Steve Eisman's Masterclass on the 2008 Financial Crisis (Part Two) | The Real Eisman Playbook Ep 39

Episode Overview

• Steve Eisman deconstructs the 2008 financial crisis, identifying systemic ownership of toxic assets and the interconnected web of derivatives as the final factors that made a collapse inevitable.
• The podcast details what Eisman calls "the largest fraud in human history," where Wall Street firms discovered fraud in loan samples but deliberately securitized and sold the uninspected majority to investors.
• It transitions to the post-crisis era, analyzing the successes of the Dodd-Frank Act in de-risking large banks but also the regulatory gaps it created for mid-sized institutions.
• The failure of Silicon Valley Bank (SVB) is examined as a case study in new risks, specifically duration risk combined with a highly concentrated depositor base.
• Eisman concludes by criticizing the current regulatory response, arguing that regulators are mistakenly applying the lessons of 2008 to today's different challenges, a classic case of "generals fighting the last war."

Key Concepts

• Causes of the 2008 Crisis: The final two drivers identified were Wall Street firms keeping excess toxic subprime assets on their own balance sheets and the use of Credit Default Swaps (CDS), which created an opaque, interconnected system where one firm's failure could cascade globally.
• The Core Fraud of Securitization: Wall Street firms performed due diligence on only a small 10% sample of mortgage pools. After finding high rates of fraud in the sample, they would return the bad loans from that 10% but proceed to securitize and sell the remaining uninspected 90% without further checks.
• Lack of Accountability: Despite the Financial Crisis Commission referring this fraudulent practice to the Justice Department for criminal investigation, no legal action was ever taken against the firms or executives involved.
• Post-Crisis Regulation (Dodd-Frank): The act successfully forced the largest banks to deleverage and de-risk under the supervision of regulators like Daniel Tarullo. However, its most stringent rules only applied to these large institutions, creating a less-regulated environment for mid-sized banks.
• The Silicon Valley Bank (SVB) Failure: SVB's collapse was driven by a combination of taking on excessive "duration risk" (holding long-term bonds funded by short-term deposits) and having a uniquely concentrated depositor base (the venture capital industry), which acted in unison to withdraw funds, forcing the bank to realize massive losses.

Quotes

• At 0:26 - "And that's why the financial crisis was baked. It was inevitable." - He explains that the interconnectedness created by credit default swaps made a systemic collapse a certainty once the subprime market turned.
• At 2:18 - "Arrogance breeds stupidity. Or as I like to say, incentives trump ethics every time." - He describes the Wall Street culture where enormous bonuses for creating and selling securities overrode any ethical considerations about the quality of the product.
• At 17:26 - "No Wall Street firm ever ordered due diligence on the remaining 90%. I'll say that again, no Wall Street firm ever ordered due diligence on the remaining 90%." - Eisman identifies this specific, deliberate inaction as the clear, prosecutable fraud at the heart of the crisis.
• At 18:26 - "The commission in fact referred this entire story to the Justice Department to be criminally investigated and, wait for it, nothing happened. And no one knows why." - He expresses frustration over the lack of accountability and prosecution following the 2008 financial crisis.
• At 23:38 - "One of the weaknesses of the new financial rules was that the most stringent rules only applied to the large banks." - He identifies the regulatory gap that allowed mid-sized banks like Silicon Valley Bank to take on excessive risks that larger banks could not.
• At 35:31 - "Generals always fight the last war. So regulators took out the old post-GFC playbook and argued that all banks, especially large banks, need more capital. This conclusion was just weird." - He criticizes the current regulatory response to the SVB failure, arguing it misdiagnoses the problem.

Takeaways

• Investigate and act on warning signs found in small data samples, as they often point to much larger, unexamined systemic risks.
• Be aware that financial instruments designed to reduce individual risk can, when adopted at scale, create unforeseen and catastrophic systemic risk.
• Recognize that risk management requires diversifying not just assets but also liabilities; a homogenous depositor or customer base is a significant, often overlooked, vulnerability.
• Ensure that regulatory frameworks are forward-looking and adaptable to new forms of risk, rather than solely focusing on preventing the last crisis from happening again.