To put a finer point on my post below, the people profiled by Michael Lewis in his book The Big Short are a perfect example of what I’m saying. A handful of guys like Steve Eisman and Michael Burry both figured out what was happening even while Wall Street was bursting its seams with mortgage money, and they secured enough support to bet real money on their hunch. Here was a case where a small number of relatively minor players took on the giants of their field and more than won. They utterly humiliated the traders who took the other side of their bets.
The difference? These guys took the time to understand the real housing market and the actual positions of major firms while overcompensated con artists packaging loans depended on math whiz ‘quants’ who worked with simulated markets, outdated assumptions (e.g., mortgage default rates from the Eisenhower administration) and best-case economic models. The knowledge gap between Eisman and Burry and the MBS salesmen they preyed on was about as great as the gap between the salesmen and their average client.
retr2327
“The knowledge gap between Eisman and Burry and the MBS salesmen they preyed on was about as great as the gap between the salesmen and their average client.”
Um, no. Not as I read it. More like the intelligence/willingness to stop and think about it gap.
Jim C.
Out of curiosity, how much money did these financial geniuses make?
It is a little like basic poker strategy actually. If the rest of the table is playing very loose and aggressive, then you can win big by playing tight and conservative. If the rest of the table is playing very tight and conservative, then you can pick up a ton of easy pots by going aggressive and loose.
retr2327
Adding: Burry didn’t have access to information that the sellers didn’t, he was just monomaniacal enough to read the offering portfolios that nobody else ever bothered to.
Sentient Puddle
@retr2327:
Close enough to the point, really. I think it’s sort of expected that these hedge fund traders are experts in this shit and will actually stop to think.
Or well, given Wall Street culture, it’d be more accurate to say that it should be expected.
El Cruzado
Yes and no. As much a willingness to learn gap that created a knowledge gap, since both sides in that case had in their job description the duty to figure those things out.
It’s not the same to compare the gap between trader and customer, the same way that there’s a knowledge gap between a surgeon and his patient: one has dedicated his life to figuring out that field of study, the other one just needs a service performed and has a life to take care of.
agrippa
The intersection of greed and folly.
The complete and ignominious failure to apply the principle of calculated risk.
To put a sugar coating on it.
Cat
They were also willing to believe conventional wisdom was wrong.
debbie
Thhe real difference is that Elsman and Burry are totally amoral. They saw the problem, made a half-assed attempt to inform the SEC, and when they got no reaction, decided WTF and enriched themselves with what they knew to be a wrong. They’re every bit the scum bag as the Wall St. traders were.
Martin
I have to agree with retr2327. There are plenty of examples of information asymmetry distorting markets, but Burry isn’t one of them. Burry is an example of information overload making the market blind to what’s happening. Rather than looking at the function that was really taking place, the market was too focused on making money off of the action of the second derivative of that function to be able to see what was really happening.
schrodinger's cat
Information asymmetry does not explain everything that is wrong. The problem is the definition of risk, that’s the fallacy that all risk can quantified and hedged away. It can’t.
Janus Daniels
Agreed, except “hunch” is the wrong word. The didn’t do anything on hunch; based on their research, they acted on fact, not hunch.
bobbo
I was astounded to read in that book that the guys at the very top of Morgan Stanley and AIG had absolutely no idea how the CDOs worked. But you have to remember, the guys in the Big Short who bet against the market and won essentially created the market too – they went out and found really bad risks for banks to give mortgages to so that they could then take out credit default swaps on those mortgages.
Tim F.
@debbie: I’m not making a moral point. And besides, you are suggesting, what, that the traders they fleeced were somehow more moral? I honestly do not understand what you said.
@Jim C.: I do not know the number off the top of my head. It was in the Carl Sagan ballpark. Also, your analogy is completely wrong. If the mortgage system was a poker game then Eisman knew for a fact that AIG had a shit hand when AIG thought they had four of a kind.
@retr2327: You’re not disproving my point. Most financial customers had access to the same information that Eisman and company put together as well. It was all (or mostly) in the financial instrument small print and in publicly available real estate industry trade information. The asymmetry was that most traders lacked the time or the wattage to put it together.
Financial customers were in a similar spot. Plenty of incriminating information was out there but most customers would need morewattage and almost infinite time to work it all out.
@retr2327: Exactly my point. If a trader thinks he’s holding four of a kind and Burry discovers he has nothing, it doesn’t really matter if the truth is right in front of the trader’s face. As long as he doesn’t see it the information asymmetry will clean him out.
Mike G
They were up against behemoth Wall Street institutions that have the biases and blind spots that all large organizations have that make them act in blind, stupid ways — groupthink and conformism, they make more money being reflexively bullish, and the fact that being wrong in an unconventional way can sink your career while being wrong with the herd counts nothing against you.
There’s a great schadenfreude-istic (new word?) letter on the intertubes from a hedge fund guy who closed his fund down after making a fortune, where he thanks the Wall Street trust-fund “idiots whose parents paid for prep school”, the rich-twit George W. Bushes of the world he traded against: “All of this behaviour supporting the aristocracy only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.”
http://www.guardian.co.uk/business/2008/oct/18/banking-useconomy
Nathanlindquist
I wrote about this on Kevin Drum’s site, where a number of commenters had a similar answer as Tim F: its the information assymetry.
