Color me naive

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Color me naive

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1modalursine
Sep 29, 2008, 7:36pm

According to the WSJ

http://online.wsj.com/article/SB122265697254684627.html?mod=googlenews_wsj

The number of actual foreclosures in the past and the projected number of them into 2010 may be a million or even a million and a half per year in the worst year.

With $700 Billion in the kitty, that gives us hundreds of thousands of dollars per defaulted mortgage to play with.

So: If the crisis is caused by the mortgage holders being unable to pay their mortgages, why cant the government mandata a new kind of mortgage default bankruptcy where the govt helps the homeowner to pay off the mortgage, in return for a consideration ....lower payments with interest for a longer time, equity stake in the house, something along those lines. In worst cases
the govt takes over the house and rents it back to the former homeowner.

Bingo:
1 The paper is all magically good again
2. People stay in their houses
3. Credit flows
4. Crisis averted
5. The govt gets interest and/or equity so eventually will recoup all or most or even make a profit on, the bailout money. Who knows, maybe private enterprise will by the paper at a profit to the govt?

Aside from the inconvenient circumstance of the plan helping ordinary working stiffs (yeah, yeah, they make
republicans itch) as well as the better heeled who really matter, what's the problem?

2Makifat
Sep 29, 2008, 8:15pm

Sounds good to me, although I'm an economic moron. I'm sure someone will cluck that we are "rewarding bad behavior" on the part of homeowners who overextended themselves with ARMs, etc..

But then, the behavior of the bankers hasn't been exemplarly either, practically shoving mortgages at people who had no business getting them.

Help the homeowners, and let the bankers go get real jobs.

3jasonseidner
Sep 29, 2008, 8:59pm

I've got another one. Let's say I own a house worth $500,000 (and I do mean OWN... no mortgage) and it catches fire and burns to the ground. The law says that I only have to have insurance on the house if there's a mortgage. So let's assume that since I didn't have a mortgage I was dumb enough to not have insurance.

Can you picture all my neighbors gathering together and asking each other, "How are we going to raise the money to pay to rebuild Jason's house?"

My question is, why is it any different for these big firms? Why isn't there insurance to cover the possibility of them going under (like AIG)?

I mean, if my house is worth 500k, someone in some office at some computer is determining that I need to pay X dollars per month to "protect" that home should disaster strike. Fair enough.

Meanwhile, a company worth (I'm making this up) 30 billion dollars gets bailed out by taxpayer money while its CEO and its CFO and all the others down the line (not to mention the executives BEFORE them) get to keep the "bonus" money that they received prior to this "disaster".

It's as if my neighbors paid to rebuild my house while I get to keep the money I didn't "waste" on insurance.

Now I know what some would say--no one's going to provide insurance to protect something worth 30 billion dollars. But in truth, someone would. Perhaps it would cost 9 billion per year, but the fact is, at the right price, someone would ultimately do it.

The thing is, paying such extreme prices to insure something that expensive would mean the money would have to come from somewhere--maybe customers' pockets, or, maybe, out of that 113 million dollar "bonus" that Mr. CEO got last year. Hmm...

Is there anything I'm missing here?

4Makifat
Sep 29, 2008, 9:19pm

You just gave me a great idea!

Where the hell did I put my gas can?

5oregonobsessionz
Edited: Sep 29, 2008, 10:16pm

>3 jasonseidner:

They do have a form of insurance, called credit default swap (CDS). The Wikipedia article on CDS has an interesting probability model. More technical explanations can be found here and here.

The inability to evaluate the risk of derivative bond portfolios (and therefore to adequately price and reserve the CDS) is a major contributor to the current credit crisis.

Unlike other forms of insurance, CDS instruments have been largely unregulated. Now, New York state is belatedly moving to regulate CDS.
Bloomberg
New York times

The amazing thing is that the "geniuses" on Wall Street and the so-called regulators took so long to recognize this particular train wreck. A quick Google search on "credit default swap" finds numerous articles on this topic:

In March 2008, just after the collapse of Bear Stearns, Janet Morrissey at Time asked: Credit Default Swaps: The Next Crisis?.

In April 2008, Dr. Ellen Brown at Global Research wrote Credit Default Swaps: Evolving Financial Meltdown and Derivative Disaster Du Jour, in which she referred to CDS as "the Wall Street Ponzi scheme" and warned of "the derivatives Chernobyl" and a "parade of bailout schemes".

So, after stalling for months while financial giants fell like a house of cards, Paulson suddenly attempted to stampede Congress into a bailout plan. And he is shocked - shocked! that they don't perceive the urgency of the situation.

6jmcgarve
Edited: Sep 29, 2008, 10:30pm

>5 oregonobsessionz: As I understand it, most of the credit default swap securities for the mortgages were issued by: AIG! So, as the Fed has taken control of AIG, they'd STILL have to pay for them using money from the treasury!

7Carnophile
Edited: Sep 29, 2008, 11:15pm

>5 oregonobsessionz:
“CDS instruments have been largely unregulated...”

