Force people who made money from sub-prime mess to pay for it

[SmartAleq]

@MOIDALIZE

My apologies

None needed, my fault for choosing an ambiguous username!

[Whack-a-Mole]

@Polerius

I keep hearing about these cases and my mind boggles.

Why would anyone want to buy these “bundled” loans, when they didn’t know what percentage was bad loans and what percentage was good loans?

Who the hell authorized the purchase of these “unknown risk” bundled loans?

In any case, if there is a company that is stupid enough to buy an asset with an unknown amount of risk, in a free market they should be allowed to buy that asset. It’s their money. If they want to waste it, it’s their decision.

As long as they inform their shareholders that they are making such risky moves as buying assets with unknown risk (“hey, we have no frikkin’ clue how safe these bundled loans are, but they look like a good bet”), the free market should allow them to make those risky moves.

IIRC they sort of did, or thought they did, understand the risk. While the loans were bundled they had an expectation of a (say…I forget the actual numbers) 9% default rate. When the loans got more dicey I think they moved that up to a 13% default rate. The calculation still showed them making good profits so they were ok with this. Thing is the default rates far outstripped their expectations. Those writing the loans were incented to do it to whoever. They were not going to hold the risk and they made money writing the loans. There was nothing there to stop them and they predictably did what was in their own best interests.

By forcing transparency in these assets by law, we are forcing market participants to be prudent. In a free market, if we believe that it works and does it job, the imprudent participants will be weeded out. We shouldn’t need the law to force participants to be prudent.

If we need to make a law that prevents people and companies from buying assets so ridiculous that the buyer has no idea what the composition and risk profile of the asset is, then we have no faith in the market participants, and we have no faith in the fact that the free market will weed out such stupid behavior before it all blows up and bring the whole economy down.

In an ideal situation sure. But it clearly is not an ideal situation. This may all look good on paper to you but how can you deny the 800 pound gorilla in the room with you in the form of this financial crisis? Clearly and obviously the market did not and would not operate under your ideal circumstances. As a result we are all left holding the bag of an exceptionally serious financial calamity. To argue that the market will really sort all its own problems seems to be willfully blind to reality.

[Polerius]

@Whack-a-Mole

In an ideal situation sure. But it clearly is not an ideal situation. This may all look good on paper to you but how can you deny the 800 pound gorilla in the room with you in the form of this financial crisis? Clearly and obviously the market did not and would not operate under your ideal circumstances. As a result we are all left holding the bag of an exceptionally serious financial calamity. To argue that the market will really sort all its own problems seems to be willfully blind to reality.

I’m not arguing that the market will sort this out. I’m arguing that someone who believes in the free market should believe that the market would have weeded out such imprudent behavior by making the imprudent investors go bankrupt before the whole economy was in danger.

And since there seems to be an agreement that we need to make a law that prevents people and companies from buying ridiculous assets, then this implies that we have no faith in the market participants, and we have no faith in the fact that the free market will weed out such stupid behavior before it all blows up and brings the whole economy down. That is, we are accepting the fact that the free market does not work “as advertised”.

[SmartAleq]

One of the big headscratchers of this whole situation is how in the hell did dodgy subprime loans manage to become, seemingly only through the process of bundling and selling them, AAA-rated investments? The insurers who were supposed to put a value and a risk assessment onto these things were apparently just asking “So, what are these things anyway? Oh, bags of Krugerrands? Hey, your word’s good enough for me, no need to open the bag or even sniff it!” Maybe the fact that the banks, investment banks and insurers were all consolidated into one (due to the Gramm-Leach-Bliley Act) so they could basically play ball with themselves for a while, selling these things back and forth to themselves until all record of their origin and provenance had been filed off before selling them to other companies might have had something to do with it. :smack:

We don’t need laws to prevent people from buying stupid shit, we just need truth in packaging laws so that BAG OF SHIT will be prominently displayed on the front–if you wanna buy a bag of shit, be our guest, but nobody gets to lie and tell you it’s a bag of Krugerrands. That’s fair regulation.

[XT]

@Polerius

I’m not arguing that the market will sort this out. I’m arguing that someone who believes in the free market should believe that the market would have weeded out such imprudent behavior by making the imprudent investors go bankrupt before the whole economy was in danger.

How would the market have weeded it out since there were other factors that were distorting things? I really wish people would stop trying to use this mess as an example of a free market in operation that failed…it wasn’t one.

