Tag Archives: unemployment

Thanksgiving on Wall Street

thanksgivingWith the holiday season rapidly approaching, we are all looking forward to seeing our loved ones.  Thanksgiving is a time to catch up with old friends, hang out with obscure members of the family, and gorge ourselves on mashed potatoes, pumpkin pie, and turkey and tofurkey.  Of course, Thanksgiving is also a time to stretch the truth about how amazing our lives actually are, in order to one-up our cousins and give our parents something to brag about.  So, in order to impress Uncle Jerry and crazy Aunt Lisa, here are some responses that may be better than the cold hard truth.

Crazy Aunt Lisa: “So, what are you up to these days?”

You: “Well, I’m working in New York at [prestigious company] as a credit derivatives trader.” 

(Translation:  I’m probably going to be unemployed soon.)

Crazy Aunt Lisa: “Wow, that sounds mighty impressive!  So you work in one of those tall, shiny skyscrapers?  What do you do as a trader?”

You: “Essentially, we run complex financial risk models and look for arbitrage opportunities.  My personal responsibility is to oversee all the trades that come through my desk.  Right now we’re in a bit of a liquidity crunch, as I’m sure you’ve heard, so even though it’s been tough, we are working through it.”

(Translation: I spend most of the day trying to break down the firewall that prevents me from checking my fantasy football stats.  At lunch, I serve as the designated pizza bitch for the traders on the floor who are actually making trades.  A few months ago, I used to carry six or seven pizza boxes back to the office.  Now, given the tanking credit markets, I’m ordering by the slice.  The rest of the day, I take bathroom naps and think about how I spent $120,000 on my education to get to this point: where, after a year on the job, I am a glorified delivery person with a Brooks Brothers suit and the financial modeling skills of an orangutan.) 

orangutanCrazy Aunt Lisa: “My goodness… and at such a young age!  So do you get to see friends a lot, given your busy job?”

You: “Even though the job is demanding, I definitely try and make time to see my friends.”

(Translation: If I didn’t see my friends, I would jump out the window of my shiny office building.)

Uncle Jerry: “How are you all liking New York?  Are you staying out of trouble?”

You: “Oh, of course.  My friends and co-workers are all young professionals, and we are always trying to do something different in the city.  There is so much culture in New York.”

(Translation: Yesterday I woke up sprawled outside my apartment door with the imprint of my floor mat on my cheek.)

Crazy Aunt Lisa: “That sounds like so much fun!  You are just so accomplished already… I hope [your screwup cousin] can follow your lead. Do you know of any job openings there?”

You: “I can talk to the HR rep about it.  Getting into the business is tough right now given the market, but I will check, definitely.”

(Translation: I would not wish this job on anyone.  Not even my screwup cousin.)

Uncle Jerry: “So, do you think this is it?  Found your calling?”

You: “Well I’ve enjoyed the work, and it’s been a great learning experience so far… I’m not sure I want to settle on anything just yet, because I’m still young, but I’ve learned a lot about myself.”

(Translation:  I’m peacing out after two years.  I have no idea what I’m going to do, but I know that it’s not this…)

Crazy Aunt Lisa: “Sounds like you have it all figured out!  To be so young and so driven… what a success!”

You: “Yep, that’s me… Could you please pass the sweet potatoes?  And take some more of my BS… I’ve had too much.”

Crazy Aunt Lisa: “Of course, dear.

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Lessons Learned from Buying Lehman at $61

In the past few days, another investment bank has fallen, another huge government bailout has been announced, and WaMu customers are making like it’s 1929 and rushing to take money out of their Whoo Hoo! checking accounts. Year to date, the S&P 500 has fallen by over 20%, unemployment is at a five-year high of 6.1%, and it doesn’t seem like the end is in sight.