Oh, but they are, and furthermore their connection to the current mortgage-backed asset mess is, at best, insufficiently established. See, e.g.,
this
at post 68 et seq. At least you didn’t say “totally unregulated,” thank you for that.

Not only are they regulated, but their connection to the current mess is, um, fuzzy. Does anyone know of a citation to a reliable and detailed source that establishes that CDSs had something to do with the current mess? I am aware of many assertions to this effect in the mainstream press, but no actual substantiation of the assertions.

EDIT: Post 68, not 38.

8Carnophile
Edited: Sep 29, 2008, 11:17pm

I find this passage in the Bloomberg piece particularly irritating:
U.S. Securities and Exchange Commission Chairman Christopher Cox today said Congress should grant the authority to regulate the market. “Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure,'' and that should be addressed “immediately,'' Cox said.
Cox says this even though the Fed article I cite in the above-linked thread makes it clear that bank examiners (from the Fed and possibly other regulators) do have authority over those kinds of contracts.

I particularly love Cox’s line about “not even disclosure.” This is probably the most flagrantly dishonest statement I’ve read about this mess yet. The very idea that financial institutions don’t have to reveal activities like this to government auditors is hilarious, folks; it’s like a physicist denying that there’s such a thing as gravity. Again, see the Fed article; which talks about how regulators should set capital requirements as a function of involvement with CDSs. I say it’s dishonest because Cox, given his job, can’t plead ignorance. He said something he knew isn’t true for political reasons. It’s that simple.

By the way, one might say “Why trust the Fed over the SEC; they’re both gov’t entities involved in the financial system.” The answer is that the Fed is a bank regulator. So they know what they’re talking about when it comes to regulating banks. The SEC has a more tangential relationship to banks since its primary repsonsibility is the “classic” securities markets like the stock & bond markets and now some of the more newfangled derivatives markets. Still, Cox definitely should know better.

9Carnophile
Edited: Sep 30, 2008, 5:41pm

Equally annoying, from the NYT piece:
“...credit-default swaps, which have gone unregulated...” This is simply not true.

I’m bending over backward to try to interpret these statements in a way that can be read as something other than lying like an unregenerate old-school Texas con man.(*) It’s a strain, and I think I might have pulled something, but here’s one idea: Maybe there are certain kinds of entities that can become involved in these markets without even telling anyone. It seems unlikely, but maybe, say, hedge funds can do so. If that’s what they mean, though, then then should say that: “Some entities can get involved in these without them being regulated,”, not “They’re totally unregulated.”

The NYT piece continues,
“Credit-default swaps essentially function like insurance contracts to protect bond buyers from the risk that companies will default, but over the years they have become a favorite tool of speculators who use them to bet that a certain company will fail.”
This is outrageous propaganda designed to get NYT readers in a froth about CDSs. It is very simple. Every bet has two sides. Someone who buys default protection in a CDS contract could be betting the company will fail, but the seller of the CDS protection is then betting the company won’t fail. So it is just as accurate to say “speculators who use them to bet that a certain company will succeed.”

Anyway, the more common - by far - use of CDSs is not to speculate, but simply to protect oneself from default on an asset one is holding. This market originated because various financial institutions were holding assets that posed significant default risk, and they wanted to protect themselves from it. That is still the typical use of these CDSs. In fact, I’d never heard of speculators using them to “bet a company will fail” until now.

(*) Colorful figure of speech copped from the Illuminatus! trilogy.

10maggie1944
Sep 29, 2008, 11:12pm

oh, darn, you all are making my head hurt. I, foolish girl that I am, took seriously the advice to pay off my mortgage before I retired. (-:

I live in a cheap house but it is mine (-:

Unfortunately, some of my retirement income....is in the hands of the geniuses who engineered this fiasco. )-:

11Carnophile
Sep 29, 2008, 11:13pm

I find it very odd that New York Gov. Paterson wants to require that all dealers in CDSs be licensed as insurers, even though AIG, he tells, us (1) went under because of CDSs, and (2) was an insurer. Am I missing something?

12jmcgarve
Sep 29, 2008, 11:25pm

Carnophile, would you point to the regulations on CDSs? My understanding is that they are indeed unregulated, which is why AIG got themselves in such trouble ... and that they are unregulated because of the December 2000 Commodity Futures Deregulation Act of Phil Gramm.

13Carnophile
Sep 29, 2008, 11:42pm

Yes, it’s here at the Federal Reserve Bank of Chicago, 4th quarter 1998 “Economic Perspectives.” Page 9 et seq. are the parts I was referring to in the other thread.

Sorry about the confusion, jmcgarve - the Cleveland Fed piece I originally linked to was the related but distinct matter of the correlation between CDSs and the mort mess. The Chicago piece, which is the one that talks about regulation, was from a hard copy I had but am glad to find they put it online.

As far as I know, the Commodity Futures Deregulation Act didn't repeal any of the regs mentioned in the Chicago Fed piece.

