The Big Short_ Inside the Doomsday Machine - Michael Lewis [49]
The more they examined the individual bonds, the more they came to see patterns in the loans that could be exploited for profit. The new taste for lending huge sums of money to poor immigrants, for instance. One day Eisman's housekeeper, a South American woman, came to him and told him that she was planning to buy a townhouse in Queens. "The price was absurd, and they were giving her a no money down option adjustable-rate mortgage," says Eisman, who talked her into taking out a conventional fixed-rate mortgage. Next, the baby nurse he'd hired back in 2003 to take care of his new twin daughters phoned him. "She was this lovely woman from Jamaica," he says. "She says she and her sister own six townhouses in Queens. I said, 'Corinne, how did that happen?'" It happened because after they bought the first one, and its value rose, the lenders came and suggested they refinance and take out $250,000--which they used to buy another. Then the price of that one rose, too, and they repeated the experiment. "By the time they were done they owned five of them, the market was falling, and they couldn't make any of the payments."
The sudden ability of his baby nurse to obtain loans was no accident: Like pretty much everything else that was happening between subprime mortgage borrowers and lenders, it followed from the defects of the models used to evaluate subprime mortgage bonds by the two major rating agencies, Moody's and Standard & Poor's.
The big Wall Street firms--Bear Stearns, Lehman Brothers, Goldman Sachs, Citigroup, and others--had the same goal as any manufacturing business: to pay as little as possible for raw material (home loans) and charge as much as possible for their end product (mortgage bonds). The price of the end product was driven by the ratings assigned to it by the models used by Moody's and S&P. The inner workings of these models were, officially, a secret: Moody's and S&P claimed they were impossible to game. But everyone on Wall Street knew that the people who ran the models were ripe for exploitation. "Guys who can't get a job on Wall Street get a job at Moody's," as one Goldman Sachs trader-turned-hedge fund manager put it. Inside the rating agency there was another hierarchy, even less flattering to the subprime mortgage bond raters. "At the ratings agencies the corporate credit people are the least bad," says a quant who engineered mortgage bonds for Morgan Stanley. "Next are the prime mortgage people. Then you have the asset-backed people, who are basically like brain-dead."* Wall Street bond trading desks, staffed by people making seven figures a year, set out to coax from the brain-dead guys making high five figures the highest possible ratings for the worst possible loans. They performed the task with Ivy League thoroughness and efficiency. They quickly figured out, for instance, that the people at Moody's and S&P didn't actually evaluate the individual home loans, or so much as look at them. All they and their models saw, and evaluated, were the general characteristics of loan pools.
Their handling of FICO scores was one example. FICO scores--so called because they were invented, in the 1950s, by a company called the Fair Isaac Corporation--purported to measure the creditworthiness of individual borrowers. The highest possible FICO score was 850; the lowest was 300; the U.S. median was 723. FICO scores were simplistic. They didn't account for a borrower's income, for instance. They could also be rigged. A would-be borrower could raise his FICO score by taking out a credit card loan and immediately paying it back. But never mind: The problem with FICO scores was overshadowed by the way they were misused by the rating agencies. Moody's and S&P asked the loan packagers not for a list of the FICO scores of all the borrowers but for the average FICO score of the pool. To meet