-XT

[gonzomax]

Free markets encourage this kind of behavior. If it makes money, it is right. Regulation is intended to protect the system from those who will loot it. Born in the trust busting, monopoly times ,regulation was a reaction toward making America a more level playing field. The rich and powerful will never stop. The government has to restrain them. The last few years show how much will be stolen if we permit it.
If Paulson really believes it will save the system ,he should get his other looter friends to kick in the seed money. They have the cash.
Paulson does not need to be beyond the laws ,courts and regulation. That is scary. He is worth 700 mill. Is that the kind of guy who shows economic restraint. ?

[mazinger_z]

@DoctorJ

I more or less understand what a credit default swap is, but this is the part I really don’t get–how on Earth could this market be worth so much? $70 trillion is ten times the value of the entire US mortgage market.

I have a friend who I went to school with (econ) consulting at AIG right now in credit-debt risk management. He’s been doing this for like 15 years. I only got a sense about what he does in the last 3. He’s been telling me for the longest time that the DOW does not state the health of the economy. There is 100x (I’m not sure if this is hyperbole) more “action” going on in the debt markets. The problem is that debt is changed around and repacked so much that it’s difficult to put an indicator on it, so there’s nothing factual to report (cf. the DOW). The credit default swap is a function of other factors (e.g. including callable debt premiums, spreads, coupon rates, par values, etc.) than just nominal value of the underlying asset.

[Oy]

@Polerius

As long as they inform their shareholders that they are making such risky moves as buying assets with unknown risk (“hey, we have no frikkin’ clue how safe these bundled loans are, but they look like a good bet”), the free market should allow them to make those risky moves.

By forcing transparency in these assets by law, we are forcing market participants to be prudent. In a free market, if we believe that it works and does it job, the imprudent participants will be weeded out. We shouldn’t need the law to force participants to be prudent.

Don’t see how you can inform the shareholders without transparency, is the thing. How can you make sure people who are considering becoming shareholders know what they’re getting into?

[Whack-a-Mole]

@Polerius

And since there seems to be an agreement that we need to make a law that prevents people and companies from buying ridiculous assets, then this implies that we have no faith in the market participants, and we have no faith in the fact that the free market will weed out such stupid behavior before it all blows up and brings the whole economy down. That is, we are accepting the fact that the free market does not work “as advertised”.

Who is getting weeded out here?

Technically the market has done what it is supposed to do and corrected itself. Companies are going out of business as they should for getting caught in this mess.

Except…

There are a lot of people who made scads of money on this and are fine. Those people will do it again. Some few gamed the system and made out like bandits. These are very complex financial instruments. Many people in the industry have a hard time getting a handle on it all. Some few did get it enough to loot the system and are fabulously wealthy.

Unfortunately the market correction did not come soon enough and grew to monstrous proportions such that the inevitable market correction that will keep the patient healthy will in fact kill the patient.

Hell of a pill to swallow.

[SmartAleq]

Here’s a transcript of PBSs News Hour with Jim Lehrer talking to some pretty smart people–I’m rather liking this guy:

Allan Meltzer is a professor of political economy and public policy at Carnegie Mellon University and a visiting scholar at the American Enterprise Institute.

He has a few observations on this whole mess that I think make a ton of sense both historically and economically:

ALLAN MELTZER, Carnegie Mellon University: It’s a terrible idea. It’s undemocratic. It’s bad economic policy, and it’s bad social policy. And it has a very little chance of solving the problem in a meaningful way.

JEFFREY BROWN: Well, flesh that out a bit. Is it that we are not in a crisis? Or is it that government intervention of this kind is not the right answer?

ALLAN MELTZER: Well, I’ve listened to governments tell me for 40 years that there was a crisis and the world was going to fall apart if we didn’t do this or that. But there have been a few cases where they weren’t able to do that.

One was the commercial paper crisis in 1970. There have been several others. The world did not fall apart. Last week, we had Lehman Brothers went into bankruptcy. Within three days, most of the assets were sold.

We had AIG turn down three offers to buy the company because they thought they would get a better deal from the government. It turned out they didn’t get the better deal from the government. Now the stockholders suddenly woke up and said – the major stockholders said, “We’d like to buy the company.”

Well, that’s what I think we need to do. We need to get the government’s hand out of this, and let’s see whether we can’t get a market solution.

The market people caused this problem. They ought to be the ones that pay the cost of having it cleaned up.

And as a solution:

ALLAN MELTZER: Yes. I don’t want to join a debate about different ways of picking the public’s pocket. I think, if they’re going to do something – and I don’t think that we really need to do anything. I’ve heard these stories over and over for 40 years. You know, maybe there will be a crisis.