14jmcgarve
Sep 30, 2008, 12:30am

>13 Carnophile: Carnophile, the source you listed does not regulate CDSs. It does regulate reporting of CDSs as liabilities, but ineffectively. The issuer must estimate the "credit exposure of the underlying credit" i.e., how much can I lose? But that assessment requires some transparency in the exchange, and there isn't much, because of lack of regulation. Look at the end of page 9. It says:

"Less than full transparency implies that some
investors may underestimate risks so that capital
costs for firms creating additional contracts are too
low. This situation can result in excessive contracting
activity. If contracts begin to fail and loss experience
reveals the extent of oversupply, the market value of
outstanding contracts declines. If these failures are
seen as systemic, they could lead to social costs in
the form of government-sponsored bailouts. "

Which is EXACTLY what happened. On the other hand, the Commodity Futures Deregulation Act didn't deregulate CDSs, because they were never regulated in the first place.

Hm, this is getting a little technical here. We also have to worry about CDOs, collateralized debt obligations, which is another unregulated way of passing on risk, at a cost of still more loss of transparency. Nobody can really figure these things out. They may make individual banks safer -- but the credit system as a whole develops what might be called "self organizing criticality", meaning that when the crunch hits the scope of failure becomes enormous.

15oregonobsessionz
Sep 30, 2008, 1:47am

>7 Carnophile:

The article you linked in that other thread was dated August 2003, so the specifics are somewhat out of date. However, it doesn’t exactly appear to support your position.

First, in terms of the quantity of privately issued pool securities:
In 1983, privately securitized assets totaled less than $4 billion. Then, private issues took off sharply, reaching more than $2 trillion in total assets at the end of 2002 – a more than 600-fold increase in 19 years. Current information can be found here; perhaps someone will feel inclined to wade through all 49 pages to extract the relevant info and create a graph showing the trends since 2002.

Continuing with the Federal Reserve Bank of Cleveland article:
As described thus far, investors would quickly recognize a major conflict of interest in this structure. The lender could keep all the good loans for itself and dump all the bad ones into the special-purpose entity. Because investors don’t originate the loans, they cannot verify the quality of every loan being securitized. To reassure investors, the lender asks a credit-rating agency to certify the quality of the loan portfolio. The rating agency estimates the default risk of the portfolio relative to that of an investment-grade (low-risk) security and decides how much default protection the lender must provide to investors to make the asset-backed security investment grade.

So how effective have those rating agencies been? Moody’s and S&P were sounding alarms early in 2007, but no one seems to have done much in response.

More from the Cleveland Fed:
Banks began to securitize a large volume of their loan portfolios in response to changing regulations and market forces during the 1980s. Starting with the International Banking Act of 1978…federal regulators ratcheted up minimum capital requirements for commercial banks. By the mid-1980s, banks were required to hold primary capital…of at least 5.5 cents for every dollar of assets carried on the balance sheet. Capital requirements limit the risks banks will take by putting bank owners’ own money at risk

What a radical idea! Why on earth would anyone want to “limit the risks banks will take”? The article continues:

But there is a way to circumvent capital requirements, and it hinges on the fact that the bank does not have to hold capital against the loans it originates, only those it actually carries on its balance sheet. So, there is no capital requirement if the bank originates loans and transfers their ownership to a special-purpose entity, effectively removing them from its balance sheet….regulators allow banks to keep these loans off the balance sheet, reducing the need for additional capital….

...A major inhibiting factor was uncertainty about whether securitization was banned by the Glass-Steagall Act’s prohibition of commercial banks’ underwriting of corporate securities. This uncertainty was resolved by the Office of the Comptroller of Currency when it decided that banks could sell interests in a pool of loans. A court of appeals upheld that decision in 1985 and ruled that these instruments were not corporate securities but investments in the underlying loans; therefore, Glass-Steagall did not apply. This ruling and the Supreme Court’s refusal to hear an appeal by the Securities Industry Association opened the floodgates.

16oregonobsessionz
Edited: Sep 30, 2008, 1:49am

>7 Carnophile: again:

Does anyone know of a citation to a reliable and detailed source that establishes that CDSs had something to do with the current mess? I am aware of many assertions to this effect in the mainstream press, but no actual substantiation of the assertions.

I don’t know what you consider to be the “mainstream press”. The Wall Street Journal said this:
That the government would prop up AIG financially offers a stark indication of the breadth of the insurer's role in the global economy. If it were to have trouble meeting its obligations, the potential domino effect could reach around the world.

For one thing, banks and mutual funds are major holders of AIG's debt and could take a hit if the insurer were to default. In addition, AIG was a major seller of "credit-default swaps," essentially insurance against default on assets tied to corporate debt and mortgage securities. Weakness at AIG could force financial institutions in the U.S., Europe and Asia that bought these swaps to take write-downs or losses.

AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.


