# 10 The Big Short, Stree Dhan, and IPOs

“I have 5 mortgages”

The Big Short

Last week, I watched The Big Short again. In compelling performances, Christian Bale plays an idiosyncratic hedge fund manager, and Brad Pitt a retired Wall Street guru who reluctantly helps his young neighbours get rich quick. 

In its “Upshot Series”, the New York Times wrote that the film offered the "strongest film explanation of the global financial crisis". Investopedia said it was acclaimed for its energetic, innovative, and even humorous depiction of Wall Street greed.

“Greed is good”, as Gordon Gekko said in another film, especially when you are a filmmaker, and want to tell a morality tale. Bankers are easily cast as villains. The truth, unfortunately, is more complex, and as someone else said, in the global financial crisis, there was more than enough blame to go around.

Made in 2015, the film is based on a book of the same name, by Michael Lewis, and it explores the role of housing loan mortgages in bringing about the near collapse of the US economy, and the global banking system in 2008. The villain of the piece is a devilish instrument called the MBS, or Mortgage Backed Security, a term which deserves some explanation. 

When a US home-buyer took out a mortgage, she received a cheque to pay the builder from the local bank or thrift association, to whom she now owed her monthly instalments.  In reality, though, her mortgage was now just another financial instrument, like any loan. For banks, loans are assets, because they generate a stream of income, from interest payments  and the principal amount. Such assets, or securities, are easily traded, and a mortgage from Smalltown, Idaho could find itself in a Wall Street bank in a day or two. There, it would be bundled along with hundreds of other small loans into a larger asset, or security. A hundred mortgages, say, of 100,000 dollars each, became one bundle worth 10 million dollars, the Mortgage Backed Security. This MBS, duly stamped as being credit-worthy by ratings agencies, could now be traded across the world, especially in countries with a glut of savings, like Germany and Japan. Within a week, a school-teacher from Idaho actually owed her loan cheques to a savings bank in Bavaria. Meanwhile her bank, the ‘originator’ of the loan, had passed on the risk up the chain, got its money back, and was ready to make another loan.

Between 2004 and 2007, the volume of MBS trading grew feverishly; soon, Wall Street created ‘derivatives’ of MBSs, essentially bets on whether the price of MBSs would go up or down, a concept brilliantly explained by a Big Short scene played directly to the camera from inside a casino. Soon, the volume of these derivatives exploded, and the hedge fund manager played by Christian Bale was an early buyer of bets that housing prices, and hence MBSs, would crash. The Wall Street establishment, of course, thought this was easy money, as “housing prices never crash”. 

Of course they did. Because of the sheer volume of outstanding MBSs, and the cascade of derivative bets on those loans, they brought Wall Street to its knees. US financial authorities - the Federal Reserve, and the Treasury - had to inject vast sums of money into the banking system to rescue it. The government was the White Knight to the rescue of a system broken by Greedy Bankers.

This greed, in the film’s narrative, was represented largely by three forces:

• The creation of the MBS, by Lou Ranieri, a senior executive with leading US investment bank Salomon Brothers (subsequently merged into Citibank).

• The frenzied peddling of housing loans by originators, to those who didn’t have the ability to repay them. In a picaresque scene, a pole dancer in the middle of her act tells a banker, “You can touch me”, while also revealing how many mortgages she owns.

• The unethical rating of MBSs by credit rating agencies, who clearly didn’t exercise due diligence on the quality of those loans.

Reality is a lot more complex:

The first MBSs were actually issued by Freddie Mac (Federal Home Loan Mortgage Corporation), in 1971. Freddie Mac was a Government Sponsored Enterprise, or GSE, set up by an act of Congress, “focused on purchasing conventional housing mortgages from thrifts and issuing MBS, rather than holding these mortgages in its portfolio. In doing so, Freddie Mac transferred the interest rate risks associated with the mortgages… “ Exactly what Wall Street did in The Big Short, 30 years later.

Salomon did play a major role in developing mortgages for commercial banks, not backed by government guarantee, but as late as 2002, the GSEs, such as Freddie Mac and Fannie Mae, accounted for the bulk of the MBSs created - 2.1 out of 2.9 trillion dollars. Interestingly, by then, the GSEs were not actually owned by the government, but still supervised by the US department of Housing and Urban Development, HUD. 

