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Ben Stein How Not to Ruin Your Life

Ben Stein, How Not to Ruin Your Life

Why I’m Still Buying

by Ben Stein

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Posted on Friday, October 17, 2008, 12:00AM
This is my most serious column yet. So let's get to it.

I get a fair amount of mail about the economy. Lately, much of it asks the same questions:

* What the heck happened to our economy so suddenly and powerfully that it caused the immense uproar and fear and stock market crashes we have had lately?

* Why didn't I, Ben Stein, famous so-called braino, get what was happening and why did I remain optimistic so long?

* What is the future going to bring?

First of all, obviously, I don't know what the future will bring. If I knew the future, I would be the richest man on the planet very soon and I assure you I am very far from that.

But I now see what has happened and I can explain that, and it might give a tiny bit of insight into what will happen in the future.

Start around 1995. Groups involved with civil rights issues and activities for poor people began to complain that poor people and especially non-white poor people got mortgages much less often than white well to do people. Many economists, including me, explained that it was not at all surprising that poorer, less credit worthy people were often turned down for credit. That's how credit is supposed to work: you lend to people who will pay you back.

But the advocates for poor and black people had immense political clout. Under President Bill Clinton, they passed legislation that called on banks to be required to lend to non credit worthy borrowers. The laws, including the Community Reinvestment Act, the CRA, required two large government sponsored enterprises, Fannie Mae and Freddie Mac, to buy those lower quality mortgages from the banks, guarantee them, and sell them to the public. These were bundled into immense pools of subprime mortgages as they were called, and sold all over the world.

Soon, the private sector got into the act in a vast way. They also went to banks and bought their subprime loans, packaged them, and sold them as Collateralized Mortgage Obligations all over the world.

Supposedly, the subprime collateralized mortgage obligations (CMOs) were sliced up in such a way that buyers could have a very high likelihood that they would be repaid even if many of the mortgages in the portfolio defaulted. This assumption was based on a misunderstanding of poor quality credit that had been popularized during the era of the junk bond investment powerhouse, Drexel Burnham Lambert.

As it happened, these low quality mortgage bonds were recognized as highly likely to have real problems very soon after they started to be issued by private banks in the billions. The people who recognized the high likelihood of defaults were able to profit from that likelihood:

First, they could sell the mortgage securities short, a straightforward wager that has long been available.

Second, they could buy credit default swaps (CDS) from financial entities. These were essentially a side bet that anyone could make about a certain mortgage bond (or any other kind of security). It paid off fantastically if the bond went into default or was close to default. The people who sold these CDS were banks and insurers, especially Merrill Lynch and A.I.G., that believed the mortgage bonds would not default and therefore charged very little to the other side, the counterparty, to make the bet.

Things went along well for everyone on the long side for several years as the housing market boomed. Even if borrowers could not repay their mortgages, they could refinance the mortgages for more money than was owed on the original mortgage, pay off the first mortgage and live happily in their new home. The mortgage in question in the bond would - again-- be paid off and the bond would continue happily in its owners hands.

Then, the housing market started to stabilize and soon fall, as housing prices do. They move in cycles, although around a rising mean, as we economists say.

Now, when the subprime mortgage holder could not pay off his mortgage, he could not refinance. Instead, he had to default. When a lot of these mortgages defaulted, the bonds into which they had been lumped declined in value.

So far, I, your humble servant, followed the deal just fine. It was extremely similar to the collapse of the Drexel Burnham Lambert junk bond empire. This had caused barely a ripple in the national economy when it fell apart in the early 1990's. I assumed that the same would happen with junk mortgages. There would be some failed banks and insurers, but the Federal Reserve, the Federal Deposit Insurance Corporation, and the Treasury could make all of those losses good. The total amount of subprime mortgage bonds was large but not compared with bank capital or the regenerative powers of the Fed.

So, I assumed, and wrote, things would be fine.

Where I missed the boat was not realizing how large were the CDS based on the junk mortgage bonds. They were not only large, but absolutely staggeringly large. Where the junk mortgage bonds were in the hundreds of billions, the CDS were in the tens of TRILLIONS. If the sellers of the CDS had to pay off in large part, the liability greatly exceeded the total bank capital in the United States and maybe in the world. That is, the derivatives based upon the junk mortgage bonds could be - and were - not in any way limited to the size of the mortgage bonds themselves, and this I did not know until a few months ago.

