The actual challenge with the “correctly evaluated property” idea is that, just like stock prices, there’s some sense of what a long term value *ought *to be. But the short term value can be a large multiple above or below that value. And hold there for a meaningfully long time. And then shift suddenly. Worst of all, shift suddenly in a highly correlated and self-reinforcing direction.
As the aphorism has it: “The market can stay irrational longer than you can stay solvent.”
As long as we all have to do business in the presence of large-scale irrationality of unknowable magnitude and duration, we’ll continue to have shit happen now and again.
Widespread malfeasance just throws gasoline on what’s already a pretty good-sized inferno.
Interesting article … the authors make a good case for flippers contributing to the crash … and I’m not sure anyone has speculated otherwise … Mortgage Backed Securities have always had a high risk of early payoff … what was unexpected is that sub-prime mortgages had an increase in risk of default … as demonstrated by AIG’s collapse by writing too cheap insurance policies against the Mortgage Backed Securities …
Also interesting is to apply the theory in the article to the third quartile … where I assume we have a mix of sub-prime mortgagees and flippers … I think the data only really says who was hurt the most by the crash (in absolute dollar value), nothing pin points the specific cause …
Note the article claims the information comes from the New York Federal Reserve Bank … “But as a Federal Reserve Bank of New York report from 2011 reveals (pdf, p.26), an increasing share bought with the aim to “flip” the home a few months … [snip]” … but from page 1 of that PDF document, the NY FED Bank disclaims any involvement … “The views expressed in this paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.” …
Andrew Haughwout et. al. are entitled to their opinion … and the opinion is worthy of consideration … however, too many other things were going on to say this was the wooden stake that slayed the evil vampire …
The problem like any bubble is there was an incentive for everyone in the process, from home owner to lender and all the parts in between. The money was just too much. Flippers probably were a contributing factor, but like sharks at a feeding frenzy, it was the bloody money that attracted them. the cash was already there floating around.
The one group who should have grounded the whole thing in reality are the ratings agencies. However, IIRC their pay structure incentive also was structured to pay for good reviews. So, incompetence is the kindest interpretation of the reason they rated the bonds incorrectly.
I agree the ratings agencies deserve a hefty dose of the overall blame.
But the value of any debt security is what somebody else will pay for it today. Once panic set in, no buyers would buy them for anything close to last week’s value and no seller wanted to hold them past today. Freefall ensued.
It is darn hard for a ratings agency to come up with an honest rating that’s still valid in a freefall market. It’s be something like “This is a grade AA bond. But if suddenly nobody will buy yours and you insist on selling anyway, then it becomes an F.” Gee thanks, what am I supposed to do with that kind of rating??
I’ve often said that the real magic of financial derivatives is not, as the proponents say, to distribute risk to those best equipped to handle it. Instead they’re purpose-designed to distribute risk to those least aware of the risk they’re taking on. And when awareness eventually dawns, the reaction won’t be gentle or pretty.
Had everybody buying CDOs known and accepted that that the price would take an incremental hit when some unusually large but still plausible fraction of loans defaulted, we’d have a had a much less exciting crisis.
The problem wasn’t the misstating of incremental default risk so much as it was misunderstanding the expected price response once any defaults happened.
It’s not about the crash. It’s easy to see why the panic followed the accelerating defaults.
No, the problem is the ratings agencies said the bonds were reliable investments before the crash, even though a little digging would reveal they were junk bonds built on relying on the worst consumers in America to pay their mortgage - mortgages that were beyond their ability to pay anyway, once their initial interest rate holiday ended. (“Exploding ARM” was an apt choice of words). And… even if their claimed income had not been exaggerated or faked by either the applicant or the bank itself.
So investment managers for assorted banks, funds, and trusts invested in AAA bonds that suddenly were worthless. They share some of the greed-based blame, for buying something with a rating and return too good to be true. The resulting crash meant that no bank even trusted any other bank, until the Fed stepped in, so nobody would loan anyone any money and nobody would trust a transfer from another bank. In a world built on transfers and electronic IOU’s, complete distrust of the process is not a good thing.