Business Insurance has an ongoing series titled AIG in Crisis.
Mortgage woes, stock fall trigger crisis says this:
Poor management of arcane financial deals faulted in meltdown
Over several years, AIG built massive portfolios of mortgage-related credit derivatives and residential mortgage-backed securities. As the housing bubble burst, writedowns on those portfolios rose quarter by quarter to total $18 billion earlier this year. Then, over a few days last week, a liquidity crisis pushed AIG to the brink of what would have been the largest insurance holding company bankruptcy in history….

…The downfall of one of the world's most powerful financial services companies had multiple causes, ranging from internal risk management failures and the lack of adequate regulation of its credit derivative business to the more immediate impact of rating agency downgrades and this month's collapse of Lehman Bros. Inc., industry observers say….

…AIG, more broadly diversified than most insurance holding companies, also had a much heavier exposure to mortgage-related products than most insurers. That exposure came mainly through credit default swaps and other credit derivatives written by AIG Financial Products and through investments in residential mortgage-backed securities.

As of June 30, AIG carried credit derivatives with a net notional exposure of $441 billion on its books, the company reported. Of that, $57.8 billion represented subprime-exposed collateralized debt obligations. The insurer separately held $77.5 billion in RMBS, including $40.2 billion backed by subprime and Alt-A loans.

As the housing market deteriorated last year, AIG's real estate exposure—particularly the credit default swaps—became the source of mounting quarterly losses. Over the first half of this year and the last quarter of 2007, the insurer racked up more than $25 billion in unrealized market valuation losses on its mortgage exposures, resulting in more than $18 billion in net losses….

AIG's large portfolio of credit default swaps built up over several years until the insurer largely stopped committing itself to new swaps in late 2005. It continued investing heavily in RMBS in 2006 and 2007, though, the worst years of the subprime era.

The CDS and RMBS exposures, along with mortgage origination and mortgage insurance business that AIG did through other units, amounted to an aggregation of mortgage risk that the company didn't watch closely enough, observers say.

"The events leading to the current crisis stemmed from company-wide excessive exposure concentrations to the mortgage industry, which remained unchecked by AIG's risk management efforts," A.M. Best & Co. Inc. said in a statement last Thursday.
Another factor may have been lack of regulatory oversight: The derivative business of AIG Financial Products, unlike the operations of the company's insurance units, was not subject to state oversight, and the holding company is overseen by the federal Office of Thrift Supervision.


Bailout drama fuels debate on regulation of insurance explores the implications of the takeover for AIG’s business insurance operations and for insurance regulation in general.

17Carnophile
Edited: Sep 30, 2008, 5:38pm

>14 jmcgarve:
Carnophile, the source you listed does not regulate CDSs.

It does. Look at the second full paragraph, the one beginning “The first guideline published...” If you read a little into that ‘graph, you’ll see “It directs bank examiners to base captial requirements for a credit contract on th credit exopsure of the reference asset.” In other words, the Fed was telling its bank examiners to impose capital requirements on credit derivatives (in particular, as a function of their perceived riskiness).
The next ‘graph talks about about capital requirements on trading account positions, i.e., credit derivatives on banks’ books that they intended to trade, or were willing to trade. And much of the rest of page 9 discusses regulation, principally capital requirements, that apply to CDSs.

As for the passage you quoted, I think the part you particularly were focusing on (correct me if I’m wrong about this) was “...some investors may underestimate risks so that capital costs for firms creating additional contracts are too low...” But that doesn’t refute the fact that capital requirements applied.

As for the rest of that passage, I don’t care to dispute it (right now, anyway) because I was talking about the claim (by Cox, etc.) That CDSs are “unregulated.” I just wanted to lay that one to rest. Whether pricing in these markets is adequately transparent is an entirely different question.

18Carnophile
Edited: Sep 30, 2008, 11:15pm

>15 oregonobsessionz: (short version.)

Oregon, I think you missed my point in the original post 68. My point, responding to inkdrinker at 65, was that trading of mortgage-backed assets, and their growth, long pre-dated the expansion of the CDS market. Also pre-dated the 2000 Act inkdrinker referred to. Ginnie, Freddie and Fanny were in fact created decades before to make a market in mortgage-backed assets, and they succeeded. The credit derivatives markets have only grown large enough to be noteworthy since the early/mid 1990s. (Maybe the mid-1990s is more accurate.) (This is much clearer if you read, not only my post 68 in the “Liberalism” thread, but also inkdrinker’s post 65, to which I was responding - perhaps I should have referenced 65 in the first place.)

What particularly riled me up was this in 65:
"Credit default swaps... have been at the heart of the subprime meltdown because they have enabled large financial institutions to turn risky loans into risky securities that could be packaged and sold to other institutions.—–” More on this in next post.

19Carnophile
Sep 30, 2008, 11:22pm

>15 oregonobsessionz: (long version)

Oregon said:
The article you linked in that other thread was dated August 2003, so the specifics are somewhat out of date. However, it doesn’’t exactly appear to support your position.

