Section Insights
Introduction to the Trade
What is the initial context of the trade being discussed?
The conversation begins with a meeting where Mr. Vennett from Deutsche Bank is discussing a trade involving mortgage bonds. There is skepticism and humor about the interest in the deal, but also an underlying sense of opportunity.
- The meeting sets a tone of skepticism mixed with curiosity.
- Mr. Vennett is trying to gauge the interest of others in a potentially risky trade.
- The mention of 'smelling money' indicates a focus on financial opportunity.
Understanding Risk in Mortgage Bonds
What are the risks associated with B-rated mortgage bonds?
The discussion highlights that B-rated and double B-rated bonds have become extremely risky, with default rates rising. If these rates reach 8%, many bonds could fail, presenting a significant opportunity for profit.
- B-rated bonds are considered high-risk investments.
- Current default rates are concerning, indicating a potential market collapse.
- The conversation reveals a disconnect between market perception and reality.
The Concept of Credit Default Swaps
How can investors profit from failing bonds?
Investors can use credit default swaps as a form of insurance on bonds, allowing them to potentially earn high returns if the bonds fail. The current market conditions suggest that many bonds are already on the verge of failure.
- Credit default swaps can provide significant leverage in a failing market.
- The lack of attention from banks on these failing bonds creates an opportunity.
- The conversation emphasizes the potential for high returns amidst market risks.
Understanding CDOs
What role do collateralized debt obligations (CDOs) play in the mortgage market?
CDOs are created by bundling together various risky bonds, including those that have not sold. This process allows banks to repackage and sell these risky assets as diversified investments, often misleading investors about their true risk.
- CDOs can obscure the true risk of underlying assets.
- The practice of repackaging risky bonds contributes to market instability.
- Understanding CDOs is crucial to grasping the broader implications of the housing crisis.
Skepticism and Opportunity
What is the reaction to the proposed trade and its implications?
There is skepticism about the trade, with concerns that the presenter may have ulterior motives. However, there is also a recognition that if the presenter is correct about the market, it could lead to significant profits for those willing to take the risk.
- Skepticism about the presenter's motives highlights the tension in financial markets.
- The potential for profit amidst a failing market creates a moral dilemma.
- The discussion reflects broader themes of trust and self-interest in finance.
Transcript
0:10 Okay, hi. How are you? Have a seat. Okay, Mr. Vennett from Deutsche Bank. Here we have So, how many people have you talked to about this trade? A few. There's definitely some interest. Oh, my boss would have my ass. You crazy, Jared? Get lost. You. Which is why you're here talking to us from wrong number. Sounds like there's a lot of interest.
0:42 All right. A few people have invited us in just to laugh at me on this deal. Is that you? No. Is that what this is? >> That's not what this is. That's just how Mark is. Let's see what you got. >> I'm sorry. >> You smell that? What is that? What? What's that smell? Cologne? No. Opportunity. No, money. Oh, okay. I smell money. Okay. Chris. God dammit. I'm sorry. >> >> This is your basic mortgage bond.
1:15 All right. The originals were simple. They were just thousands of triple-A mortgages bundled together guaranteed by the US government. The modern ones are different. They're private. And they're made up of layers of tranches. >> >> The highest level, triple-A's getting paid first. The lowest rated B's getting paid last taking on defaults first. Now, obviously if you're buying B's you can make more money, but they're a little risky. Sometimes they fail.
1:46 Chris. Somewhere along the line these B's and double B's went from a little risky to dog Where's the trash? Behind you. I'm talking rock bottom FICO scores. No income verification. Adjustable rates. Dog The default rates are already up from 1 to 4% fellas. And if they rise to 8% and they will a lot of these triple B's are going to zero, too. And that You're too close.
2:22 Is an opportunity. Okay, you're saying that at 8% the bonds fail and we are already at 4%. That's right. >> If they go to eight, it's our >> again. Yeah, that's right. How come nobody's talking about this? You're completely sure of the math. Look at him. That's my quant. Your what? My quantitative my math specialist. Look at him. You notice anything different about him? Look at his face. That's pretty racist. >> Look at his eyes. I'll give you a hint.
2:50 His name's Yang. He won a national math competition in China. He doesn't even speak English. Yeah, I'm sure of the math. Actually, my name's Jiang and I do speak English. Jared likes to say I don't because he thinks it makes me seem more authentic. And I got second in that national math competition. So, you're offering us a chance to short this pile of blocks. How? With something called a credit default swap.
3:21 It's like insurance on the bond and if it goes bust you can make 10 to 1 even 20 to 1 return. And it's already slowly going bust. >> 10 to 1, 20 to 1. No way. And no one's paying attention. No one is paying attention because the banks are too busy getting paid obscene fees to sell these bonds. But wait, you are the bank. When you work for the bank, I bet your margins are pretty nice and fat. Let's not talk about my margins, by the way.
3:49 Being nice and fat. That's a nice shirt, too. Do they make it for men? Aren't you the bank? I work for the bank. I don't think like a bank. Big bank, small bank, I like to make money. All right. Let me put it this way. I'm standing in front of a burning house and I'm offering you fire insurance on it. How can these underlying bonds be as bad as you say? It wouldn't be legal. >> >> Nobody knows what's in them.
