[H]ere was a guy who knows the market really, really well, who is a real expert in the nuts and bolts of mortgage lending, and really knew the collateral really well--but he was a true believer, and I think a lot of people were, who were in that paradigm, right, they were true believers in the paradigm. "You know what, sub-prime is a really good thing, it's opening up home ownership to people who couldn't get it before for reasons that didn't really have to do with their ability to pay, but had to do with outmoded criteria for thinking about credit." And, you know, most of these mortgages were going to pay off fine and that the housing collateral behind them was solid.
And there were other people at the firm, say, at the middle of last year, who were not mortgage experts, who were saying, you know, "I see the run-up in housing prices in some of these geographies, and I just don't really get it. I go down to Florida and see the forest of cranes, and I just really wonder, who's going to be in all those apartments? And I hear about all sorts of friends who are getting loans to buy apartments or houses speculatively and who are lying about the fact that it's not a primary residence, and I see these commercials on TV, you know, about low-doc, no-doc mortgages--and there is no way, there is no way that this is not going to end badly. And I see that these mortgages are being created by this massive demand for CDO paper, by this robotic bid, and this is the perfect example of a bubble--and we should be short, we should be short sub-prime paper."
... And we all, a number of us thought, "This is just crazy. We should be short. This is a bubble waiting to be popped." But the person who was the expert, the person who ran the sub-prime business, who traded sub-prime paper and issued the CDOs, he was a true believer in the paradigm: "In 2003, people said that the credit quality of the average sub-prime mortgage was deteriorating, and now look, those mortgages have performed fine. The sub-prime market works."
And, hey, he was the expert--you defer to the expert.
n+1: He didn't listen.
HFM: But he's the expert, right? It's a tough thing. If you have somebody who's really trained in the mortgage business, he's been in the mortgage business for fifteen years, in equilibrium he'll do a great job. He'll be able to pick, of the mortgage pools out there, which is the good one, which is the bad one. He did a very good job of that, because the ones that he picked were better than the market. But in terms of detecting the paradigm shift, the guy who's just buried in the forest... he's not going to see the big picture, he's not going to catch the paradigm shift.
n+1: When he saw the cranes in Florida, when he saw the commercials on TV, what did he think?
HFM: I think his view was, the people who were predicting a crash in sub-prime were not experts in the sub-prime market. They were guys just basing their conclusions on anecdotal evidence. "But look, I'm knee deep in the data, I see the remittance reports every month, I've been involved in the 2003 sub-prime issuance, and the 2004 sub-prime issuance, and people said that stuff was dodgy, but it's performed very well. And I know all the details. You have anecdotes? I have details."
Sometimes the devil really is in the details.