They are a good outline to many events behind the current crisis; many of you have been writing to me and asking for background reading.
Another of my colleagues, David Levy, just published this short piece (with Sandra Peart) on the ratings agencies and the idea of experts.
Levy is saying that MBS caused regional housing markets to become more correlated? Is there (i) any empirical evidence for that proposition or (ii) a theoretical mechanism which predicts such a result? I am even sure that such correlation has increased, much less that MBS are the reason.
Tyler and Roger,
Well done. One big exception, 7 (d) and (e) on page 2. Roger confused percents and percentage points. A one-percentage point decline in the risk premium, which he obviously means, is a 50% decline (50% of 2%), which is huge. By making the statement, “Suppose the bundler-insurer can lower the risk premium by just 1%,” he made it sound easy. He meant one percentage point, which is hard.
Best,
David
I loved this line from Congleton:
If a general credit crisis is coming, it will be in the future.
Yogi couldn’t have said it better.
Thanks for the link. Lots of good thought here.
But he doesn’t mention two aspects that my other reading suggests are critical:
+ creation of huge amounts of collateralized debt obligations from MBS, which new obligations were poorly structured and misrated by the agencies;
+ explosion of credit default swap market, largely driven by insuring these CDOs, and the facts that the market for these derivatives is private, opaque and unregulated and that capital requirements are insufficient at best.
My understanding is that Fannie and Freddie, though they created the underlying MBS, weren’t responsible for the critical addition of the CDOs or the CDSs.
Have I misunderstood the situation, or are these major factors in the transformation of this mess from a large but garden variety housing crisis to a major credit crisis?
Robert Ayers, I don’t think you are serious or even writing in good faith. If you want a list of senior Merrill executives who have lost their jobs, read the annual reports and the financial pages. If you want to know the numbers of mid-level and junior employees who have lost their jobs, that too has been reported in the financial pages rather extensively (try Google). If you are too lazy to do that work, I infer that you are not in fact interested in the question. If you want people sent to jail, you are being silly.
Some thoughts –
History:
7(e) – … (As long as one does not have to actually pay much out on the insurance provided).
Couple this with 7(f) – which compares the insured sub-prime rates to the average default rate (without actually specifying which average or whether prime default rates are included – and it seems that while the insurance can be profitable the insurers in this case seem to be betting that the lenders are mis-pricing their loans.
I would challenge that such activities can be “highly profitable” in the long-term, and basic macro-economic theory – not to mention the realities of today – seem to support that conclusion.
Meltdown:
3(a) – “…insurers of [MBS] had assumed (or hoped) that housing prices would rise forever…” – this is not necessary if those making the decisions are “greedy”; which it is ignorant to assume they are not. They take their cut while the taking is good and get out (are kicked out) when things turn south. I don’t think government or even shareholders can avoid this reality no matter how much regulation is imposed. Slash-and-burn comes to mind.
How Bad?:
1(c) – The statement “failed to clear at long-run equilibrium prices” makes no sense to me? Long-Run doesn’t matter, the currently equilibrium price IS one where all assets clear. If someone would rather hold an asset than sell it at a given price then it is illogical to consider that assets as “failing to have cleared”.
5(c) Has there been a comparison of the total bankruptcies (liability values at declaration) between now and previous times frames (i.e., do the fewer large firms constitute more liabilities than the many small firms, with adjustments for say the average GDP at the time – or without)?
It does appear that “mark-to-market” does have a greatly negative effect that could be reduced since these assets could be held to maturity and thus an expected payout/default calculation could be done. If the maturity calculation gives a higher asset value credit ratings would stabilize and loan calls would decrease. One possibility is introduce a CD-like product that could wrap the MBS using the hold-to-maturity value with some room for slack. If the government, or banks, offered these then the market for those impaired assets goes away and effectively becomes an annuity. There would be no way for the “CD” to be sold and so while it would become a long-term asset tying up capital for the firm in question it would never change in value and could be amortized away over time as opposed to the immediate loss incurred from selling the impaired asset.
y81 – Those people may have lost their jobs but that doesn’t mean they have been black-listed nor haven’t saved their cash in safe investments and thus never need to work again anyway. I would offer that being able to pull out 10s of millions of dollars and then walk-away and never have to work again is a great career gig if you can get it.
I think jail would be good (or exile), though meeting a burden of proof would be nearly impossibly except in cases of fraud and that can already be prosecuted anyway.
“The art of medicine is to entertain the patient while nature cures the disease.” ~ Voltaire
From Congleton “predictions of a “great depression† to be fear mongering.”
Regardless of what happens going forward, which will happen in the future, while the experts who now want to lead us out of the wilderness kept quiet, other experts were telling us our biggest problem was health insurance, or global warming, or terrorists, or oil speculators. Can we at least agree that experts are full of crap? Or, more formally, they suffer what Charlie Munger calls incentive-cause bias.
I vote we say no to them until they start giving real information. As long as they are blowing smoke, we simply don’t have to do business.
The current bill passed by Senate is road to a new New Deal. In other words, a prolonged recession is ahead of us.
Tyler-
Thanks for the reference. I thought the article was very clear and a terrific antidote to the unreasoning fear that’s being peddled.
I appreciate the effort Mr. (?) Congleton put into his outline of the crisis, but I am dissatisfied w/ his apparent desire to put blame squarely on Freddie and Fannie (with very little mention of the role of the entirely private players).
In 2004, Fannie and Freddie purchased 44% of all subprime MBS sold, in 2005, 35.3%; and in 2006, 25.2%. Total 2006 estimates have 15% of Fannie and Freddie’s mortgage exposure as subprime.
Now, I think it is deplorable that our politicians did nothing about this when voices from all sides warned about the impending Fannie and Freddie blowup. However, since the gov’t has already stepped in and “rescued” the two GSEs (as well as stepped in as explicit guarantors), if the problem had been isolated to F/F, as suggested in the outline, we certainly wouldn’t be progressing to the much more dire situation we are in today.
The outline mentions CDSs almost not at all (as another reader notes above), despite the fact that they were the sole instrument that necessitated the takeover of AIG. With somewhere between $40-$70 trillion CDSs outstanding and tottering, which completely overshadows the underlying $12 trillion in mortgages in the US, its no wonder the Paulson twins felt the need to come in with their emergency bailout.
It seems we will be in economy resin for quite a long time. We can see the economy crisis effect everywhere.
Every success is based on continuous efforts. It is not possible be done over nigh.
Comments on this entry are closed.