Did politicians rumble the trade? Did governments, or international forums or symposiums, provide the sharp instrument? Did academic research and expertise expose the dodgy product? Did statutory regulators apply the pin? No, the free market wised up and pricked this bubble. Politicians and finance ministers (if they had had the power) would have tried to keep it inflated. The market puffed itself up, and then, without intervention – despite intervention – the market let itself down. The speed with which this has happened has been awful, but however inconvenient for many or catastrophic for a few, correction is not a failure of the market, but a success.
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Economic sense from the mainstream press (and from a former MP as well). Wonders will, indeed, never cease. Had the government been in charge we would have kept up the lending for years or decades until the mass defaults on 25 year mortgages actually occured, and even then it would have required several years, 2 major inquiries and a change of government before the policy was actually changed, meanwhile millions more surplus houses would have been constructed.
Can we also debunk the rhetorical question of “why didn’t anyone see this coming?” Market participants did see the coming mortgage defaults coming; that is why the market in CDOs collapsed. Of course, when market participants see that a class of assets is overvalued their price immediately falls – asking why the market does not see these price falls coming is, in effect, asking why the market did not realise they were overvalued before the market realised they were overvalued.
I start from the position that there is no situation that a government cannot make worse. I see that John Redwood is wishing the government would just stop doing things.
I suggested to him way back (six months ago) that the best thing would be for The Great Helmsman to just stop and wait. Maybe take an extended holiday.
I start from the position that there is no situation that a government cannot make worse. I see that John Redwood is wishing the government would just stop doing things.
I suggested to him way back (six months ago) that the best thing would be for The Great Helmsman to just stop and wait. Maybe take an extended holiday.
Quite !!!
But then, what is “The Market?”
Is it anything else than all the factors of human interactions?
It might be instructive to go back to read again of “the Market” in the era of guilds and guild rules (a somewhat different aspect of governance, separate and apart from individual interactions – but, somewhat also to same effects that obtain today).
I see some light at the end of the tunnel!
Timothy said:
We have been told again and again that securitisation was a means to spread and transfer the risks of lending. From my very limited knowledge of what the banks were doing either they completely misunderstood the risks or deluded themselves. It is as if a groupthink took hold with the regulators, bankers, credit rating agencies, insurance companies and borrowers all playing their part.
CDOs were risky from the outset and appear to have hinged solely on increasing house values. Banks turned inflating assets of varying qualities into massive liabilities. In the same way in which a home owner with an interest only mortgage may find themselves in a lot of difficulty should house prices plummet, banks have become trapped in negative equity thanks to ‘mark to market’ and made worse by their increasing capital requirements.
Lord Turnbull recently suggested we should look elsewhere to find the start of all this – combating deflation. The growth of manufacturing in China was seen as a threat. To combat this without resorting to protectionist trade tariffs the only answer was to keep inflation going through loosening credit. The questions that spring to mind are: Who has had to blink first – the west or China? and How much have we sacrificed combating this economic threat that may turn out to be as fictional as the balance sheets of our banks?
On Gareth’s specific point:
I have been told that turning home loans into securities and then trading them on a large scale has been tried six times in the United States since the Civil War, and each time has ended badly.
However, it is not some specific financial fashion that caused the present crises (for once the word “crises” is correct) either the United States or in other nations.
The “market” (i.e. private individuals and companies) did not “puff itself up” – it was puffed up by the increase in the money supply by government entities such as the Federal Reserve (please no one tell me the Fed is “private” – Alan Greenspan was not appointed by a shareholders meeting) and the Bank of England.
It is true that the banks (and other such) then played fractional reserve games with the money (building pyramids of credit money debt upon it), but the actual basis of the Great Bubble was from Alan Greenspan “rescues” (remember “Alan Greenspan saves the world” headlines in the financial press every time this tosspot got involved) and his New York Federal Reserve boss sidekick Tim G. (now Obama’s boy).
Nor is the Great Bubble (the malinvestments) being liquidated now – M. Parris is just wrong (again).
The American, British and other governments all doing all they can to prevent the market clearing – and are doing vast harm as I type this.