No, that’s ignoring what the ratings agencies did - they were not helpless bystanders with no good options. What you’re leaving out is that they played games with packaging mortgages to present investments that should have been rated at BBB or A- as AAA. A more accurate description of the situation would be more like “I’m telling the buyer this is a grade AAA investment, but really it’s an A-. Once some of these start having the kind trouble that you’d expect from an A- but not an AAA investment, people will realize the earlier rating was bad, and won’t want to buy it or similar securities. Suddenly people realize I lied when I said it was AAA in the first place, and don’t want to buy these at all because they never were AAA at any point, but I’m going to throw up my hands and pretend that it’s just forces of nature and not my falsification that’s to blame.”
The first three responses laid the background for the Debate. One admires the nerve (or verve) of SDMB Moderators of yore, who kept the thread in GQ.
The lightning-fast liquidity (suffering from too much lubrication?) defeated time-honored practices (e.g. paper trails) and should have been viewed with caution. Instead, the men who operated Wall Street treated the loss of information Ludovic describes as a feature not a bug!
Blame the feds and libs! I’d report the post, but some statute of limitations has expired.
The banks were certainly unscrupulous, but many of them were relatively immune from the mortgage collapse, or even actively betting on and rooting for it.
It is with hindsight that the pernicious evil of men like Gingrich and, yes, even the Ayn Rand fan Greenspan becomes clear.
There had already been warnings. In 1998 LTCM, a smallish hedge fund but with huge leverage, had big bets turn against it, was forced to sell some positions at huge losses. Meeting its obligations to counterparties would drive it to insolvency; there was a risk that credit links would fall like dominoes.
Warren Buffet (joined by two financial giants, GS and AIG) offered $250 million for all of LTCM’s assets and liabilities, pledging $3+ billion cash to keep the fund liquid. LTCM’s head was given 1 hour to agree, and the deal fell through. Eventually a dozen major banks, led or coerced by the Federal Reserve Bank of NY, put up $300 million each and LTCM was bailed out. (As liquidation proceeded I think each bank lost more than $300 million :eek: . LTCM’s previous partners got little if anything.)
That the collapse of a smallish hedge fund could almost bring Wall Street to its knees should have been a wake-up call. Instead it was “Ho hum. The system works!” :eek: :smack: Black Swan was written — soon to be a major movie — and Wall Street continued to devise ever more dangerous, and overly leveraged gambles.
I’d accept this analogy — If the climbing teams are led by egomaniacs who have made some drunken bet, and most of the climbers are being held hostage.
Yes, that was the main point of the “securitization.” Package the bad paper and find a willing buyer. It was all a great parody of Dog-eat-dog capitalism.
I highly approve of Mr. Frankensteen’s entire remark, but have abbreviated it here.
The real story is that “government was the ultimate root cause” is #FakeNews. Now you’re welcome to call my last sentence #Fake. Feel free: there is no objective reality anymore.
The betrayal of fiduciary duty by rating agencies was astonishingly criminal. It is a shame that none of them went to prison.
The banks took the crappy loans they made, and sold them as mortgage-backed securities; i.e. pay us today for loans that ought to get paid tomorrow. Wonder why they then went out and roped in anyone who looked like they could pretend to pay a mortgage, to create even more crappy mortgages that they then resold as AAA bonds. The pressure on everyone to find more and more mortgages to re-package certainly induced ignoring the rules and outright fraud at that end of the transactions. It certainly wasn’t the government agencies forcing the banks to make those loans. And the banks suffered for it… to the point where so many failed and got taken over. “Freddie Mac” for example sold mortgage backed securities (MBS), that was one of its main businesses, but a huge part of the market that blew up in investors’ faces was private MBS without the participation of Fred.
