In Search of the Perfect Investment

Wherever I travel, whomever I speak with, they speak of pools and pools of  sloshing, idle money. You’d think they’d talk of The Great Recession and the 18% who need a real job. But no. It’s gobs and gobs of money looking for a home. The money is frightened — three boom-and-busts of the last decade has its toll. But the sloshing money is  still there.

In La Quinta, CA home prices have dropped a third from 2005-2006 peaks. And now they’re edging up. “Cheap” homes — under $500,000 — are being snapped up. More expensive ones — $1 1/2 million plus — are selling more slowly, often to successful businessmen who are buying their third or fourth “holiday home.” They see cheap real estate as a better investment than anything Wall Street is offering.

In fact, Wall Street and the administration are vying for the  lack of credibility top prize.  Latest insanity: “Let’s pass the health bill, come hell or high water.” Oih. My wish is for one person in Washington — just one — who’s managed a business and met a payroll.

Meanwhile, markets are sliding sideways, as “investors” await news on any more shoes to drop — another Greece, a currency exploding, horrible employment numbers.

No shortage of great financial writing. From Andrew Ross Sorkin’s great book, “Too Big to Fail” to Michael Lewis’ upcoming “The Big Short: Inside the Doomsday Machine” we have not lacked for great financial books. The Lewis book is excerpted in the latest Vanity Fair, which, like Rolling Stone, publishes a remarkable number of great financial stories. Here are excerpts:

In early 2004 a 32-year-old stock-market investor and hedge-fund manager, Michael Burry, immersed himself for the first time in the bond market. He learned all he could about how money got borrowed and lent in America. He didn’t talk to anyone about what became his new obsession; he just sat alone in his office, in San Jose, California, and read books and articles and financial filings. He wanted to know, especially, how subprime-mortgage bonds worked. A giant number of individual loans got piled up into a tower. The top floors got their money back first and so got the highest ratings from Moody’s and S&P, and the lowest interest rate. The low floors got their money back last, suffered the first losses, and got the lowest ratings from Moody’s and S&P. Because they were taking on more risk, the investors in the bottom floors received a higher rate of interest than investors in the top floors. Investors who bought mortgage bonds had to decide in which floor of the tower they wanted to invest, but Michael Burry wasn’t thinking about buying mortgage bonds. He was wondering how he might short, or bet against, subprime-mortgage bonds.

Every mortgage bond came with its own mind-numbingly tedious 130-page prospectus. If you read the fine print, you saw that each bond was its own little corporation. Burry spent the end of 2004 and early 2005 scanning hundreds and actually reading dozens of the prospectuses, certain he was the only one apart from the lawyers who drafted them to do so—even though you could get them all for $100 a year from 10kWizard.com.

The subprime-mortgage market had a special talent for obscuring what needed to be clarified. A bond backed entirely by subprime mortgages, for example, wasn’t called a subprime-mortgage bond. It was called an “A.B.S.,” or “asset-backed security.” If you asked Deutsche Bank exactly what assets secured an asset-backed security, you’d be handed lists of more acronyms—R.M.B.S., hels, helocs, Alt-A—along with categories of credit you did not know existed (“midprime”). R.M.B.S. stood for “residential-mortgage-backed security.” hel stood for “home-equity loan.” heloc stood for “home-equity line of credit.” Alt-A was just what they called crappy subprime-mortgage loans for which they hadn’t even bothered to acquire the proper documents—to, say, verify the borrower’s income. All of this could more clearly be called “subprime loans,” but the bond market wasn’t clear. “Midprime” was a kind of triumph of language over truth. Some crafty bond-market person had gazed upon the subprime-mortgage sprawl, as an ambitious real-estate developer might gaze upon Oakland, and found an opportunity to rebrand some of the turf. Inside Oakland there was a neighborhood, masquerading as an entirely separate town, called “Rockridge.” Simply by refusing to be called “Oakland,” “Rockridge” enjoyed higher property values. Inside the subprime-mortgage market there was now a similar neighborhood known as “midprime.”

But as early as 2004, if you looked at the numbers, you could clearly see the decline in lending standards. In Burry’s view, standards had not just fallen but hit bottom. The bottom even had a name: the interest-only negative-amortizing adjustable-rate subprime mortgage. You, the homebuyer, actually were given the option of paying nothing at all, and rolling whatever interest you owed the bank into a higher principal balance. It wasn’t hard to see what sort of person might like to have such a loan: one with no income. What Burry couldn’t understand was why a person who lent money would want to extend such a loan. “What you want to watch are the lenders, not the borrowers,” he said. “The borrowers will always be willing to take a great deal for themselves. It’s up to the lenders to show restraint, and when they lose it, watch out.” By 2003 he knew that the borrowers had already lost it. By early 2005 he saw that lenders had, too.

You can (and should) read the entire piece on Vanity Fair’s web site.

I hesitate to publish this. But it is funny.

If it offends you, I apologize in advance.

Harry Newton, who took his wife to brunch (fun), played tennis (semi-fun, elbow hurts), played with some investment ideas — including TreeHouse Foods (semi-fulfilling) and tried to talk some businesspeople into doing the logical thing (totally unsatisfying). Nobody listens. That’s another column.