This is why the “Economist” magazine is mistaken – the economy will of course NOT recover. Because so many governments of the world (with their bank support, and their “fiscal stimulus” borrowing orgy) are not going to let it recover.
On Gareth’s specific point:
I have been told that turning home loans into securities and then trading them on a large scale has been tried six times in the United States since the Civil War, and each time has ended badly.
However, it is not some specific financial fashion that caused the present crises (for once the word “crises” is correct) either the United States or in other nations.
The “market” (i.e. private individuals and companies) did not “puff itself up” – it was puffed up by the increase in the money supply by government entities such as the Federal Reserve (please no one tell me the Fed is “private” – Alan Greenspan was not appointed by a shareholders meeting) and the Bank of England.
It is true that the banks (and other such) then played fractional reserve games with the money (building pyramids of credit money debt upon it), but the actual basis of the Great Bubble was from Alan Greenspan “rescues” (remember “Alan Greenspan saves the world” headlines in the financial press every time this tosspot got involved) and his New York Federal Reserve boss sidekick Tim G. (now Obama’s boy).
Nor is the Great Bubble (the malinvestments) being liquidated now – M. Parris is just wrong (again).
The American, British and other governments all doing all they can to prevent the market clearing – and are doing vast harm as I type this.
This is why the “Economist” magazine is mistaken – the economy will of course NOT recover. Because so many governments of the world (with their bank support, and their “fiscal stimulus” borrowing orgy) are not going to let it recover.
For those interested in specific facts:
The full Federal government deficit in the United States this year (including TARP subsidies and so on) will be about 13% of G.D.P. – many thanks to the people at the Wall Street Journal editorial page team for pointing this oout.
At the worst year of the 1980’s Cold War the deficit was 6% of G.D.P.
Also whilst everyone is going “oh and ah” over the signing into law of the “stimulus” binge on Tuesday and over the housing bubble maintainence on Wednesday they will miss something.
The retail and commercial property bubble – all those empty shops and offices. No rent comming in and the whole thing with debts going up into outer space (not an overuse of language – if the money was piled up it would go into outer space).
By the way more stuff is being noted in the “stimulus” binge all the time – now the 1075 page bill is being read (including all the hand written stuff in the margins – no I am not making that up).
For example, welfare reform is dead.
Instead of block grants to the States (as passed by the Republican Congress of the mid 1990’s – and signed into law by Bill Clinton) new welfare cases will be 80% funded by the Federal government.
So instead of an incentive to keep the welfare numbers down – there will be an incentive to increase the numbers.
Just one of many examples.
I feel like Robert Conquest.
“I told you f****** fools”.
“You have not said much about the British economy Paul”.
I say what I have to (as a member of Kettering Council) when I state (over and over and over again) that “investing for recovery” makes no sense as government spending (local or national) is not “investment” and THERE IS NOT GOING TO BE A RECOVERY (there will not be one – because policy is preventing it).
Other than this I tend to try and avoid thinking about the state of Britain – because such thoughts tend to make me shout and smash things.
Again I am not using lose language – I have a cut on my hand from glass from a large jar of coffee I smashed a couple of days ago.
Quite pointless of course – but much less harmful than what the government is doing.
Gareth, securitization is indeed a means of spreading risk, but probably not in the way you think. What it actually does is concentrate the risk into specific segments of the deal. The holder of the “residual” interest assumes the lion’s share of the risk; it is in the “first loss” position, so all credit losses are allocated to the residual until it is completely consumed. After that any additional losses work their way up the “food chain” to the lower-ranked “tranches” and ultimately to the higher-ranked ones. That is why, regardless of the losses ultimately recognized by these trusts, the holders of the AAA-rated tranches are unlikely to be hurt.
But those losses will most certainly be far higher than was anticipated when the securities were originally issued, and you are correct that most of the participants in that process were deluding themselves. The investors failed to look closely into the underlying mortgages being placed into these deals, choosing to rely instead on the underwriters (talk about letting the fox watch the henhouse!) and the rating agencies. In my view it is the latter which bear primary responsibility for letting matters get completely out of hand, but that’s a story for another time.