It is this liability that swamped the banks, investment banks, and insurers. It is the CDS liability that broke AIG and Lehman.

When I realized the extent of this problem, I wrongly thought the federal government would step in and in some way rescue everyone who had sold CDS. They did, except they ‘forgot' to rescue Lehman. Lehman was so large that when it failed, it was like a torpedo striking an ocean liner below the water line. A gaping hole was left in the whole world finance system.

Bankers panicked. If Lehman could fail, then anyone could fail. In that case, the banks that were still solvent figured they had better hoard their assets and stop making loans. This led to the ongoing credit freeze. This led to a rapidly gathering economic downturn and a drastic fall in prices of all kinds of securities, real estate and commodities. It also led to a severe credit squeeze on hedge funds, which saw credit dry up and their asset prices fall suddenly, and were forced to sell stocks and other assets on a dramatic scale, leading to still greater falls in securities prices, and the worldwide panic that it still unfolding.

In turn, this led to huge infusions of liquidity into the banks of the world, the semi-nationalization of the banks of the United States and of many other nations to shore them up, thaw credit, and bolster world markets and economies. These were drastic steps for drastic times, all generated by derivatives. Warren Buffett had warned us against them, and he was dead right, as always.

Now, these acts should help. But it might not do the job all by itself. Major lender solvency issues remain. If housing prices keep falling, more mortgage bonds will default and the liability attached to the credit default swaps based upon them will still be in the trillions or even tens of trillions.
I might well be too alarmist here, but I think the only rational possibility is for the federal government or the New York State government (because most of the CDS were entered into in New York) to simply annul the credit default swaps as void as being against public policy. After all, there was no insurable interest in most cases, which tends to void insurance contracts, which is what a CDS is.

Once that happens, the banks can breathe freely again, take risks, and the economy can revive. Or, perhaps the housing market will stabilize, mortgage based bonds will rally, and the CDS will be out of the money and will not be a threat to the lenders. But something has got to happen to defuse these deadly derivatives.

In any event, we now know a lot we did not know before. Credit default swaps are way too dangerous. Derivatives generally are dangerous. There is much that Ben Stein does not know. I hope this explains some of how we got to this precarious place, I apologize for not seeing it sooner. But I am still optimistic that the government will save us from the CDS, and we will go on to renewed prosperity. In other words, I am still buying.

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1587 Comments

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  • Eric - Friday, December 12, 2008, 6:38PM ET  Report Abuse

    • Overall: 5/5

    Thank you Ben.

  • Ben - Wednesday, December 3, 2008, 12:35AM ET  Report Abuse

    • Overall: 1/5

    I really feel sorry for people following advise from this lunatic. he even argued with peter schiff and lost. youtube "stein schiff" and he'll be exposed for the tool that he is.

  • LioNiNoiL - Tuesday, December 2, 2008, 1:24PM ET  Report Abuse

    • Overall: 1/5

    Poor ol' Ben still doesn't get it. You just keep on buying, Ben -- buy, buy, buy! Think of it as a Darwinian means to transfer wealth from yourself to the smarter people who short your picks.

  • Larry - Monday, December 1, 2008, 5:33PM ET  Report Abuse

    • Overall: 1/5

    people still listen to this lunatic? this guy is completely out of his mind, seriously.

  • Yahoo! Finance User - Wednesday, November 26, 2008, 1:22PM ET  Report Abuse

    • Overall: 1/5

    Your average cab driver was more on top of this than Ben.

  • Yahoo! Finance User - Friday, November 21, 2008, 10:59PM ET  Report Abuse

    • Overall: 1/5

    His "most serious column yet". That's saying something. But as an apology for being totally wrong, and in fact understanding less about the economy than an average gravedigger, it leaves a lot unsaid. Stein's contention that he simply didn't get the size of the CDS market is hogwash. Take a look at this video of his appearances on Fox: http://www.youtube.com/v/2I0QN-FYkpw&hl=en&fs=1 He was told exactly what the reality of the situation was, and again and again he chose to scoff at it and belittle those who told the truth. Why? Because he preferred to be on the side of "see no evil" bullies", because as you can see on that video, to tell the truth meant being treated like a leperous idiot. We were let down by group think that consistently marginalized and insulted those who understood what was really going on. Ben Stein should be ashamed of himself and come clean, rather than this half hearted explanation of how he missed the boat.