In 1995, HUD demanded of the GSEs  “affirmative action to facilitate the financing of affordable housing for low-income and moderate-income families.” This reminds me of nothing more than our farmer loan melas - though a dance club is hugely more cinematic. It’s easy to sell loans, tough to get your money back. Easy to blame the originator, and gloss over the political incentives of those who demand affirmative action. Retail banks, too, especially those applying for national banking licences, were under political pressure to extend loans in low-income areas they had earlier ignored. A typical narrative went like this “in the years leading up to the 2008 housing crash, mortgage lenders peddled hundreds of thousands of risky subprime loans.”

The political reality, as journalist Nick Timiraos said,  is that “We begin to really push home ownership, both parties do it, Clinton does it. George W. Bush does it with his Ownership Society.”* In his book Fault Lines, Raghuram Rajan set out the conviction that the mandated expansion of housing ownership was a political imperative, and doomed to end in a spectacular collapse. Moral hazard begins with the need for votes. 

Clearly, there was more than enough blame to be shared for the 2008 housing collapse that became the Global Financial Crisis, or GFC. The ratings agencies certainly played an abominable role, but in my book, the biggest villain was the one with the most power over the financial system, the US Federal Reserve. In response to the Dotcom bust of 2000, the US central bank had lowered interest rates from 6% to 1%. Mortgage rates had fallen to levels that hadn’t been seen for 50 years. Good times, aka cheap money, always makes for bad loans. 

Though they began to raise rates in 2005, the Fed had already set the global financial system up for a ballooning of debt. As late as 2007, the Chairman of the Federal Reserve, Ben Bernanke, confidently said, “we believe that the effect of the troubles in the subprime sector on the broader housing market will likely be limited....and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system”. 

Famous last words? But only for that particular chair.

Until November 2021, current Fed Chair, Jamie Powell, said that inflation was transitory, implying that ultra-low interest rates did not need raising. He is now being forced by reality -  that complex, but inexorable beast - to deal with soaring consumer prices, and plan to tighten money. 

I’m sure there are other big or bigger shorts being set up today, as we look into 2022. There will be simplistic morality tales told tomorrow, in cinema and on the web. But I think the biggest truth was told by Thomas Hoenig, a member of the Federal Open Market Committee, who consistently voted against Bernanke’s cheap money policy.  In his book, The Lords of Easy Money, Christopher Leonard quotes Hoenig: “The Federal Reserve doesn’t have a good track record of withdrawing policy accommodation in a timely manner.”

If you’ve been watching US equity markets this last week, you might be praying that’s not true.

Stree Dhan, etc.

Last week, the Business Standard carried a five page announcement by Muthoot Finance, listing gold loans that were going up for auction. I counted the number of reference numbers per line and the number of lines per page, and estimated that these were 33,000 pieces of gold going up for auction. When I tweeted this fact, along with a picture of the ad, my time-line went viral, suggesting how emotional we Indians are about household gold.

Friend and economist, Shruti Rajagopalan responded, “This page tells me more about the economy than all the pundits put together.”

Earlier, a friend texted privately, “Gold loans and Tanishq sales, both going up - this is the K-shaped recovery.”

As another reader pointed out, we don’t know the corresponding figure for earlier years, so we shouldn’t rush to declare widespread despair. I agree completely, and have reached out to get time series data on gold auctions

What I do know is that, apart from Muthoot and Manappuram, which are Non-Bank Finance Companies (NBFCs), banks have expanded their gold loan portfolios. The latest RBI data for bank credit, dated Jan 17th, 2022, has a detailed break-up for personal loans as of November 2021. “Loans against gold jewellery” stood at 65630 cr, up 42% from November 21. This is a very substantial increase, and suggests a surge of households reaching for that most precious last resort. 

How many households, I wondered. I know that the average gold loan by NBFCs is a little under 50,000. If I use the same figure for bank loans, last November, 13.1 million households had pledged their gold to banks to meet their expenses.

I will be following this space.

IPOs

Three IPO biggies of 2021 drooped last week, and all ended up with market capitalisation below 100,000 cr.

Both Nykaa and Zomato are well above their issue price, but if speculators bought in the initial frenzy of listing, they would be hurting badly. Paytm has been a disaster from the word go; as of Friday closing, it sells at a discount of 55% to the issue price.

This recent experience will colour the enthusiasm of IPOs in 2022.

                       Issue Price        Peak         Current

Zomato, Jul 2021          75               169            113

Nykaa,  Nov 21          1125              2573           1998

PayTM,  Nov 21,         2150              1955            960