It is the CDOs which are the true “toxic waste”. “CDO” is a generic term and can mean many things, not all bad. However, many of them were used to re-securitize the residual interests form ordinary mortgage securitizations. In other words, they were leverage on the leverage, a sort of second order risk security.
Paul, I don’t know where you’re getting your information, but securitization as we know it was basically invented in the 1990’s, and really hit its stride after the turn of the century. It didn’t become possible until computer technology evolved sufficiently to support the “financial engineering” upon which it depends. Fannie Mae (and later Freddie Mac) were created to provide a deep secondary market for residential mortgages, but even they didn’t “securitize” those loans in the sense we mean today until the 80’s at the earliest (not sure of the exact date). So I don’t understand where your “six times since the Civil War” idea comes from, but I don’t think it’s correct. I’d like to see a citation if you have one.
@ Gareth and Laird:
Used to work in a securitized lending unit of a very well-known bank (whose stock has, to my immense schadenfreude, tanked hard).
Securitization does indeed both spread and concentrate risk, due to the ratings of the various loan mixes within a given securitized package. But here’s the rub, the common sense which I and everybody else who wasn’t in a position to make out on the huge bonuses pointed out (and got slapped down for, thus leading to me leaving)….
1. If the appraisals aren’t honest, the securitization package is a joke. I was on the corporate side, rather than the home side, but it’s the same deal: the minute you have a broker/originator-dictated “negotiated appraisal” to which your underwriter must underwrite-or-walk, somebody ought to be coming in and indicting for fraud.
2. Market share is not the answer. Several of the big-boys were so focused on marketshare that whether or not they held 56% of crap, rather than 19% of solid assets, was a null question. Lo and behold, the market has (quite justly) punished them for it.
“As we know it” covers a lot of technical stuff Laird.
However, turning home loans into securities and buying and selling them has been tried on a large scale several times since the Civil War – and has ended badly each time.
Of course people should be free to do it, but they are unwise to do so.
If loan a man money to buy a house you had better know that man as well as you can – to try an judge whether he is good for the loan.
Who knows what mixed up ACORN stuff is in the securities?
If without ACORN (and so on) a person who buys a security does not know anything about the people who took out the actual loans.
All this paying people for deals they make (as if “selling” someone a loan was the same as selling them milk or bread) is silly. The job of a banker is to get to know the people he does business with over the years – to see what could advantage them both over time (lending money to people who are not going to pay you back is not good long term business).
And then getting the loans and playing games with them is sillyness on stilts.
Although, of course, it should be legal.
Just as long as the person or bank who ends up with the securities at the end of the “pass the package – quick now, it is ticking” game gets to go bankrupt without a bailout.
I am leaving aside those who build pyramids on the basis of the securities – on the grounds that this is too disgusting to carry on writing about.
Although, of course, that depended on the Fed increasing the money supply every time the farce looked like it was finally comming to an end.
And each time they “saved the world” they made the problem worse.
May I risk the wrath of some by pleading some defence for these much-maligned securitisation products? On one level, there is nothing necessarily sinister or bad about seeking to repackage loans/bonds so that the specific credit risk component of a debt instrument can be traded or hedged? Take credit default swaps (CDS). They are basically a form of tradable insurance policy, where the risk insured against is the risk of default. It is useful for a portfolio manager who is running a basket of bonds to be able to adjust that portfolio, either by going bearish or bullish of different bonds, by using derivatives to express those views rather than trade in the individual bonds themselves. Many bonds are quite illiquid and not easy to short-sell. Derivatives get around that problem.
As Paul Marks said, securitisation may have been the transmission mechanism through which the current financial SNAFU has played itself out, but culprit, ultimately, is lax monetary policy.
I am glad to see someone like Parris making such a comment. It is about time that the freeding frenzy of hate about financiers began to be combatted by cooler heads.
Don’t worry, Jonathan, I’m picking up what you’re setting down here.
My problem with securitization of home mortgages isn’t with the securitization. It’s with the packaging in such a way that the buyer couldn’t easily assess his exposure to subprime markets (or any other given segment of that market.)
