That Jenga Tower

The 2015 film The Big Short had a huge, almost gargantuan task. The book upon which it was based, Michael Lewis' "The Big Short" had already taken on the difficult task of explaining the causes of the 2008 subprime mortgage crisis in relatively understandable terms. The film not only had to condense the book into 140 minutes of screen time, it also had to do so in a way that would be interesting to a broader audience, and thus keep their attention for the entire 140 minutes. To that end I think the film did an admirable and fantastic job. Of course, it is to be expected that the film couldn't be absolutely thorough, and might give some slightly ambiguous impressions.

One of the most iconic scenes from the movie was the one wherein the Ryan Gosling character (named Jared Vennet in the movie but actually based on real-life Deutsche Banker Greg Lippmann) used a Jenga Tower to illustrate the vulnerability of Subprime Mortgage-Backed Securities.

The scene no doubt provides a creative visual analogy, but one that unfortunately is bound to have left those wanting to have a deeper understanding of mortgage-backed securities with a nagging feeling of inadequacy. For instance, while correctly stating that mortgage-backed securities consisted of "tranches" of mortgages, it stops short of explaining why there is need for such tranches to begin with. I'll try to fill that gap to the extent that I am able -

It was sometime in the late 1970s when bankers at Wall Street tried to make home mortgages into standardized bonds that they could sell to big institutional investors like pension funds, insurance companies, mutual funds, and the like... Precisely because these institutional investors are the big boys, they of course do not want to get into the more messy business of extending home loans to individuals. Note that it wasn't that they weren't willing to loan their investible funds to homeowners, but they did not want to have to deal with homeowners individually. To fulfill its role as a market maker, Wall Street needed to come up with a security that would enable the institutional investors to make loans to groups of homeowners. This seems simple enough, just group mortgages together into standard pools (use a Jenga tower to visualize). There remained a problem though. Unlike say, a corporate bond wherein the entire bond is issued by a single company, pooling individual mortgages to form bonds meant that behind each bond were groups of diverse individuals whose lives and decisions were separate and distinct from each other. This further means that the buyer of a mortgage bond would be subject to more uncertainty vis-a-vis other types of bonds. Imagine for instance, a pension fund buying a mortgage bond thinking it had locked in an investment at x% over y number of years, only to wake up next month to realize that Jack over at 100 Elm Street had pre-terminated his mortgage and that thus, some part of their investment had been returned in cash. It would wreak havoc on financial planning. To solve this problem, at least partially, the bankers separated each bond into tranches. Some tranches would pay more interest, but would be hit with prepayments and defaults first (the BBB / BB / B tranches), while some tranches would pay less interest but would be the last to be hit with prepayments and defaults (the AAA / AA / A tranches). An investor could choose which tranche he wanted to invest in depending on his appetite for yield vs. uncertainty. While this separation into tranches is not a perfect solution to the problem of diverse individuals behind a bond acting differently from each other, it at least provides a partial solution - an investor who values certainty for instance, could invest in the AAA tranche knowing that before the consequences of individual homeowner circumstances reach him, these would have to go through all the other tranches first. 

When looking at the Gosling/Vennet's tower of mortgages, it is absolutely critical to understand that the AAA's are different from the B's not because the underlying mortgages are somewhat better, but primarily because the tranche is more senior (i.e.. gets paid first in the event of defaults) than the B's. Without this understanding, the more inquisitive viewer will be left to wonder why there is a need to mix different quality mortgages into a single bond to begin with. Why not just put them in separate towers to begin with? It is not that different quality mortgages were mixed together - the mortgages were all of roughly the same quality, but what made an AAA an AAA is that the tranche would be the least susceptible to the uncertainties of prepayments and defaults. What made a B a B was that it was the most vulnerable. Again, the need for tranches is a characteristic specific to mortgage securities because each bond is effectively issued by groups of individual homeowners, each of whom has a different financial story, with different consequences for the debt that he owes.