  • Yahoo! Finance User - Thursday, November 20, 2008, 11:56PM ET  Report Abuse

    • Overall: 1/5

    Confidence in the markets are gone. Bernake is making us lose confidence in the dollar. The Bush administration has manipulated oil prices until stagflation became a threat. And Ben says he's still buying? These are really bad times, so the only explanation for low gold prices is gov't manipulation to save the dollar. Now with deflation a real threat, does the gov't sacrafice the US auto industry? Buy GM, Ben. Buy Ford Ben, Then say Bye-Bye to your money.

  • First - Wednesday, November 19, 2008, 4:10PM ET  Report Abuse

    • Overall: 1/5

    Only wish that I had shorted your favourite stock Merril Lynch today Ben, down 15.79%. Never too late too late to profit from the opposite of your plugs I suppose. Can you pimp some more super bargains so I can build a balanced short portfolio please?

  • charles - Tuesday, November 18, 2008, 10:58PM ET  Report Abuse

    • Overall: 4/5

    We always enjoy seeing and hearing you on TV Ben--- we are FANS!

  • Scott - Sunday, November 16, 2008, 9:23PM ET  Report Abuse

    • Overall: 1/5

    http://www.youtube.com/watch?v=2I0QN-FYkpw This video is enough to suggest NOT taking advice from Ben Stein. He should hang out with Peter and Ron for a weekend and get a real education on what is going on in the economy and get real solutions. WAKE UP PEOPLE!

  • Vlad - Tuesday, November 11, 2008, 12:37AM ET  Report Abuse

    • Overall: 5/5

    Excellent run down of the cascade of events leading to the credit crunch and recession. As well, you get an A for political incorrectness. Thanks for telling it like it is. Ben Stein is the best. Anybody know if his personal finance books are good??

  • Yahoo! Finance User - Thursday, November 6, 2008, 2:31PM ET  Report Abuse

    • Overall: 2/5

    The CRA doesn't, to my knowledge, advocate for back to loan money to non-creditworthy customers. It was intended to eliminate red-lining of areas that may be less affluent. The CRA was intriduced in 1977 and has seen a number of revisions over the years. the cahnges in 1995 appear to be mostly technical. It bears noting that if banks didn't comply with CRA they were not allowed to expand into new lines of business, such as insurance. The more interesting factor appears to be 1997 which is when the first CRA loans were securitized. That opened the door to pump and dump of low-grade loans to unsuspecting buyers becasue these securitized loans were backed by Freddie Mac which had a AAA rating. Had these securities been properly rated the whole mess might have been eliminated. There were, after all, some lessons learned in the junk bond escapades most of us lived through. Would AIG have issused cheap CDS's on poorly rated loan securities? Would investors have been as anxious to buy up sub-prime securities if they couldn't hedge with cheap CDS's? I think not!

  • Yahoo! Finance User - Tuesday, November 4, 2008, 12:51PM ET  Report Abuse

    • Overall: 2/5

    Ah yes, the Republican defense: it was Clinton who forced the banks to lend to black and hispanics, and all this mess can be traced back to that fateful day in 1995. Well maybe so, but here's another way to look at it: - one glass of wine is a good thing. It tastes good, and there is some evidence that it can prolong life - three or four glasses is still a good thing. It may give us a slight hangover, but it may also help us conquer our social fears and meet new friends or even a future spouse. All in all, a pretty good trade-off that has worked in society for thousand of years - ten bottles of wine, however, is most certainly a terrible thing. We will get very drunk, make total @sses of ourselves, possibly do all kinds of damage to our social and professional lives, and wake up with monumental hangovers. The original idea was akin to a glass of wine, maybe three or four. The Bush/Greenspan doctrine was that if one glass was a good idea, ten bottles had to be great idea. I am not a card carrying Democrat. I'm not at all certain about Obama's healing powers (how could we be - he hasn't done anything so far). However I am totally certain that Bush and his party's terrible leadership are largely to blame for this mess.

  • Yahoo! Finance User - Friday, October 31, 2008, 4:37PM ET  Report Abuse

    • Overall: 5/5

    I found the article to be one of the more clearly written descriptions of how we got into this mess in the first place. One aspect that caught my attention is that the beginning was rooted in an attempt to 'spread the wealth' through government policies. Sound familiar? Thank you Mr. Stein!

