The global financial crisis devastated American communities, wiped out savings and brought banking giants to their knees.
But it also enriched a handful of investors who had bet that the financial house of cards behind American real estate lending would collapse.
Steve Eisman is among this exclusive circle of Wall Street Cassandras, with a bank account and investment portfolio that grew as bankruptcies piled up among homeowners who had taken out adjustable-rate subprime mortgages.
His audacious gamble is recounted in the 2015 movie “The Big Short,” in which the actor Steve Carell plays a Mark Baum, a fictionalized version of Eisman.
Between 2004 and 2007, Eisman, who is married to an ex-banker, ran an investment portfolio at the hedge fund FrontPoint Partners.
His job was to invest wealthy clients’ money in the banking sector, which was riding high on the success of lending to higher-risk, or “subprime,” borrowers.
The banks spread this risk across the world, selling pieces of it in the form of complex instruments known as collateralized debt obligations, or CDOs, and securities backed by residential mortgages.
But, even with a Harvard Law degree, Eisman understood little about such exotic financial products with bewildering acronyms. And at a 2004 conference in Las Vegas, he learned he was not the only one.
He soon learned, after traveling next to Florida, California, Nevada and Arizona, epicenters of the subprime crisis, about the loose lending standards applied by mortgage originators and banks.
With graying hair and a square, athletic build, the middle-aged financier’s frank talk contrasts sharply with the typical Wall Street jargon.
Shorting against the world
“How could someone make a mortgage loan when the customer can only afford to pay for the first 3 years?” he asked during an interview with AFP at the Manhattan offices of Neuberger Berman, his new employer.
He reached out to the ratings agency Standard & Poor’s, which had stamped its vaunted ‘AAA’ rating, the highest possible, on CDO and RMBS (residential mortgage-backed securities) assets.
They said their models did not include negative scenarios.
But Eisman identified a set of dubious loans and decided to bet they would fall, convincing Goldman Sachs and Deutsche Bank to issue Credit-Default Swaps, which are insurance policies against borrower defaults.
“When you are short, the whole world is against you,” he said.
Early in 2007, mortgage defaults began to pile up as investors who had been speculating that real estate prices would rise suddenly pulled out, causing prices to tumble.
Greenspan failed
In eight months, 84 real estate lenders in the United States went bankrupt. But the value of Eisman’s portfolio powered higher, rising from $700 million to $1.5 billion and higher.
“I told someone I felt like Noah,” he said, referring to the Biblical patriarch who foresaw the global flood.
“Do you think Noah was happy?”
In Eisman’s view, the guilty ones are the bankers and traders convinced of their own omniscience.
“It’s very hard to argue with someone who thinks he is God because he makes a lot of money,” said Eisman.
Published in Daily Times, September 3rd 2018.