So, when Gosling/Vennet (or more accurately, the scriptwriter writing his lines) says that "somewhere along the line, these B's and BB's went from 'a little risky' to 'dogshit'!", it is not 100% accurate. I think it would be a lot more accurate to say "somewhere along the line, the whole tower of mortgages went from 'a little risky' to 'dogshit', and these B's and BB's, as the most junior tranches in the tower, are most vulnerable to the fact that the whole tower has turned into dogshit." There, no wonder I'm not employed as a scriptwriter; but if you're here to try to clarify the concepts, there you go..

While this is meant to be neither a review nor a critique of the film, I'd really like to say that it covers a lot of ground in that it then goes on to explain, creatively and accurately, why the crisis blew totally out of proportion. Synthetic CDOs, which allowed speculators to bet on the tower of mortgages many times over (as illustrated by Selena Gomez's blackjack hand), could probably be thought of as the gasoline that turned a fire into a firestorm.

Finally, yes, the most interesting question is why the original tower of mortgages turned into dogshit. To that question I think different people will have different answers, The film certainly presents one thesis, which is Michael Lewis' thesis. Again because of the difficulties of book-to-film adaptation, the film presents a somewhat diluted version the Lewis thesis. For a more forceful presentation of the Lewis thesis one has to, quite naturally, read his book. There are those, of course, who would as forcefully reject Lewis' thesis. The Wall Street Investment Banks and the Rating Agencies come to mind.

In the end, whatever the accurate explanation of the causes of the 2008 crisis, it further convinced me of two unassailable (for me at least) truths about human behavior - 1) we'll all respond to the most immediate incentives, and 2) we will build a house right on top of a fault-line if we haven't had an earthquake in 10 years.



                

A Silent Witness

Old hotels fascinate me.

They fascinate me because they've been witness to so much history. As places that provide transient accommodations and as points of rendezvous they inevitably serve as vital crossroads for interesting people and produce stories that are often more interesting than most.

The original Manila Hilton was put up in 1968 and in the ensuing 50 years before a fire engulfed it in 2018, served as the setting for many tales of the sort I personally find interesting.

When Muhammad Ali visited Manila in 1975 to fight Joe Frazier in the Thrilla in Manila, he stayed at the original Manila Hilton. At that time he was still very much married to wife Belinda Boyd, but had already met, and was apparently totally smitten with, future wife Veronica Porche. So on his trip to Manila he left Belinda stateside, and took Porche. By her own account, Belinda had an idea what was going on, and was, surprisingly, even willing to go along, up to a certain extent. The limits of her longsuffering however, were apparently exceeded when Ali took Veronica to a reception in his honor held at Malacanang Palace, and with the international press present, allowed everyone, including First Couple President and Mrs. Marcos, to assume that Porche was his wife.

So Belinda hopped on the next plane and flew to Manila. By most accounts she "swept regally" into the Hilton, headed straight to Ali's suite, and proved once and for all that even the greatest of heavyweight boxing champions was no match for the fury of a woman scorned.

Even more fascinating for me is the story that supposedly, for years, a suite at the old Manila Hilton was home to one Severino Garcia Diaz "Santy" Sta. Romana, a man so mysterious that the only way for me to tell you about him is to tell you what I have come to believe about him. I hope that serves as a sufficient disclaimer that the story I am about to tell you is probably partially true, partially false, and partially unverifiable. It is merely a composite of different things I have read about Sta. Romana, and cobbled together with the glue of what makes the most sense to me.

