How To Make A Million Dollars An Hour, Step 6: Rig Your Bets
In part six, Leopold shows that, contrary to common conception, hedge funds don’t discipline the banks for taking risks – they collude with the banks to take risks, bet on failure and then pocket the winnings.
Whenever there’s a great upheaval, our instinct is to look for someone to blame. Who’s the bad guy in this story? If you want to be a high-roller, you want it to be you. Ideally, if you made out big on a bubble—or on a bubble popping—you want to be the force that blew it up and popped it. Why surf, unless you make your own waves? Why gamble, unless you’re the house?
Vampire Squid Or Systems Failure?
In our current financial melodrama, Goldman Sachs claimed the role (so far) of chief villain. It even has a sinister new nickname: Vampire Squid, created by journalist Matt Taibbi in his infamous Rolling Stone piece.
Since then, Goldman Sachs has wasted millions on PR trying to erase those bloodthirsty tentacles from our minds. No such luck. The Securities and Exchange Commission [SEC] further tarnished Goldman Sachs’ image when it slapped the bank with a $550 million fine for misleading its investors. Meanwhile, in its report, which used Goldman Sachs as a core case study, the Senate Permanent Subcommittee on Investigations all but accused the bank’s top officials of committing perjury.
Yet, this game of cops and robbers won’t take us very far.
When you have a systemic meltdown, it’s best to look for systemic causes. It’s doubtful that Goldman Sachs was the only bad guy and those other banks were saints.
JPMorgan Chase: The Smartest Guys In The Room?
For a long while, some people thought maybe JPMorgan Chase was the good guy in this crime flick. CEO Jamie Dimon was known as Obama’s favorite banker. The word among media mavens was that JPMorgan Chase took bailout loans only because it was asked to do so by the Treasury Department, in order to give cover to the other banks and help the government set up its controversial TARP program in 2008.
But really, they claimed, Dimon and company didn’t need that money — they’d been smart enough to avoid the gambling spree that took down the economy. (Yet, not smart enough by 2012 to avoid losing more than $5 billion on another gambling spree?)
How noble that this one bank stood above the fray, while all of its competitors were building bigger and bigger casinos and walking away with unbelievable cash until it all crashed. Yet, like the fluffed-up David-and-Goliath version of the Greatest Trade Ever, JPMorgan Chase is not the King Solomon of our story. No one is.
TBTF Banks Collude With Hedge Funds
In truth, just like Goldman Sachs, JPMorgan Chase was up to its eyeballs in designing and selling toxic mortgage-backed securities. All of the big banks were colluding with hedge funds to design financial products that were nothing short of insane.
You work for a pharmaceutical company and you design a drug to kill the patient so that you can collect on the victim's life insurance. Of course, that's preposterous. You are not permitted to design products that fail so that you the seller can collect the insurance. But in high finance that is considered a fine art.
Here's what they did:
The hedge funds would package together the very worst mortgages they could find -- those with teaser rates that were about to reset in places like Nevada, Arizona and Florida. They wanted to find the pools of mortgages that were most likely to go into default. Then these were packaged together into a synthetic collateralized debt obligation security that was designed to fail. (A synthetic CDO doesn't actually own the mortgage pools. Rather it makes bets as if it owned them. It's the pinnacle of fantasy finance. See my workshop on CSPAN BookTV for more detail.)
The hedge fund held the insurance on the made-to-fail securities. If the securities failed as planned, the hedge fund would collect. The colluding bank would find the chumps to buy the junk securities and collect fees up and down the line.
Disclosure Laws Fail Investors
The SEC fined Goldman Sachs, JPMorgan Chase and Citigroup more than a billion dollars for packaging and pawning off these mortgages. What did the hedge fund hustlers have to pay in damages? Not one penny.
Why? Because the only law against this rigged game is the failure to properly disclose information to the investors. The rest apparently is considered perfectly kosher.
Here's even a bigger question: What economic value was produced by this rigged game that put billions of dollars into the pockets of hedge fund managers? Nada. In fact, a very strong case can be made that these unsavory transactions produced negative value by accelerating and deepening the crash.