So, how did this all happen? What has caused Morgan Stanley to court Wachovia, and WaMu to pimp itself out to the Koreans? We’ve heard the terms “housing bubble” and “subprime crisis” and “credit crunch” ad nauseum over the past few months… but what does it all mean? The following is my attempt to explain the recent travails of the economy, and why I probably never should have bought Lehman at $61:

A couple years ago, you bought a house and took out a $300,000 mortgage on it. The bank that issues this mortgage takes it and pools it along with other customers’ mortgages. Then they sell this product, called a mortgage-backed security, to Lehman Brothers. Lehman likes buying mortgage-backed securities, since it can get a decent return for a perceived low amount of risk, as historically, people rarely default on their mortgages. All the other big investment banks/brokerage houses are doing it too, and so there’s a strong secondary market out there for these securities. This is a seemingly win-win situation for all: a profitable venture for Lehman, and a way for the banks to lend more money and increase home ownership.

Enter subprime.

The banks and mortgage lenders are doing well; they can sell off their pooled mortgages to the traders at Lehman, or to Fannie Mae and Freddie Mac. Much of the risk that the customer will default, then, can be transferred. Thus, the mortgage lenders start getting more lax in their lending terms. More and more subprime mortgages are issued, which involves lending to high-risk borrowers like your deadbeat cousin Charlie. The lending terms are structured so that it looks good at the time of signing (encouraging more Charlies to borrow), but after a certain initial grace period, borrowers are hit with much higher rates.

Meanwhile, the MIT grads at Lehman are concocting new complex derivatives in order to make money. Remember that a mortgage-backed security is already a pool of mortgages. Now, the guys on the Street are trading pools of these pools. And pools of pools of pools. Your $300,000 mortgage is all part of this. Thankfully, you, as a credit-worthy, responsible citizen, have been diligently making payments. But Charlie, who is using his home as a laboratory for crystal meth, is not. Of course, mortgages had already been pooled to mitigate the risk of individual borrowers defaulting. BUT, if a whole bunch of people start using meth instead of paying off their mortgages, then we’re in trouble not just for that one security, but for all of its new derivatives as well.

Then, to make matters worse, the housing bubble bursts.

Prior to 2005, housing prices had been on the rise, with higher sales and consequently, more homes being built. At some point though, supply far exceeded demand, and housing prices began a steady decline. Let’s say the house you bought was worth $300,000 at the time of your purchase. Now, the price of your home is at $200,000, a decline of 33%, right around the rate that housing prices in Southern California have declined. Because the price of his house has fallen too, your cousin Charlie can no longer afford his monthly payments (which have also skyrocketed after his low-rate grace period expired). He, along with thousands of other subprime borrowers, defaults. His meth lab goes into foreclosure. You’re still scraping by, but your monthly payments are going up because the price of your home has dropped so dramatically.

While all this is happening, Lehman and other banks with large portfolios of mortgage-backed securities are taking the losses incurred from all the Charlies defaulting. They also face the suddenly very real risk that you may default too. Already saddled with these losses, the prices of all mortgage-backed securities (and its derivatives) drop across the board. No one wants to buy, and so the value of these assets just continue to plummet. Firms are forced to issue billions of dollars in write-offs. Lehman’s stock price falls and it tries to raise capital–not only because it needs more cash as collateral for its lenders (like your mortgage payments going up when your house price falls), but also to assuage outside perception that it’s going under. But there aren’t too many institutions out there that are in a position to lend money, and not many that want to do it–especially to a firm whose net worth is unknown because of all its mortgage exposure. Banks everywhere enact tougher lending standards to individuals and businesses, making it universally difficult to get cash… thus leading to a “credit crunch”.

So in the end, with a portfolio full of assets that have no market, hedge funds aggressively shorting its stock, and no one willing to lend it money, Lehman files for bankruptcy. Charlie is living on the streets, you’re struggling to pay your mortgage, and more turmoil (involving more derivatives, including AIG’s credit default swaps) is roiling the market… Not a very happy ending.

Obviously this is a simplified version of what happened in the overall economy; in reality, the chronology of what happened is not as linear, and the situation at Lehman was far more complicated than anything I could explain. Many of our venerable publications will do a far better job of sorting through the mess than I have, but hopefully this can serve as a primer. After all, this story is probably not over yet.

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