And even then, caveat emptor still applies. My real heartache is that, by virtue of being a US taxpayer, I am the emptor.
But, but, but…..We didn’t KNOW?!?!? “The head of the Financial Services Authority (FSA) has admitted that the watchdog did not focus enough on the excessive risks being taken by banks.”
Securitization is an extremely valuable tool, and isn’t going away for long. It not only permits concentration of risk into hands which actually want it (for a higher yield), it allows the cash flows (which is all that loans really are) to be divided into discrete time segments. Insurance companies (for example) have very predictable cash timing needs, so if they can buy a “time tranche” which meets those needs it is worth more to it than a simple fractional interest in a whole loan. Thanks to disaggregation the sum of the parts really is worth more than the whole. The only problem is that people got too crazy with it and started dumping into the deals almost any sort of loan, however badly underwritten. That’s why I put most of the blame on the rating agencies; they did a horrifically bad job of policing the quality of the loans, and their models were woefully deficient in stressing forecasted performance.
Russ, I don’t disagree with anything you said. “Pushed” appraisals (no one ever dared use the word “fraudulent”) were certainly a problem, and too many companies chased market share for its own sake without regard to loan quality. But you can’t entirely blame them, because they were permitted to off-load the loans without retaining any of the risk. It still comes back to the entities which enabled such behavior: the investment banks which underwrote the securities, the monoline insurers and, especially, the rating agencies. (BTW, I’ve been in this business a long time, too; I did my first securitization in 1991 and lots more over the next decade or so. I haven’t been an active participant since about 2000, though.)
Paul, I’m still waiting for a citation to some authority for your assertion that “turning home loans into securities and buying and selling them has been tried on a large scale several times since the Civil War”. You could be correct, but that doesn’t comport with my knowledge of the industry. Where are you getting that?
@Laird:
Of course I can blame them. Appraisals are non-transparent, but signed off on as objective measurements, when anybody who’s been near underwriting knows they’re frequently nothing of the sort. Securitization is a neat idea, but without the ability to gauge the honesty of the appraisor’s product (which nobody picking their way through the pool has, since only the results of the appraisal make it into the securitization info), there’s no way to tell whether AAA is really AAA, or whether it’s junk. So yes, I do say fraudulent, and did at the time, too.
As per market share, well, it’s just bubble logic. Eventually, the music stops.
“I see some light at the end of the tunnel!”
That’s the train.
As long as financiers are sponging off the taxpayer they deserve all the abuse that is heaped upon them.
If they “knew” this was coming why did they ask for taxpayers money?
There is no free market in the USA, as we see from the massive corporate welfare and no-bid contracts which the corrupt corporate Pentagon hands out at the expense of the taxpayer.
From what I read the likes of Microsoft and Wal-Mart have been claiming billions of welfare from the taxpayer.
That Goldman Sachs has been rescued at the expense of the American people is a disgrace; Hank Paulson should be executed for treason. Remember it was his spiteful decision to allow Goldman’s rival Lehman Brothers to collapse which worsened this crisis.
Alan Greenspan (the dumbest, most naive man ever to walk this Earth) and Ben Bernanke should both be locked in a padded cell so we don’t have to listen to their idiotic crap.
Here is Gary Younge(Link), a tiresome, self-deceiving leftie when he is doing commentary, but an excellent, lucid, honest reporter when he leaves the interpretation alone:
President Barack Obama is popular for now. But his programme for reinvigorating the economy is not. Indeed, it is a sign of the dislocation between politics and everyday life that while the $787bn stimulus package that Obama is expected to sign today is being hailed as a great victory, nobody truly believes it will work.
Plenty of blame to go around, and almost everyone had the wrong incentives.
If you boil it down, it begins with the rating agencies. They built rating models that bought into the home-prices-never-decline meme. As long as they were willing to slap AAA ratings, of course the deals would keep coming. It is a foregone conclusion that they were under heavy pressure from the underwriters, although they did not have to be, as there were 2 1/2 of them in all – S&P, Moody’s, and Fitch. But… they probably got squeezed pretty hard by an even tighter duopoly – Fannie and Freddie, and here is where the gov’t’s blame begins.
