The Big Short In Pictures (The Subprime Crisis, Lehman, Bear And Countrywide)by Anthony B. Sanders •November 7, 2015 Suddenly, many of my students are reading Michael Lewis’ “The Big Short.” Even in a real estate development class! Having read Lewis’ book ( I can’t wait for the movie with Christian Bale and Brad Pitts! ), I thought I would explain the subprime crisis in a few, colorful charts. First, Lehman Brothers declared bankruptcy on September 15, 2008. But Lehman knew they were in trouble before that date (hint: Bear Stearns was sold to JP Morgan Chase in a fire sale in March 2008). Here is what was going on. First, subprime loans helped boost the housing bubble, at least until home prices started to fall. Second, home prices (for the collateral backing residential mortgages) began to fall in 2007. Subprime loan delinquencies started to rise rapidly. Both of these happened before unemployment started to rise in 2008. By the time 2008 rolled around, firms in either subprime (Bear, Lehman) or low down payment lending were in trouble. A review of Bear Stearns SR 5Y CDS reveals that the risk of a Bear Stearns bankruptcy was already building steam in the latter half of 2007. But by February/March of 2008, Bear CDS was started to explode, signalling that something was really wrong. Bear Stearns was sold to JP Morgan Chase on March 16, 2008. Bear’s 5Y CDS peaked on March 18, 2008. Do you think Lehman Brothers was watching what was happening at Bear? Of course they were. The book and movie “Margin Call” were vague about whether it was Lehman or Bear, but the whole theme that it was a “shock” to management was laughable . Just look at the home price/subprime delinquency chart and the Bear CDS chart and show me where the “shock” was. I could call the subprime crisis “Rolling Thunder” because Goldman Sachs and Bank of America (Countrywide) also saw CDS spikes (although not of the magnitude of Bear Stearns or Lehman Brothers). Now, there was more to it than just subprime lending. There was a flood of 0 or low down payment lending (as housing became more expensive during the home price bubble) and there were the exotic adjustable rate mortgage products like “Pick-a-pay” where the borrower could choose to not make any payment at all, or just pay the interest due, etc. And of course, there were limited or no documentation loans, also known as NINJAs (no income, no jobs). Bear in mind that just because home prices were falling and subprime delinquencies were rising, it doesn’t necessarily mean that the trend will continue. But there does seem to have been momentum in home price declines. So, the financial crisis was inevitable when the home price bubble began to burst, given the fragility of subprime and alternative mortgage products. Just how far home prices would fall (or mortgage delinquencies would rise) is known today, but it was the “great unknown” during the crisis. Even The Federal Reserve’s Chairman Ben Bernanke said it was contained in March 2007. Today, subprime lending for housing is mostly gone as are exotic ARMs and no/limited documentation lending. Subprime student loans and subprime auto loans have taken their place. Here is Zachary Quinto from Margin Call suddenly realizing that home prices are dropping. Apparently, Zach the analyst wasn’t reading Bloomberg News, Housing Wire or The Wall Street Journal since home price growth peaked in 2004 and started to fall in January 2007. Both Lehman and Bear were in trouble (as can be seen in Bear’s CDS spike in March 2008). This is a syndicated repost courtesy of Confounded Interest - Online Course Notes For Financial Markets . To view original, click here .
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