  • Yahoo! Finance User - Thursday, October 30, 2008, 11:26PM ET  Report Abuse

    • Overall: 5/5

    Excellent as always,Ben. Only an idiot would expect a columnist to offer 100% accurate foreknowledge of markets, but that's the kind who like to vent their nastiness on the internet. The lack of an "insurable interest" seems like an adequate justification to protect our financial system (and civilization ?) from destruction. Another great depression would be far worse, now that we are more of an urban society, with our economy dominated by service business, rather than the agrarian, rural society of the 30's. Add in an entitlement attitude, excessive materialism, and contempt for physical work ,among many. The governments first duty is to protect society from preventable disasters. Your idea should be adopted, before it's too late.

  • Yahoo! Finance User - Thursday, October 30, 2008, 4:31PM ET  Report Abuse

    • Overall: 1/5

    Ben has clearly not learned anything at all, nor does he understand CDS. First of all, his idea to annul all contracts will benefit the people who made bad decisions and were on the losing side of the trade, thereby harming people who made investment decisions based on reality. Secondly, you can't develop a law today and then have it retroactively applied. CDS is/was legal, and were not considered insurance contracts. The reason the US has fared better than the rest of the world is because we have an established system of laws that are predictable and favorable to conducting business. You can ban short-selling today, but you can't lock people up for the short-selling they did yesterday. If he thinks the financial system is in dire straights today, he wouldn't want to see what it would look like if his proposal was taken seriously. In any event, the corporate CDS market is currently working exactly as it is supposed to. The problem is the MBS market, and here it's clear that AIG underpriced risk and then wrote contracts based on that misunderstanding.

  • Bill - Tuesday, October 28, 2008, 11:31PM ET  Report Abuse

    • Overall: 2/5

    Good for Ben. He admits he was wrong about buying giving buy advice at Dow 12,000 and Dow 10,000. Hopefully his bad advice didn't burn too many investors. We know he understands leverage and margin calls. I doubt his idea about voiding CDS's will be taken seriously. The scum bags on Wall Street knew exactly what they were doing when they packaged sub prime mortgages as investment grade paper with the help of the ratings agencies that were in on the game as well. The Wall Street bankers convinced insurers like AIG to insure these bundles of crap for pennies on the dollar all the while knowing the loans would never be repaid. Ben's right, the sub prime mortgage scam is the same ponzi scheme the Wall Streeters put together during the Milken junk bond era. This turned out to be a much better scheme for the crooks on the street because they were paid three times. First they were paid to bundle up lousy loans and sell it all over the world as investment grade paper. There's good money in that. Then they bought CDS's from AIG knowing the loans would never be repaid and when the loans started defaulting those wild and crazy wall street guys made even more money and got paid again by firms like AIG. Even they couldn't have predicted this scheme could go so well and they would get paid a third time by the federal government but that's exactly what happened. Paulson crafted an 800 billion dollar bail out for Wall Street firms and the first folks to get any of the money were the same folks that had already been paid twice in this scandal and bankrupted everyone else! You have to admit this was Wall Street's shrewdest scam yet. From what I read in the papers it pays well even if your firm is bankrupt and owned by the U.S. government.

  • Shreyas L - Tuesday, October 28, 2008, 3:55PM ET  Report Abuse

    • Overall: 5/5

    Extremely crisp and clear article written very well. I have never had a better understanding of the situation before reading your articles. Annulling the CDSs seems to be simplest and the most logical solution to resolve this whole crisis from it's roots (rather than providing stimuli and financing the banks) - which I wonder why the authorities have not picked up yet.

  • Dave - Monday, October 27, 2008, 11:56PM ET  Report Abuse

    • Overall: 5/5

    Way to straight shoot it. If you can get a loan you can get a loan, if you can't, you can't. Now, no one gets a loan. I'm certaintly not a Republican, but it was the Democrats wanting DEREGULATION. Check out Youtube. The Bush white house warned of such a disaster and many of the Republican house members asked for MORE regulation. Funny how the democrats now get credit for wanting more regulation and for fixing the problem they helped create. If it ain't broke don't fix it they said. Check out Youtube

  • Brian R - Monday, October 27, 2008, 6:34PM ET  Report Abuse

    • Overall: 5/5

    Will you please school one of your other yahoo "experts", Charles Wheelan?! Also, you're article was incredibly well written. I find it disheartening that people are reading this article, yet still comment accusing you of not commenting as to where the fault is when you already explained exactly what their crying about. Ben Stein, you my friend have an amazing grasp of life and finance, I applaud you.