Even thought this answer is part of it, I think it goes deeper.
Basically since around 1973 when American production of oil peaked, we’ve been trying to come up with get-rich-quick scams to grow the economy rather than doing things the hard and slow (but real) way.
In the 80s and 90s oil from OPEC was really cheap which helped. We thought the economy was awesome because america was so awesome but whatever. The reality was we were globalizing–another word for the cannabilization of our domestic manufacturing assets for a quick profit by multi-nationals, who over the long-term will continue making money in China even if America ain’t producing a dime. But, hey, it sure goosed the stock market in the 90s, and I know I got a few good years out of it.
Then the IT and .com boom happened, and sure there was some real wealth created there, but a lot of it was just a stock market boom that petered out in 2000. And oil was the cheapest it would ever get around 1998 ($11 a barrel). That sure made it easy for Walmart to ship in cheap goods from the third world. What a coincidence that was about the best year America ever had.
After 9/11 all those quick fixes were petering out, and Greenspan saw a huge recession staring him in the face. So he boosted the finance sector and stock market. Americans weren’t getting pensions anymore, so they saw their best bet as putting all their money in the stock market. It didn’t pay anymore to start a small business or, you know, actually Make Something (except houses). So we put our money in finance, or became a realtor or insurance agent, and hoped for the best. Finance was the only industry left standing, the only way we could keep the perpetual growth machine going. So America went all in. What else could we do?
You will also note that the CDOs and assorted financial bullshit really started to pick up in 2005, the year that world oil production flatlined and has sat at around 86 million barrels a day ever since. This was the banksters saying that the Growth Machine Must Not Stop! (seriously, i hope it doesn’t, it won’t be pretty)
So In Conlusion, the growth of the finance industry was just the last in a long line of quick fix scams to keep America from looking in the mirror and asking what kind of society are we, and what kind of society do we want to be?
Because we have no fucking clue what the answer to those questions are.
agrippa
@Nathanlindquist:
good analysis.
And, we have no idea what kind of society we are.
And, we have no idea what kind of society we want to be.
Martin
@Tim F.:
But that’s not a market problem, really. For one, that’s always existed, and making sense of the data is a market itself – hell, that’s a big part of journalism. That’s also what Google does. It should be a problem that solves itself thanks to innovation.
Information asymmetry is when one party has information that the other simply doesn’t. One party has no way of balancing that market equation out – even by seeking help from others.
Janus Daniels
“A handful of guys… utterly humiliated the traders who took the other side of their bets.”
True, but perhaps misleading.
We need to remember that the individual human traders on the big bank side didn’t care which way the wagers went, and they still see no reason why they should. While they crashed the whole country, they kept making money. They still do.
retr2327
@Tim F:
I think our disagreement, such as it is, arises from a distinction between what I might call “objective” asymmetry (one side has access to information that the other doesn’t) versus what I would characterize, at best, as “subjective” asymmetry (one side takes the time to digest the info, the other doesn’t).
My sense is that most economic commentators use information asymmetry to refer to the former, not the latter. Certainly that’s how I read your initial post on this. But I could be wrong about that.
It was a pretty good book either way, no? Astonishing, really.
@Bobbo:
“they went out and found really bad risks for banks to give mortgages to.”
Um, no again. They went out and found really bad risks that the banks had already given mortgages to, which is something quite different.
debbie
@Tim F.:
What I didn’t say very well is that I think Elsman and Burry are just as lousy as the crooked traders. I question their ethics. Elsman and Burry saw the scam that was going on and thought that it was something that ought to be reported to the SEC. Which they did, but then when they got no response, figured “What the heck” and set about making their own piles of money from it. If they’d had any sort of consciences, they’d have persisted in alerting the authorities until they got a response. They certainly wouldn’t have joined in to game the system.
This is what I got out of reading the book. I know ethics and Wall Street are antithetical, but I wish Lewis had addressed this.
rob in dc
Nonsense, these guys were part of a large trend in financial circles that started in 2005-2006. They were absolutely nothing compared to the mammoth hedge funds which shorted the market, but it was them and those who made bets similar to them who stopped the price clearing mechanism from happening in the subprime market to begin with, their greed was 100% part of the problem, though of course two bit players like the ones mentioned in the big short were not a big influence.
http://www.huffingtonpost.com/yves-smith/debunking-michael-lewis-t_b_512542.html
Bill Cole
The debate over whether “information asymmetry” is an accurate phrase for the Big Short is rooted in a common semantic conflation.
Information is not the same thing as data.
Data contains information. The losers at Bear, Lehman, AIG, and the rest had the same data available to them that was used by Mike Burry and John Paulson and the others who called the bubble what it was and called its collapse accurately. In a sense they had the same information as well, but there was an asymmetry in analytical skill: the ability to extract information from data. The winners of the “Big Short” bets understood the information, the losers didn’t. In the moral framework of Market Fundamentalism analytical skill is a cardinal virtue, so for believers in that faith Burry and Paulson are something like saints. From an information theory standpoint, the MBS/CDO mess was an information hiding project which was so successful that it convinced even the people engaged in doing it that the information was being changed rather than just masked and diluted by an essentially meaningless pile of packaging data.