But despite all the talk, Main Street is not doing so badly. And the fact is that they’ve been predicting disaster since January. It hasn’t happened.

And if they’re going to do something, then what they ought to do is make loans, which the financial institutions have to repay with interest. And if you think – that’s an idea which the Chileans have used in a bigger crisis than this for them in 1982, and it worked for them.

People paid back the loans. They weren’t allowed to pay dividends until they repaid the loans. They weren’t allowed to take bonuses until they repaid the loans. I think that’s the way – if we’re going to do this, then that’s the way we should do it.

JEFFREY BROWN: Professor Meltzer, are you concerned about rewarding the people who caused this, the trouble? Is that part of this? I mean, one of the questions or issues on the table we just heard on the tape is whether we should use this opportunity to put limits on executive pay, for example.

ALLAN MELTZER: Well, I don’t want to get into the distribution of income arguments that are so prevalent in the Congress. I’m against this mainly because it seems to me this is private interest activity at the expense of the public interest.

I mean, Mr. Paulson can talk about all the things that are going to be good for Main Street, but the fact is that Main Street is going to incur a huge debt and a big loss, for the reason that Paul Krugman just mentioned, because most of these assets are not worth much.

Well, let’s do loans, which they have to repay with interest, and let’s see what happens.

I know that many people think it can’t happen. But, look, today, Morgan Stanley sold 20 percent of its company to a Japanese bank. There’s lots of money out there, liquidity. The Chinese have it. Others have it. They’ve come in.

If the government steps aside and says, “Solve this problem,” then we’ll see more of that activity and people will begin to do it.

Merrill Lynch sold itself. It sold out some of its assets. It got 22 cents on the dollar. It’s correct to say nobody knows how to value these things, and they won’t know how to value them until the housing price reaches a bottom or is expected to reach a bottom, because you can’t value the mortgages until you know what the underlying asset, which is the house, is worth. And nobody knows that.

This guy’s making too much sense, expect an assassination attempt at any minute! Check out the rest of the transcript, it’s well worth the read.

[XT]

You realize don’t you that this was exactly what Hoover did, right? And what he was blasted for. It’s interesting that you agree that this is a viable solution…

To a certain extent I actually agree. However…be aware of what this will actually mean to the American people in terms of financial hardship and privation for the next…oh, say decade or so. As long as we go into it with open eyes and know what we are getting ourselves into and all…

-XT

[Oy]

@SmartAleq

Here’s a transcript of PBSs News Hour with Jim Lehrer talking to some pretty smart people–I’m rather liking this guy:

He has a few observations on this whole mess that I think make a ton of sense both historically and economically:

And as a solution:

This guy’s making too much sense, expect an assassination attempt at any minute! Check out the rest of the transcript, it’s well worth the read.

I saw him on Lehrer. He both attracted and frightened me. As xtisme implied, this is the kind of thing that can lead to a depression. That’s a bit of a high price for the nation to pay for allowing the market to work itself out.

We’re really flying blind here. The only thing we do know is that this shouldn’t have happened, and to anyone but the complete ideologues, it’s fairly obvious that the problem was insufficient regulation.

[gonzomax]

@Oy

See, this is the problem with the “star” system, in any field, whether it’s show business or corporate America. There are undoubtedly dozens of executives who would do the job just as well for a couple hundred thousand a year, but because they’re not well known to the pundits, and there won’t be any buzz about them in the WSJ, hiring them won’t drive the stock prices up, so they aren’t hired. Similarly, there are probably hundreds of actresses who could play any role that Nicole Kidman could play every bit as well or better, but they wouldn’t sell tickets the way Kidman would. No one’s going to say “Let’s go see the new Martha Gorfrish movie this weekend” unless it’s based on a well-known book or has some other ‘hook,’ and even then, producers generally hedge their bets.

Stupid as the star system is in entertainment (and sports, where you see it a lot, as shown in your example, child), it is ten times as stupid in the corporate world. Maybe if we went back to valuing companies for their earnings rather than their stock price, and if we looked at their actual profits rather than at annual growth as a sine qua non, things might be better. Every company I’ve worked for has had to “make its numbers” every years. It was never good enough to make a profit. If it wasn’t bigger than last year, then the company was a miserable failure, and they would cut their employees and drive the people left harder, crying about economic hard times.

ETA: As I recall, Galbraith discussed this trend back in the 60s.

Galbraith also called ceo s ratifiers. They send people off to gather information and make reports describing all about it. These reports stuffed with data and give the ceo all the info he needs. The information makes the decision. It always leans one way or the other. he simply ratifies the decision the reports make obvious.