"Santy" Sta. Romana was a Filipino who supposedly controlled a staggering amount of wealth all over the world. I purposely used the word "controlled" because no one knew exactly who the real beneficial owners of that wealth was - whether it was actually Santy or some other parties - but he was nominal account holder of an incredible amount of wealth in many forms - ranging from cash to stocks to gold bullion and gold certificates. In their book "Gold Warriors", Sterling and Peggy Seagrave quotes Tarciana Rodriguez, a Filipina accountant and cousin of Santy's mistress, who served as something of an executive assistant to Santy for years: "It was in my mind then that he must be somebody because, to be billeted in a five-star hotel in the 70s was an indication of a... VIP, especially he was only a Filipino. In my going to and fro to his hotel accommodation, what amazed me so much, there were many people of different nationalities who often visited him... Bankers, Brokers, Business associates... he was a very famous personality especially to all the Banks concerned throughout the world." Both Rodriguez and her cousin Luz Sambrano, Sta. Romana's mistress, also spoke of transactions in tantalizing amounts - a $43M deposit in the Manila branch of the First National City Bank, a $500M wire transfer to HSBC Hong Kong, 20,000 metric tons of gold in UBS Geneva, transactions in amounts that sound incredible but with details that provided a ring of authenticity.

Personally, I find all of this to be plausible, because Sta. Romana emerged from the second world war an intelligence operative. As a spook he probably served multiple masters, but primarily Bill Donovan's Office of Strategic Services. He was, in fact, likely the most prominent Filipino operative of the OSS and all the OSS's future iterations and mutations. After the Japanese surrender in 1945, one of the OSS's primary objectives was bound to be the discovery of where the Japanese war loot was, and this Japanese war loot from World War II was legendary in its size:

As the Japanese Imperial Amy had swept through Asia in their march towards regional domination, it was well-known that they had accumulated vast treasures every step of the way. Much of this war loot had found its way to the Philippines to be catalogued, inventoried, and readied for eventual transport back to Japan. But as Japan started to lose the war to the Allied Forces and made plans for a retreat, the decision was made to bury the loot for later retrieval. It is, to me, only logical that the OSS surely made it their top priority after the Japanese surrender to discover where this loot was. Furthermore, it makes perfect sense to me that any part of the treasure OSS operatives did find was not officially transmitted to the US government but kept as a slush fund for intelligence operations. Intelligence organizations operate in, at least partial, secrecy and cannot constantly be justifying requests for funding to Congress. It is only to be expected that they would want alternate sources of funding that they have full control over, to be used in what they deem to be the patriotic task of fighting imperialism and communism and thus preserving the American way of life.

As a top operative of the OSS in the Philippines, Sta. Romana would have participated in every step of the process: from extracting information from Japanese military officers by whatever means necessary, to digging up war loot, to setting up safekeeping arrangements. Since, as I have speculated, any recoveries would have been set aside as an unofficial slush fund so critical to black operations, it was even highly likely that Sta. Romana was assigned to be something of a placeholder of sorts, a dummy in short, for wealth recovered by the OSS. It makes a lot of sense, Sta. Romana was not an American, not answerable to the US government, much less the US Congress, and as someone who had fought in a World War side by side with OSS Warriors, was someone they felt they could trust. Hence, his shadowy life, times, and evident control over much wealth.

By the way, it is also quite clear that Sta. Romana had dealings with Ferdinand Marcos, but that is a part of this story so complex I choose not to go there, except to say, in much simplified outline form, that there are some who firmly believe that Marcos learned about Japanese war loot from Sta. Romana, got his hands on some of it, became a very rich man even before he became President of the Republic of the Philippines, and continued to dig up buried treasure long after he became President. Marcos' hoard supposedly grew so large that if all of his overseas deposits were ever turned over to the Filipino people, we would be able to pay off all of our external debt with much left over. For precisely that reason, the developed countries cannot ever allow the Marcos Gold to ever be returned to the Philippines, because it would totally mess up the global financial system as we know it today. Now you know why, apart from mentioning this "theory" floating out there, I refuse to really dwell on this part of the story, it makes me sound too much like a crackpot. 😁

It's enough for me to believe that Santy Sta. Romana was a living person, that so few know his name in spite of the outsized role he played in Philippine history as an operative for the OSS/CIA complex, and that he used to stay at the old Manila Hilton and walk the surrounding streets. It reminds me that old Hotels stand in perfect, if silent, witness to so much history.  