Then there are the monoline insurers… The link between them and the rating agencies goes both ways – each believed the other’s BS.
Then there are the various bond funds, pension funds, insurance companies, who delegated all due diligence to the rating agencies, and bought everything that had a certain rating or higher.
I, in all honesty, cannot blame the mortgage underwriters – they had zero incentive to do any due diligence on the loans, since they offloaded them to Fannie, Freddie, and the big boys (Deutsche Bank, Merrill) before the ink was dry on them.
I also cannot blame the borrowers – they would have been idiots not to take a deal where the only downside was a blemish on the personal credit record for a few years. And they did, en masse. The only blame they can get if for whining for a bail-out, but who isn’t these days?
The truth is, the rating agencies are not getting anywhere near the blame they deserve for this fiasco – and their role was way, way bigger than that of the analysts who rated every internet and biotech stock a “buy” back in the day. Arthur Andersen got demolished for their audits, even though an audit is not supposed to be nearly as exhaustive a check as a bond rating. Henry Blodgett lost his job, AMBAC’s stock got walloped. The stock of S&P (unit of MHP) and Moody’s (MCO), while down (not surprising given the overall decline in business) are not where AIG’s is, and who was the last S&P or Moody’s executive you heard about being fired or grilled in front of a congress committee? They are the “unsung heroes” of the crisis, as anyone who does statistics and econometrics will testify. From there on, everyone who bought the smelly stuff they were selling deserves the losses, but they were the ones without whom no deal was possible, and generously obliged. They are not the only ones at fault, but they and the gov’t got off with the least bruising – and to blame the gov’t, while self-evident, is pointless, as when it screws up, I pay.
I agree that it is the ratings agencies who are the villains here. Without their CDO ratings, the bubble could not have happened, or at least would have burst a lot quicker.
I am not allowed to sell people what I claim is gold, but is actually gold-plated bars of lead. It’s a criminal offence. And “I didn’t know they were lead” is not a defence. If you haven’t checked that they are actually gold, then don’t sell them as gold. The people running the ratings agencies ought to be indicted for fraud.
Plamus is correct. I’ve been saying this for months.
Glad to have some company here. (This was supposed to be part of the last post. I hit the “send” button too soon.)
The Financial Times describes Alan Greenspan as a “supporter of laissez faire principles”.
A Federal Reserve Board Chairman who supported laissez faire would call for the getting rid of his vile organization (which exists for the purpose of corporate welfare – and has done ever since it was set up in 1913).
In fact even by the bad example of Fed Chairman Greenspan was bad – almost as bad as B.B. (oh if it only it was Bilbo Baggins – there might be some hope if it were) and Tim G.
Wild printing corporate welfare degenerates all off them – whose minds think only of “bailout or nationalize”.
And the Financial Times?
It was boasting of its circulation numbers today – all those “businessmen” reading it to get their view of the world.
No wonder so many “businessmen” think Obama is wonderful, and consider their job is to get the maximum amount of subsidy money (and government contracts and other favours) that the British and American government can provide.
This system can not last – and Comrade Obama knowns that, and (privately) laughs at such people.
The Financial Times describes Alan Greenspan as a “supporter of laissez faire principles”.
A Federal Reserve Board Chairman who supported laissez faire would call for the getting rid of his vile organization (which exists for the purpose of corporate welfare – and has done ever since it was set up in 1913).
In fact even by the bad example of Fed Chairman Greenspan was bad – almost as bad as B.B. (oh if it only it was Bilbo Baggins – there might be some hope if it were) and Tim G.
Wild printing corporate welfare degenerates all off them – whose minds think only of “bailout or nationalize”.
And the Financial Times?
It was boasting of its circulation numbers today – all those “businessmen” reading it to get their view of the world.
No wonder so many “businessmen” think Obama is wonderful, and consider their job is to get the maximum amount of subsidy money (and government contracts and other favours) that the British and American government can provide.
This system can not last – and Comrade Obama knowns that, and (privately) laughs at such people.