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Greed Unbound

In 2005, Alec Litowitz, was rested and relaxed from waiting out a non-compete clause from his previous employer.  During his time off, he and his wife spent a year traveling the UK on the hunt for artifacts to add to their replica of an English manor in the Chicago suburbs.  Apparently, the year abroad provided him some perspective.  Now, at the helm of a new hedge fund, Magnetar, with $1.7 billion in assets, he spotted an opportunity of a lifetime.

It was clear that by 2000, technological change finally caught up with the massive US mortgage market.  The sleepy loan market that had successfully funded the aspirations of home ownership for Americans for most of the Century was undergoing a profound change.  The dissemination of technology within the banking industry now made it possible to turn a bank’s entire portfolio of illiquid mortgage loans into liquid mortgage backed securities (a “derivative” of the original loan).  

The “securitizaton” process isn’t magic.  Securitization is simply the process of crunching “big financial data” to convert mortgage loans with unique characteristics (the story of the borrower and the home) into a financial derivative with a simple numerical quality rating (risky to safe).  These new, easy to use derivatives were a hit with investors worldwide.  Demand soared and he process rapidly spread to the entire industry through the Internet.

Soon, the entire US mortgage industry was out in the field, beating the bushes to drum up new mortgages, with increasingly poor results.  Further, bankers on the leading edge of technology had found ways to combined these derivatives into even more complex derivatives called CDOs.  These CDO’s crunched big financial data to bundle securitized mortgages with different quality ratings into a single package that provided superior rates of return to buyers with presumably, little risk.

Of course, as we know, this entire edifice was a house of cards.   Technology had accelerated this market so quickly, the entire bureaucracy — from government regulators to banking risk officers — were left in the dust.  The biggest debt market in the world was now, inevitably, beyond bureaucracy.

Despite this unfettered trajectory, concerns over the quality of these derivatives was slowing the market in 2005 — a rare occasion when market forces did actually work, in this technologically juiced financial world.  Left on its own, it might soon dry up.  Alec saw this too.

Alec saw that the mortgage derivative market would soon crash and he wanted to make money on the way down.  To do that he needed to short (make a bet on a decline in price) CDOs.  The problem was that there weren’t enough being built anymore.

So, he decided to make more by partnering to rapidly build “improved” CDOs.  To “improve” them, his firm bought the riskiest portion, making them appear, based on the big data financial data, less risky.  These improved CDOs sold like hotcakes, giving Magnetar plenty of opportunity to bet on the downside.  But it also extended the runaway amplification of the mortgage market for a couple of more years, radically increasing the damage to the entire system when it did eventually crash.

In sum, Alec and Magnetar made some money, by increasing the damage to the entire system and all the people in it, and we learned nothing.  Nobody involved in any of the frauds associated with the crash (there were countless) went to jail.

As a result, the same conditions we had then, prevail today.  The financial system is still being “managed” at bureaucratic speed with the expectation of normal results, despite the fact that technological change is increasingly producing non-linearity.

JR

PS:  Alec Litowitz made $280 m in 2007.

PPS: I’m writing a book online. This is a page of it. Will package it and the rest of the pages for Amazon. If you want to join me for free in the meantime, sign up with your e-mail in the space below.

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Discussion — 7 Responses

  • Trip January 23, 2014 on 1:28 pm

    In the mob they call that a “bust out”.

    Reply
  • Burgundy January 23, 2014 on 4:12 pm

    I’m not sure it is greed. It is a label we seem to apply to people in finance a lot, not that I mind, it seems to suit them. Would we apply the same tag to say Elon Musk (what a great name) because he enthusiastically builds technologically innovative businesses?

    I think people get a great deal of satisfaction out of excelling in what they do and even more so by creating innovative solutions that break new ground. And as I’ve said before, the System rewards those that do push out the technological boundaries. For some reason finance and entertainment seem to be of particular importance in the reward stakes.

    Of course exponential technological growth, as per Moore’s law for example, is very expensive. This explosive growth has to be funded somehow and capitalism, with its demand for profit, obviously isn’t up to the task (far too slow). Although it was attempted with new accounting techniques to make profits magically appear where there were non. So the job has fallen to governments (military, etc.), global finance, innovative means (crowd sourcing, etc.), seducing the public into buying products which funds the wider technological development (laptops, gaming consoles, smart phones, electric vehicles, etc.).

