How Steve Eisman Saw the 2008 Housing Crash Coming

TL;DR

Steve Eisman spotted the subprime collapse by buying Moody's and S&P credit databases and reading the raw delinquency data: a 2004 securitization showed roughly 0.75% 30-day delinquencies at month six, while a comparable 2006 pool ran near 4%. The industry had ballooned from about 50-60 billion to 600 billion in annual volume, forcing lenders to abandon underwriting standards.

Transcript

Hey, there's a bubble. It's time to call Iconic levels of dynastic wealth are going to be created. He was one of the investors who shorted the housing bubble before it crashed more than 10 years ago. And Steve Iceman, he is host of the Real Eyes Playbook podcast. Mortgage defaults have gone through the roof. Is anybody jumping off the buildings ye... Read More

Key Insights

• Steve Eisman was a sellside analyst at Oppenheimer in the 1990s who covered as many as 60 stocks, including subprime mortgage companies, giving him an unusually direct history with the industry before its collapse.
• The first generation of subprime lenders was a cottage industry originating only about 50 to 60 billion dollars a year, and in 1998 the entire sector blew up with most companies going bankrupt.
• Eisman's pattern-recognition came from experience: in early 1998 he stood on the Oppenheimer sales floor with no notes, named eight companies that would go bankrupt, and they did.
• The second generation of subprime companies went public around 2002 run largely by the same people who ran the first generation under new names, signaling to Eisman that the tragedy would repeat.
• By 2006 subprime origination had exploded to 600 billion in volume, equal to about 20% of the entire US housing market, and the only way to grow tenfold was to loosen underwriting standards.
• The canary in the coal mine was securitization credit data: buying Moody's and S&P's database for around 10,000 dollars a year let investors compare 30-day delinquencies, which rose from roughly 0.75% in 2004 pools to about 4% in 2006 pools.
• No-doc and low-doc 'stated income' loans meant lenders effectively coached borrowers, telling someone who earned 30,000 dollars that they needed 50,000 to qualify until the borrower simply restated the higher figure.
• Insatiable demand drove the boom: after Greenspan cut rates to 1% in the tech recession, the fixed income world, three to four times larger than equities, chased subprime's higher yield to meet pension obligations.

Questions & Answers

Q: How did Steve Eisman first suspect the US housing market was in trouble?

Eisman's suspicion grew from his own history. As a sellside analyst at Oppenheimer in the 1990s, he covered the first generation of subprime mortgage companies, and in 1998 watched the entire industry blow up with most companies going bankrupt in about six months. When the second generation went public in 2002, run by the same people under new names, he recognized the pattern, telling himself he had seen this three-act play before and that act three is a tragedy.

Q: What data did Eisman use to confirm the subprime mortgages were failing?

Because the loans were securitized and rated by Moody's and S&P, issuers had to report all their credit data to those agencies. Wall Street investors willing to pay around 10,000 dollars a year could buy that database, which reported credit metrics on every securitization each month over two days mid-month. Eisman lined up an issuer's securitizations by month and read across the 30-day delinquencies at the same age, revealing a clear upward trend that was exploding by 2006.

Q: How much did subprime delinquencies rise between 2004 and 2006?

By comparing securitizations at the same age, Eisman could see delinquencies climbing sharply. He cited illustrative figures: a 2004 securitization might have shown 30-day delinquencies of about three-quarters of 1% at six months, while a comparable 2006 securitization ran around 4% at the same point. He described the 2006 numbers as exploding, and called this rising delinquency trend the canary in the coal mine that something was seriously wrong.

Q: How big did the subprime mortgage industry get before the crash?

The first generation of subprime lenders was a cottage industry that Eisman estimated never originated more than about 50 to 60 billion dollars of volume a year. When the second generation restarted around 2002, it began near that same level. By 2006 the industry was originating 600 billion dollars in volume, which amounted to roughly 20% of the entire US housing market, a tenfold expansion in just a few years.

Q: What are no-doc and low-doc loans in subprime lending?

No-doc and low-doc loans, also called stated income loans, replaced the thick stacks of loan documentation used in the first generation of subprime lending. Instead of verifying income, the lender simply asked the borrower what they earned and accepted the answer. Eisman described lenders effectively coaching borrowers: telling someone who said they made 30,000 dollars that they needed 50,000 to qualify, prompting the borrower to restate the higher figure until it was approved.

Q: Why did underwriting standards collapse during the subprime boom?

Eisman explained that a cottage industry with very tight underwriting making 50 to 60 billion a year could only grow tenfold in one way, by loosening underwriting standards. Because losses always take time to show up, the deterioration was masked for years. By 2006 the standard had effectively become whether a borrower could breathe, and the market turned into the wild west as origination ballooned toward 600 billion dollars in annual volume.

Q: Why was there such high demand for subprime mortgage-backed securities?

Demand came from a hunt for yield. After Greenspan cut interest rates to 1% during the tech recession, low rates made it hard for investors like defined benefit pension plans to meet their obligations. Since the fixed income world is three to four times bigger than the equity world and pensions hold most assets in bonds, Wall Street sought higher-yielding assets. Subprime mortgages offered more yield because they were riskier loans, fueling insatiable demand.

Q: What was Steve Eisman's track record predicting company failures?

Eisman had a notable record before the 2008 crisis. He recounted that in early 1998, seeing the first generation of subprime lenders coming apart, he got up on the Oppenheimer sales floor with no report and no notes, rushed to the podium, and announced that eight named companies were going to go bankrupt before walking off. All of them did go bankrupt, an early demonstration of the pattern recognition he later applied to the broader housing collapse.

Summary & Key Takeaways

• Steve Eisman, featured in 'The Big Short' and host of the Real Eyes Playbook podcast, was a former Oppenheimer sellside analyst who covered subprime mortgage companies. When the first generation of these lenders blew up in 1998, the experience left a lasting imprint on how he read the market.

• When a second generation of subprime companies went public in 2002 under the same operators with new names, Eisman recognized a repeating tragedy. As the industry ballooned to 600 billion in volume by 2006, roughly 20% of the US housing market, underwriting standards collapsed to whether a borrower could breathe.

• Eisman confirmed the crisis by buying Moody's and S&P securitization databases and reading delinquency data directly, watching 30-day delinquencies climb from under 1% in 2004 pools to around 4% in 2006. Demand for yield, fueled by Greenspan's rate cuts, drove Wall Street into riskier subprime loans.