First, in terms of the quantity of privately issued pool securities:
In 1983, privately securitized assets totaled less than $4 billion. Then, private issues took off sharply, reaching more than $2 trillion in total assets at the end of 2002 –– a more than 600-fold increase in 19 years...

Oregon, this does support my position in that post, which is that the growth of securitization happened long before credit derivatives became a factor. Specifically, that the mortgage-backed asset markets were growing, and very rapidly, long before CDS were a relevant market development. In particular, I was responding to inkdrinker in post 65 on that thread with this Mother Jones quote:

“Credit default swaps... have been at the heart of the subprime meltdown because they have enabled large financial institutions to turn risky loans into risky securities that could be packaged and sold to other institutions.—–”

This is pure nonsense! “Securities that could be packaged and sold to other institutions” were around for three decades before the 2000 law the MJ piece refers to. The Cleveland Fed piece mentions that Ginnie Mae started this in 1970. And the MBS market was already growing noticeably by the mid-1970s, though it went through ups and downs. At the top of the second page: “Banks began to securitize a large volume of their loan portfolios in response to changing regulations and market forces in the 1980s...” Comfortably before the law inkdrinker was talking about that passed in 2000.

Securitization is used with assets other than mortgages, by the way, but the data for mortgages specifically are in the graph the Cleveland Fed piece, second page. You can see that mortgae-backed securitzation was growing fast long before the 1999 Gramm-Leach-Bliley Act or the 2000 Act the Mother Jones quote mentions.

As far as being out of date, that’s not a factor because my whole point was that these markets started decades before the de-reg inkdrinker cited. Obviously I don’t need a source from 2008 to talk about history.

I know all this “he said this, so I was responding to that” is annoying, but it is much clearer if you read the original thread.

20Carnophile
Edited: Sep 30, 2008, 11:32pm

Then there’s the part about rating agencies, which is interesting but has nothing to do with when the growth of secondary markets for mort-backed assets started (or if it does, help me out here, I don’t see the connection). It gets interesting to me again when you say:

The article continues:
…the bank does not have to hold capital against the loans it originates, only those it actually carries on its balance sheet. So, there is no capital requirement if the bank originates loans and transfers their ownership to a special-purpose entity, effectively removing them from its balance sheet…….regulators allow banks to keep these loans off the balance sheet, reducing the need for additional capital…….

I think you’re confused between mortgage loans, mortgage-backed securities backed by those loans, and credit derivatives, which can be written to insure either morts or mort-backed securities. It is true that banks’ capital requirements don’t apply to loans they’ve sold off. But capital requirements do apply to CDSs banks are involved with, as the Chicago Fed article makes clear.

...A major inhibiting factor was uncertainty about whether securitization was banned by the Glass-Steagall Act’’s prohibition of commercial banks’’ underwriting of corporate securities. This uncertainty was resolved by the Office of the Comptroller of Currency when it decided that banks could sell interests in a pool of loans. A court of appeals upheld that decision in 1985 and ruled that these instruments were not corporate securities but investments in the underlying loans; therefore, Glass-Steagall did not apply. This ruling and the Supreme Court’’s refusal to hear an appeal by the Securities Industry Association opened the floodgates.

This is interesting (seriously), but what does it have to do with credit derivatives? If your point is one about deregulation, note that the fact that the govt allows you to do something at all doesn’t mean it’s not regulated. That was the topic of the foregoing post and the “Liberalism” thread (and the “Unregulated banking” thread for that matter).

21oregonobsessionz
Sep 30, 2008, 11:44pm

>19 Carnophile:

I didn't read all of the posts around the Cleveland Fed article in the other thread. In post #7 above, you were responding to a comment about CDS being unregulated.

22jjwilson61
Sep 30, 2008, 11:47pm

“Credit default swaps... have been at the heart of the subprime meltdown because they have enabled large financial institutions to turn risky loans into risky securities that could be packaged and sold to other institutions.—–”

This is pure nonsense! “Securities that could be packaged and sold to other institutions” were around for three decades before the 2000 law the MJ piece refers to.


Yes but the quote refers specifically to risky loans. Didn't CDS allow risky loans to be turned into securities because before them they were too risky for anyone to touch?

23oregonobsessionz
Edited: Oct 1, 2008, 12:15am

>20 Carnophile:

Agreed, we don't want to have a long exchange of "x said this, so y said that", but it does get hard to follow.

The point of the rating agencies: in #5 I had commented that CDS were "largely unregulated", and that the inability to evaluate the risk of derivative bond portfolios (and therefore to adequately price and reserve the CDS) was a major contributor to the current credit crisis.

Your response in #7 referenced the article from the Cleveland Fed. The author made the point that securitized loans would be subject to conflict of interest (or "moral hazard" if you prefer that term), and that the credit rating agencies had a key role in evaluating the quality of those intruments. These agencies are somewhat reactive, typically downgrading only after some adverse event becomes widely publicized. In the case of the current Wall Street meltdown, the major rating agencies had been gradually downgrading some of the bad debt, but it appears their warnings were ignored until the problem reached crisis stage.

