“The Big Short” Report
One of the topics I found most interesting in this book was the differences between the stock market and the bond market that Michael Lewis to some extent explains in the beginning of chapter three. While the stock market was intensely regulated and mostly transparent, the bond market consisted of primarily large institutions and escaped serious regulation. This lack of legislative control played a great part in allowing the credit default swaps on subprime mortgage bonds, CDO’s, and the eventual collapse of the subprime market. Following the subprime mortgage crisis, the Department of the Treasury released a new regulatory plan, The Department of the Treasury Blueprint for a Modernized Financial Regulatory
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AIG and its imitators had created a market to sell the credit default swaps that had been conceived by the investors. Eventually, AIG was insuring 95% subprime mortgages without even being aware they were doing so and, in essence, providing the same service to subprime loans as to corporate loans. The consequence of AIG and other insurance companies reinsuring subprime mortgages was that Goldman Sachs was able to create collateralized debt obligations, or CDO’s, which concealed the risk of subprime mortgage loans. Although CDO’s were not understood by investors and rating agencies, Goldman Sachs was somehow able to get them rated as triple-A, which in the end spelled disaster for the subprime mortgage market. The market not only became less efficient, but these triple-A ratings created a sense of security in loans that had become increasingly uncertain. As a result of this, The Securities and Exchange Commission conducted a 10-month examination of three major credit rating agencies and exposed significant weaknesses in ratings practices. The most alarming shortcomings included: no disclosure to investors and the public, inefficient policies and procedures to manage the rating process, and inadequate attention to conflicts of interest. The conflict of interest issue arises from the fact that the rating agencies receive commissions for rating companies.