  • Dilbert - Monday, October 27, 2008, 3:42PM ET  Report Abuse

    • Overall: 5/5

    Hi Ben, wow, I feel like I finally understand what exactly happened. I think your idea of the government annuling the swaps is ingenious. Also, I like how you are willing to call a spade a spade and identify the civil-rights groups as the ones who pushed this subprime mortgage thing into happening in the first place. Shame on them for applying affirmative action not just to blacks in the job market but also in mortgages.

  • E - Monday, October 27, 2008, 11:24AM ET  Report Abuse

    • Overall: 5/5

    5 stars for proposing that the credit default swaps be voided as against public policy.

  • Yahoo! Finance User - Monday, October 27, 2008, 10:10AM ET  Report Abuse

    • Overall: 1/5

    Ben, what happened to you? Please, the CRA and other minority homeowner programs are a drop in the bucket (which has a gaping hole at its bottom right now) and blaming them for this is a phony smokescreen. I expected better from you.

  • BrianF - Sunday, October 26, 2008, 11:41PM ET  Report Abuse

    • Overall: 1/5

    Wow.. those crafty poor black people.. learning to flip mortgages and all that, even when many are near illiterate they able to outsmart wallstreet.. man, those poor black people are really tricky. No... how about massive deregulation of just about everything under the last eight years of bozo the clown, and the unbridled greed of wall street. I've never heard such a steaming heap of crap.. Poor people are almost always undereducated people, easily manipulated people. If they are loosing a house under Clinton, they would have lost it. This was just a deregulated system run amoke and a massive deficit that like a speeding car with loose wheels, flew apart. Such a steaming heap of crap.

  • lacey - Sunday, October 26, 2008, 9:59PM ET  Report Abuse

    • Overall: 5/5

    thank you for putting it out there so clearly and easy for our friends who seem to be a little clouded at the moment!

  • Affectionate - Sunday, October 26, 2008, 8:27PM ET  Report Abuse

    • Overall: 1/5

    I love you Ben but as an entertainer and talking head... not as an investment advisor. You are much smarter than I but even I was able to sniff this one out way back in 2006. I sold all stocks and shorted REITS. Even though you advised me to stay in stocks. Also, starting off by blaming civil rights groups is a diversion from those that truly deserve the most blame; Greenspan, Bush, and the greedy financial institutions that over leveraged. Yes Ben it was leverage that blew this economy up not the poor getting loans.

  • been there - Sunday, October 26, 2008, 5:52PM ET  Report Abuse

    • Overall: 1/5

    do you think you've gotten it yet, ben? which hedge fund put you up to this cds contract cancellation nonsense? there are a few of them out there that profited fat & happy until now that it's time for the fat lady to sing (ie, make good on those cds contracts). with counterparties beginning to ask for a little margin cover, those poor little funds just can't seem to stop liquidating their best assets (until the bad counterparties come and take them over, i guess . . . ). welcome to capitalism (or what's left of it) -- ain't it grand?

  • ScottP - Sunday, October 26, 2008, 5:38PM ET  Report Abuse

    • Overall: 4/5

    laureld60 - it not that non-whites caused this crisis by defaulting on their loans. It is because democrats/liberals cried racism whenever a non-white was denied a loan due to BAD CREDIT. They forced banks to make bad loans and Fannie/Freddie than made guarantees on the resulting bad loans(to all people) and actually increased the percentage of these loans they backed. This opened the market to freely make these loans (to anyone, not just non-whites) and resell them. Instead of crying racism - look at the facts and be outraged at the real criminals: congress. Look and see how much those in control of Fannie / Freddie have made over the last 10-15 years. You will be shocked. Anyone involved should be forced out of congress (Barney Frank, Chris Dodd, etc.) Choose your votes carefully this year.

  • Yahoo! Finance User - Sunday, October 26, 2008, 5:37PM ET  Report Abuse

    • Overall: 4/5

    Good article - except for the still buying ( aka DOLLAR LOST AVERAGING ) portion. How much of your cash reserve ( non day-to-day expense portion) have you used for buying.

  • Neil - Sunday, October 26, 2008, 5:24PM ET  Report Abuse

    • Overall: 5/5

    Right on the money (and politically incorrect, as well!)

Showing comments 6-35 of 1587<< PreviousNext >>
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