I wasn't disputing when the use of derivatives began; the issue is that the increased use of these instruments made companies more vulnerable when the housing market began to fail. Back in 1983, when CDS represented less than $4 billion, every last one could have failed and the US economy would have shrugged off the impact. Considering that CDS and other derivatives had grown to $2 trillion by the end of 2002, they must have represented a much larger percentage of assets by, say, the end of 2007.

The article I quoted in #16 says that AIG alone was carrying credit derivatives worth $441 billion as of June 30, of which $57.8 billion was subprime CDOs. AIG also had $77.5 billion in RMBS, including $40.2 billion backed by subprime and Alt-A loans. They may have thought this was "easy money"; clearly they did not anticipate the actual failure rate for these derivatives.

24Carnophile
Edited: Oct 1, 2008, 9:49pm

Yes but the quote refers specifically to risky loans.

All loans are risky. I guess they meant to refer to sub-prime loans, but that is a matter of degreee, not kind.
Securitization and credit derivatives are used for many assets of various degrees of risk: Sovereign debt of some nations, various kinds of consumer debt, corporate debt (both bonds and loans), and including so-called “junk bonds” (*), rents due on leases for equipment that businesses rent, etc. Also credit card receivables, iirc. These are all over the risk spectrum.
It is a mystery to me why the mess is concentrated in the mortgage markets.

* “Junk” bonds are themselves a portmanteau category. Not all of them are hair-raisingly risky, but some of them are. And all of them are of a level of riskiness that puts them “below investment grade,” by definition.

Me: Does anyone know of a citation to a reliable and detailed source that establishes that CDSs had something to do with the current mess?

Oregon: Several references, then: Didn't CDS allow risky loans to be turned into securities because before them they were too risky for anyone to touch?

I don’t know. That’s why I asked; I was hoping someone would have some sources on that. It looks like you found some and I’m looking forward to digging into them.

25Carnophile
Edited: Oct 1, 2008, 9:52pm

Meanwhile, a certain other playa deliberately forced lenders to make exceptionally risky loans.

Hat tip to Lunar for the link.

26oregonobsessionz
Oct 1, 2008, 10:46pm

Thomas Frank at the Wall Street Journal sees it differently: The GOP Blames the Victim; Capitalism sure is fragile if subprime borrowers can ruin it.

27jmcgarve
Oct 1, 2008, 11:03pm

>25 Carnophile: Purest nonsense. It was the idea of the originating banks to make the loans. Yes, there were activists that fought against redlining, which was and is a racist practice, but there is no evidence at allthat the reason for the collapse of the mortgage market was lending to minorities. If you know any real statistic on that Carnophile, point to it. Otherwise it should be dismissed as so much racist slander. We know where the neighborhoods where the massive foreclosures and defaults are. They aren't the neighborhoods that ever were redlined. They are middle class neighborhoods with plenty of white middle class people defaulting.

There's no secret here. The mortgage companies didn't even risk the money, so they didn't care about the documentation borrowers provided. The banks bet that the price of homes would continue to rise, so that defaults wouldn't matter -- the homes could be resold. Greenspan bet that the sales did not have to be regulated, because the end would come smoothly. Congress bet that Fannie Mae should keep buying loans with minimal capitalization, because the builders and realtors (and Freddie and Fannie) wanted to keep building, and because it was the only section of the economy that was growing at a healthy rate other than military procurement, so to turn off the tap would make the sluggish economy even worse. Homeowners bet that they could pay their credit cards off with their home equity, and some banks let them take it down to 0. Flippers bet that the price of homes would continue to rise so they could make a lot of money with small down payments.

All that needed to happen for this Ponzi scheme to fail was for housing prices to fall, which was going to happen sooner or later, and a lot of people knew it.

Blame it on ACORN, eh? Maybe it was sunspots.

28maggie1944
Oct 1, 2008, 11:28pm

Thank you for your comment, jmcgarve, I too was very disturbed to hear so called experts blaming ACORN for this whole mess. I do not believe "liars loans" were popular in minority, previously red-lined, neighborhoods. And if people with low to moderate incomes were sold mortgages with unrealistic escalator clauses, I think the seller is to blame as much as the buyer. This blame the victim mentality is very distasteful and gives capitalism the bad reputation it deserves.

29vq5p9
Oct 1, 2008, 11:43pm

Thing is, it isn't capitalism if they aren't aloud to crash.

30maggie1944
Oct 1, 2008, 11:49pm

And how much noise do we expect?

31oregonobsessionz
Edited: Oct 2, 2008, 6:20am

Aaron Pressman in Business Week: Community Reinvestment Act had nothing to do with subprime crisis.

The source material for that article is this interesting study from January 2008: The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis .

The authors found that loans issued under the Community Reinvestment Act (CRA) represented 22.8% of all loans, but only 9.2% of high cost loans (see report for breakdown by city).