    Trouble is that the exponential growth in technology is not only leaving the bureaucracy behind the curve, its also leaving us behind and with an overdrawn account to boot. The economy we all depend upon is being hollowed out by technology, the environment is being destroyed by technology and the World’s resources are being consumed by technology. Such is the price that technological evolution is extracting. But even so, as we’re pushed into an evolutionary bottleneck (climate change), we need technology more than ever, regardless of the cost. A Faustian bargain in which we offer our soul, our biological inheritance, for the greater good and survival as a species (albeit somewhat altered).

    Reply
  • Cliff January 23, 2014 on 5:03 pm

    The interesting question to me is, in light of Burgundy’s observations: which horse in the race to the bottom brought about technological development is going to come in first – 1) environmental cataclysmic collapse or 2) financial cataclysmic collapse? Of course, whichever is first, will be soon followed by the other. Double whammy!

    Reply
  • Cliff January 23, 2014 on 5:15 pm

    On the other hand Burgundy, maybe financial cataclysmic collapse is the preferable winner of the race, because such – if it is not too late – can undercut the financing that is funding technological development that is undermining the environment. Kill the money for tech and save the environment.

    Reply
    • Burgundy Cliff January 23, 2014 on 6:21 pm

      Cliff, global finance is already buckling at the knees under the weight and no doubt will collapse when the unsustainable central bank printing spree ends. But a burnt out financial system isn’t going to put an end to the exponential technological evolution. New ways and means will pop up. Fukushima for example, the catastrophe without end, will require increasingly sophisticated technology to deal with its expanding problems (like killing everything in the Pacific Ocean). And with potentially global reach, both its radioactive pollution and unlimited financial needs can force a global bailout. A kind of global tax that sucks a slice of global GDP and directs it into technological solutions. Which unfortunately bankrupts an ever great number of the global population. You could say the same of Climate Change and resource depletion too.

      As for the environment, technology doesn’t give a hoot. Its collapse just spurs ever greater technological development. Crises are just more grist for a solution seeking mechanism. The fact that solutions create yet more problems means that the whole system becomes self-sustaining due to the positive feedback loops (aka. runaway growth). And as John has been pointing out, negative feedback is being dampened, thus allowing the increasingly unfettered technological growth.

      Essentially, to answer your question, the environment is toast. I heard somewhere the other day that they use depleted uranium in the fracking process. Anyway, if we’re going to survive in a world where our problems double every few years, creating change that we cannot adapt to fast enough, then we will need technology to do the adapting for us.

      Reply
  • Cliff January 23, 2014 on 10:51 pm

    If the environment is toast, what’s the point in preparing or making changes? If you are living in your little resilient community, growing food locally and manufacturing 3-d printed implements, etc., and a wacked-out Mother Nature blows or floods or earthquakes or freezes or bakes the land all away into oblivion, what we do with tech isn’t going to protect or prosper us. I sometimes wonder if Mother Nature has to annihilate most humans and their technology as a pre-condition for doing a hard reboot of the Earth in order to rebalance the planet.

    Reply
    • Burgundy Cliff January 24, 2014 on 3:25 am

      Well we can make assumptions on the future based on our current knowledge, but we cannot know for certain what the future will be. For example the Sun is behaving strangely at the moment, we may actually be heading into a Maunder Minimum like event which will offset some of the warming we’re experiencing (ie. more time to act and adapt). So whatever we think will happen we should still follow what we believe to be the best course of action (eg. better to die trying philosophy). Hope for the best, but prepare for the worst.

      Technological evolution and biological evolution are inimical to each other and cannot enter into a symbiotic relationship. We’ve thrown our lot in with technology in the war raging across the planet between the two evolutionary systems. A hard reboot looks increasingly likely, but the System already looks to be working on plan B with the reawakening of the Space Program to move off-planet. Either way, the consequences look rather dire for our species as we need both systems to survive.

      Whatever happens, we have a life up to the point we don’t and we should do what we can to make it as pleasant and as happy as we can. And as the current version of the System is fracturing and failing, it is entering into a new exploratory phase to find the best solutions for moving forward. This means we suddenly have choice again so we can experiment with new ways of living and doing things, in a world that is going berserk around us.

      Reply