The old Manila Hilton during its glory days:

Philippine History and Architecture @ Facebook

The new Hilton, located at the Resorts World Hotel and Entertainment Complex:

How to Keep it Up Longer

In the 2008 film Gran Torino, there was a scene wherein Clint Eastwood said that any man "worth his salt can do half the household chores with just... WD-40, vise grips, and a roll of duct tape." What he meant was that a man "worth his salt" would understand the basic principle underlying common handyman tasks and thus would be able to improvise accordingly. Yesterday, I replaced the insides of an aging toilet tank with spanking new fittings, including, of course, the central stem and its flapper, as pictured on the right. Soon after, I realized that the flapper would not seem to stay up long enough to get a good, proper flush. I could still get a proper flush if I held down the flush lever long enough, but I knew that ideally, for a system working perfectly, I only needed to press the lever once, and the flapper would take care of the rest. Since I think of myself as a man "worth my salt", I immediately thought I knew what the problem was, the chain that pulled up the flapper was probably too long and loose, and therefore it wasn't pulling up the flapper far enough for it to stay open. But after adjusting the chain and making sure that it would pull the flapper as far up as it could go, I found that the flapper still would not stay up and would clamp shut as soon as I let go of the lever.

I went to YouTube for answers. (See, it isn't true that men refuse to ask for directions. We do ask for help, as long as the source is not a living, breathing person and we can still feel that it was our own "research" that came up with the answer.) Anyway, what I discovered on YouTube absolutely...

...blew. my. mind.

Okay so apparently, these flappers that are so commonplace that we take them for granted are actually works of high science. Seriously. Turns out that the flapper stays up while the cone shaped thing is still filled with water. The water serves as a weight to hold the flapper in an upright position. As the tank empties of water as we flush, eventually that hole at the bottom of the cone is no longer covered by water and the water inside the cone flows out also. Once the cone is empty, then there is no longer any weight to hold the flapper in position and it clamps back down.

Wow. Who knew?

And get this, that's only half the story. There's more good stuff.

Think back to when you were a child and first learned to punch a hole in a can to pour the contents out. To get a good flow it's not enough to have one hole right? You need to punch a second hole to get a good flow going. The reason is because to get a good flow going, air has to flow into the can, and if you only have one hole, that single hole cannot accomplish the dual tasks of letting fluid out and letting air in. Anyway, the reason is not even important. We just have to remember the principle we learned with those cans and understand that it applies to our flapper cone as well. To get water flowing out smoothly, that one hole at the bottom is not enough. We need a...

 ...second hole!

sheeeeeeeeeeeeeeeeeeeeeeiiiiiiiiiiiiiiiiiiiiiiit... (said in a low and awed tone).

And all this time I thought the small hole was just there for decorative purposes. And if your mind isn't totally blown by now, there's even more! That second hole begins to serve its function of allowing water inside the cone to flow out of the first hole when, and only when, it itself is no longer submerged in water. So on some of the newer flappers you can even control when the second hole becomes exposed. In so doing you decide when it begins to serve its function of allowing water to flow out of the first hole. Controlling when water flows out of the cone allows you to control when the cone empties, because in controlling when it empties you also control when the flapper drops back down. I want to know who the people are who sit around thinking up these things! They are geniuses whose names need to be in science textbooks that are used in our high school classes.

So to keep water inside the cone for as long as possible, you need to move the small hole to a lower position, say from (1) to (2). This way, water in the tank will have to have dropped to a lower level before the small hole is exposed and it begins to let water inside the cone flow out. The flapper stays up much longer because only when the flapper cone is finally empty of water does it clamp back down.

As a last word, all this doesn't mean that adjusting the chain is unnecessary. You still need to adjust the chain so that it pulls the flapper up to the correct starting position whenever someone flushes. However, whether the flapper will stay up, and how long it will stay up, is not related to the chain at all. 

whoa!