with fabricated or otherwise fraudulent docs
* loan officers effectively tricking ill equipped borrowers into unsuitable products against suitability requirements
At the macro level:
* rating agencies were ill equipped and were rating structured products AAA despite them paying junk bond returns - we tried to show them models demonstrating their ratings were too rosy but they kept us at arms length - as they should - but we felt it was really important they reassess. They wouldn’t.
* Large institutional investors seeking juiced returns but were restricted to AAA investments were eager for the junk returns, and were aware that these products were very risky despite the rating
The banks weren’t angels in this, but it’s been sold as a Wall Street issue. It was far greater than the street.
Also, “the big short” was taken on because Goldman stopped using theoretic models for valuing CDO’s and used fundamental models that showed they were extremely long subprime mortgage risk. As market makers they have risk limits on their books by internal policy and were required by their risk officers to short subprime to bring them within neutral risk with respect to their subprime mortgage exposure. It wasn’t a nefarious plot to screw the American mortgage holder - it was the bank functioning properly with proper risk management, the problem wasn’t the “big short” - it was the “big long.” Market makers are not speculators - their whole purpose is to stay neutral in the market and facilitate anyone who wants to trade long or short by quoting both sides.