4:12 Nobody knows what's in the bonds. I've seen some that are 65% triple-A rated that I know for a fact are filled with 95% subprime with FICO's below 550. Get the out of here. You want me to really blow your mind? When the market deems a bond too risky to buy, what do you think we do with it? Take a guess. I don't know, you tell me. All right. You think we just warehouse it on the books? No. We just repackage it with a bunch of other that didn't sell and put it into a CDO.
4:41 A CDO? Yes, a CDO. What is that? This is where we take a bunch of B's, double B's and triple B's that haven't sold and we put them in a pile. And when the pile gets large enough the whole thing is suddenly considered diversified. And then the at the rating agency give it a 92, 93% triple-A rating. No questions asked. Say that again. A collateralized debt obligation. It's important to understand because it's what allowed a housing crisis to become a nationwide economic disaster.
5:15 Here's world famous chef Anthony Bourdain to explain. Okay, I'm a chef on a Sunday afternoon setting the menu at a big restaurant. I ordered my fish on Friday, which is the mortgage bond that Michael Burry shorted. But some of the fresh fish doesn't sell. I don't know why. Maybe it just came out halibut has the intelligence of a dolphin. So, what am I going to do? Throw all this unsold fish, which is the triple-B level of the bond, in the garbage and take the loss?
5:46 No way. >> >> Being the crafty and morally onerous chef that I am, whatever crappy levels of the bond I don't sell, I throw it into a seafood stew. See, it's not old fish. It's a whole new thing. And the best part is they're eating three-day-old halibut. That is a CDO. Well, I just need to know how these could possibly be correlated. So, somehow you're like the Dora the Explorer and you're the first person who has found this thing that Hold on. So, mortgage bonds are dog CDO's are dog wrapped in cat Yeah, that's right. Okay.
6:19 Institutions treat these CDO's like they're as solid as treasury bonds and they're going to zero. No, it can't be right. There there were over 500 billion in housing bonds sold last year alone. The ratings agencies, the banks, the government. You're saying they're all asleep at the wheel? Yeah. My whole department's long on this stuff. They call me chicken little. They call me bubble boy. A's zero. B's zero. Double B's zero. Triple B's zero.
6:55 And then that happens. What is that? That's America's housing market. Thank you. Hey, Jared. Shut your mouth. Hang out with you. Good. Okay. Zach up to the deal. Let's be friends. And we will stay. Thank you. Don't me. All right. >> You're going to say no, aren't you? No. No, I'm just evaluating right now. Thank you. Thank you for seeing me. Bye, Jared.
7:30 I don't like it. He's playing us. He's playing us. He's got too much skin in the game and he's dumping his position. What if he's right? You want him to be right. Yes, I do. The banks have given us 25% interest rates on credit cards. They have screwed us on student loans that we can never get out from under. Then this guy walks into my office and says those same banks got greedy, they lost track of the market and I can profit off of their stupidity.
8:00 Yeah, I want him to be right. I mean, how come you don't hate this guy? He's everything you taught us not to trust. >> I can't hate him. He is so transparent in self-interest that I kind of respect him. Would I buy a car from him? No. Is he right about the mortgage market? Let's find out. Let's find out.
Summary
- The trade centers on mortgage bonds, which are bundled loans, with varying risk levels (triple-A to B-rated).
- The speaker highlights that many lower-rated bonds are filled with high-risk loans, suggesting a high likelihood of defaults.
- A credit default swap is introduced as a way to profit from the impending failure of these bonds, offering returns of 10 to 20 times the investment.
- The conversation reveals that banks are incentivized to sell these risky bonds without disclosing their true nature, leading to widespread ignorance about their value.
- Collateralized debt obligations (CDOs) are explained as repackaged risky bonds, misleadingly rated as safe investments.
- The discussion reflects a broader critique of the financial system, where institutions fail to recognize the risks involved, potentially leading to a major economic disaster.
- The characters express skepticism about the banks and the ratings agencies, acknowledging a potential opportunity amidst widespread financial negligence.
Questions Answered
What is the initial context of the trade being discussed?
The conversation begins with a meeting where Mr. Vennett from Deutsche Bank is discussing a trade involving mortgage bonds. There is skepticism and humor about the interest in the deal, but also an underlying sense of opportunity.
What are the risks associated with B-rated mortgage bonds?
The discussion highlights that B-rated and double B-rated bonds have become extremely risky, with default rates rising. If these rates reach 8%, many bonds could fail, presenting a significant opportunity for profit.
How can investors profit from failing bonds?
Investors can use credit default swaps as a form of insurance on bonds, allowing them to potentially earn high returns if the bonds fail. The current market conditions suggest that many bonds are already on the verge of failure.
What role do collateralized debt obligations (CDOs) play in the mortgage market?
CDOs are created by bundling together various risky bonds, including those that have not sold. This process allows banks to repackage and sell these risky assets as diversified investments, often misleading investors about their true risk.
What is the reaction to the proposed trade and its implications?
There is skepticism about the trade, with concerns that the presenter may have ulterior motives. However, there is also a recognition that if the presenter is correct about the market, it could lead to significant profits for those willing to take the risk.