Low and moderate income (LMI) borrowers were issued 22.7% of all loans, but only 11.1% of CRA loans.

CRA banks retained 36.2% of all loans, and 41.7% of loans to LMI borrowers, in their portfolios. These retention rates are approximately double the retention rates for non-CRA banks.

32Carnophile
Oct 2, 2008, 7:54am

jmc - I am going to try to remain calm in the face of this:
"If you know any real statistic on that Carnophile, point to it. Otherwise it should be dismissed as so much racist slander."

I'm not impressed. The part that matters is the forcing of lenders to make loans to borrowers who were riskier than were traditionally accepted. Whether those borrowers were minorities or not is completely irrelevant. This is obvious from reading the article. Race is brought into this only because it was part of the motivation for the policies that were implemented.

So if you meant to call me racist, go to hell. If you were referring to the author of that article, then take it up with him.

I am really restraining myself from saying what I want to say, here. I find this topic interesting and am trying hard, not to have it degenerate into a typical Pro & Con bitchfest. You do your part too, mmm'kay?

As for all the posts on that matter, I'll respond after work as usual, but a brief point before I go: This is not the first I've heard of that Boston Fed study. It has been notorious, at least in my mind, for years, long before the current mess, for the way it was abused in order to advance a pre-determined agenda.

33geneg
Oct 2, 2008, 8:51am

This is another familiar Republican tactic, blame the victim. It's easy, cheap, and increases their prideful self-righteousness in their own eyes. Besides, the self acknowledged masters don't have the balls to look a problem in the face and say, "I did that". They're either too arrogant, or too chicken sh%t to recognize that their vaunted ideology is wrong and harmful. (As are ALL ideologies when slavishly followed.) I sure would like to know who was getting the blame for the crash of '29. Probably those buying on margin, rather than those gleefully selling on margin.

Gosh, it's too bad we didn't tie social security to the stock market. An infusion of capital like that probably would have staved this off another, oh, say, thirty years, right before the market based social security retirement would start paying benefits.

For all you Republicans out there this is exactly why social security is NOT market based. I paid a ton of money into it when I was working and I expect something back.

Of course a $10,000,000,000,000 war being fought off book didn't have anything to do with this either, right? As Ronald Reagan proved, deficits don't matter.

Republicans have been blaming victims as long as their policies have been creating them.

34jmcgarve
Edited: Oct 2, 2008, 9:33pm

>32 Carnophile: I appreciate your calm. But, the narrative, the meme, is a racist one, because it blames lending to minorities, which is a story unsupported by any facts. You did not originate this meme -- it has been circulating on the rabid right for some time -- but before passing it on, it might pay to check it out. The narrative, as very plainly described in the NY Post article, is that banks were forced to lower their standards to make these loans, under the terms of the community reinvestment act. Here is disproof:

http://www.house.gov/apps/list/hearing/financialsvcs_dem/barr021308.pdf

The paper points out that:

(a) 50% of subprime loans are made by institutions that are not subject to CRA oversight; and
(b) 30% of subprime loans were from affiliates of banks and thrifts, which are only infrequently subject to CRA oversight.

That leaves 20% of the subprime mortgages that were issued by the banks and thrifts themselves, the only segment that could be in any way attributed to the CRA. Moreover, CRA supervised loans were made at lower rates and under more sustainable terms. We may surmise that as a result, default rates are in fact lower for CRA supervised loans than for the subprime market generally. This hypothesis is confirmed by the Trager-Hinckley study that Maggie44 posted above. A number of studies have also pointed out the association between predatory lending and subprime loans. Most of these find that about 1/3 of subprime loans are made to individuals that qualify for conventional loans -- but the lenders press for subprime terms, because they give higher rates of interest. Predatory lending is very common in minority communities, but also among the elderly.

We can also look at who gets subprime loans:

http://www.federalreserve.gov/boarddocs/speeches/2004/20040521/default.htm

Characteristic Subprime share of number of
home purchase loans Subprime share of number of
home equity loans
Borrower income

Lower 10.9 14.4
Middle 11.2 10.5
Higher 9.0 6.7

(OK, the columns didn't come out right. On the right side is income range. In the middle is the percent of mortgages for this group that were subprime. On the right is the percentage of home equity loans for this group that were subprime.)

I did not copy the whole chart, which is in the reference. We do see that minorities are disproportionately represented. But one can also see that subprime loans were roughly the same percentage of total loans for lower, middle, and upper income individuals. Many of the subprime loans did go to people trying to buy McMansions when their income would not afford it, or speculating that the price would go up and they could either sell or refinance and make a profit. Quite a few of the defaults so far have apparently involved occupancy fraud -- where the purchaser never lives in the home, but buys it as a speculator. But another study found that in 80% of the cases involving fraud, the issuer of the mortgage was a participant in the fraud.

So, we have to try to base our judgments on the facts, on real data.

