The Wall Street Takeover and the Next Financial Meltdown

Free financial markets enable money to go to the places where people need it. But on top of our allegedly free market, our banksters have erected a system that is indescribably complex and that provides many opportunities to make money at the expense of their customers, at the expense of their counterparties -- even at the expense of the U.S. economy. The internal systems of Wall Street banks have become so complex that if you are a smart banker, who is out to maximize your own income, you can find big loopholes in the system and you can exploit them for enormous financial gain, at everyone else's expense.

Managers of the hedge fund Magnetar saw that the American financial system was broken. And they found a specific way to exploit that. They knew that they could go to Wall Street banks and the banks would collaborate with them in creating some extremely toxic securities. Magnetar also knew that there was nobody watching out for the investors, thanks to the Republican deregulation efforts of the last 30 years. Finally they knew there was nobody watching out to make sure that the securities they manufactured were actually good securities. Therefore what Magnetar wanted to do was to use these toxic securities to short the housing market (Wall Street lingo for betting that the housing market was going to collapse). And so they shorted the market in such a way that they actually made the problem worse (for the country): they got the banks to create these toxic securities, so that they could then bet against them more specifically, so that they could then bet against the suckers who purchased these toxic securities (fraudulently portrayed as top quality), which basically consisted of bundles of mortgages, most of which mortgages were written up with the "benefit' of plenty of false information, for people of less-than-modest income, and poor credit, who desperately wanted to become home owners.

In a nutshell, Magnetar was shorting, or betting against, the fantasy that the American Dream could be extended so broadly, i.e. to large numbers of people with relatively low incomes and relatively poor credit. Essentially, Magnetar was, with great but cynical foresight, exploiting a system that was deeply broken, but not yet widely perceived as such. Magnetar had the foresight to see that most of these mortgages would soon be going belly up (along with the mortgage-backed junk securities that were based upon them), as working class incomes shrank, workers continued to be laid off, and growing numbers of houses went unsold.

We like to think that the financial system we have on Wall Street is set up so that as people there try to make lots of money they are they are indirectly helping the economy as a whole, by making sure that capital goes where it's needed most. What the Magnetar story shows us, however, is that what we have instead, now days, on Wall Street, is essentially a casino, where you can make the most money if you can simply find a way to exploit the weaknesses in the casino. It has nothing to do with helping people realize the American Dream. It has nothing to do with making sure that capital goes to the places where it's needed most. Rather it has to do with becoming the most unscrupulous and clever kind of gambler. (For more on this, see the reports at "ProPublica," "Planet Money," and "This American Life," whose investigative reporters did much to uncover this story.) http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going

http://www.thisamericanlife.org/radio-archives/episode/405/inside-job

1. Hedge fund manager John Paulson wrote a check for $10 million and handed it to a Wall Street bank, Goldman Sachs, and asked them to "make us a bomb of a CDO (Collateralized Debt Obligation) that we can sell to suckers.
2. Goldman created the CDO, using very risky mortgage-backed securities picked by Paulson, which they cajoled a rating agency desperate to hold on to their business to stamp triple-A.
3. Investors on the other side of the deal, kept in the dark about how the securities were actually selected, then committed hundreds of millions of dollars to buying into the CDO, essentially betting that the value of housing and the associated mortgages packaged into these CDO securities would continue to increase in value. They had no idea that they'd just bought into a mess of falsely labeled bottom-of-the-barrel mortgages selected by the very successful manager of a multi-billion dollar hedge fund that was betting against them and who was essentially setting them up to lose, big-time.
4. Paulson's hedge fund then bet against the CDO, once it was sold, using what is called a credit default swap, which refers to the purchase of an insurance policy that will pay off lavishly if the market value of housing in general, and this CDO in particular, begin to fall.
5. The housing market then crashed, as Paulson and a few others expected, and the CDO's value went to zero, with the bet made by the hedge fund paying off lavishly at the expense of investors on the other end, who had been purposely kept in the dark by Goldman Sachs about what they were really buying into.

For decades, we've been told that Wall Street and financial innovation were promoting the American Dream. But the truth turned out to be that in the kind of system we have today, the real money to be made, at the end of a housing bubble, was by betting against the American Dream.

Still more fraud by Goldman Sachs

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