An excellent explanation of the crisis is here: http://www.businesspundit.com/sub-prime/

I'd also like to cite this splendid example of a racist explanation for banking problems:

http://www.salon.com/opinion/greenwald/2008/09/26/national_review/

35Carnophile
Oct 3, 2008, 12:09am

I don’t know about the extent to which the Community Reinvestment Act or this “ACORN” group mattered; but the government regulators certainly mattered. From Liebowitz’s article:

...the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: “discrimination may be observed when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.”
Some of these “outdated” criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification...
Those “outdated” standards existed to limit defaults. But bank regulators required the loosened underwriting standards...
Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department.

Now we’re told by the furrowed-brow set that lending to people who didn’t have sufficient income, etc., is an unscrupulous practice and the principal cause of the curent mess. Well, is it or isn’t it?
I am not asserting that every single instance of risky lending was required by the Fed’s regulators. But some of it plainly was.

Liebowitz continues:
Flexible lending programs expanded even though they had higher default rates than loans with traditional standards. On the Web, you can still find CRA loans available via ACORN with “100 percent financing . . . no credit scores . . . undocumented income . . . even if you don’t report it on your tax returns.” Now oregon and jmc are claiming that Community Reinvestment Act loans don’t have troublesome default rates.

I don’t know if that’s true, but if it is it completely destroys the entire left-wing narrative about this crisis. So lending to people with no income verification ISN’T a high-risk practice: It doesn’t lead to higher default rates. It’s not “predatory lending.” Lending to people with income too low for the loan (by traditional standards) ISN’T a high-risk practice. Et cetera, et cetera. This substantially discredits the left liberal model of the current mess.

36Carnophile
Edited: Oct 3, 2008, 12:17am

A very good article in, of all places, the Village Voice:
http://www.villagevoice.com/2008-08-05/news/how-andrew-cuomo-gave-birth-to-the-c...

QUOTE OF ARTICLE STARTS

Andrew Cuomo, the youngest Housing and Urban Development secretary in history, made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis. He took actions that——in combination with many other factors——helped plunge Fannie and Freddie into the subprime markets without putting in place the means to monitor their increasingly risky investments...

In 2000, Cuomo required a quantum leap in the number of affordable, low-to-moderate-income loans that the two mortgage banks - known collectively as Government Sponsored Enterprises - would have to buy. The GSEs don't actually sell mortgages to borrowers. They buy them from banks and mortgage companies, allowing lenders to replenish their capital and make more loans. They also purchase mortgage-backed securities, which are pools of mortgages regularly acquired by the GSEs from investment firms. The government chartered these banks to pump money into the mortgage market... The 1992 law required HUD's secretary to make sure housing goals were being met and, every four years, set new goals for Fannie and Freddie.

Cuomo's predecessor, Henry Cisneros, did that for the first time in December 1995, taking a cautious approach and moving the GSEs toward a requirement that 42 percent of their mortgages serve low- and moderate-income families. Cuomo raised that number to 50 percent and dramatically hiked GSE mandates to buy mortgages in underserved neighborhoods and for the "very-low-income."...

Franklin Raines, the Fannie chairman...warned that Cuomo's rules were moving Fannie into risky territory: "We have not been a major presence in the subprime market," he said, "but you can bet that under these goals, we will be."...

Moody's didn't sound an immediate alarm, but its senior analyst, Stanislas Rouyer, said the expansion into subprime loans and the lower level of documentation that came with them could mean that Fannie 's loss levels would increase in the future. Steven Holmes, a reporter from the Times's Washington bureau, wrote at the time: "In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk,

After this initial uptick, the two banks purchased $434 billion in securities backed by subprime loans between 2004 and 2006. The Washington Post noted this June that the GSEs' aggressive acquisitions "created a market for more such lending" by others, feeding the fire...

QUOTE OF ARTICLE ENDS

Now I think I know what Oregon would say about this: CRA loans in at least some cities had lower rates of securitization than non-CRA loans. But that would be a red herring. The point is, the government-sponsored enterprises expanded the securitized mortgage markets (CRA or not), including in the more risky end of those markets.

37codyed
Edited: Oct 3, 2008, 2:26pm

When you lower loan standards to allow for more minority representation, you allow individuals from all income levels and all ethnic groups to partake in the fun.

There's nothing racist in pointing out that giving loans to minorities (non-Asian minorities) tends to be a very risky affair. If that upsets your sensibilities, then you should gracefully exit the reality based community because reality is obviously having a deleterious effect on your mental faculties.

Here's a New York Times article from 1999 detailing how credit standards were loosened to accommodate minorities with bad credit.

The New York Times: Racist.

Carnophile, don't sweat it. If you are called a racist by a liberal, all that means is that you are winning the argument. If a liberal had good arguments to put forward, then there would be no need for him to call you a racist. But since calling someone a racist these days is an effective way to end a conversation, the liberal will often prefer to resort to name calling than engage in civil discourse, no matter how discomforting he may find the topic.

38geneg
Oct 3, 2008, 11:46am

Does anyone have any real statistics on the nature of the default problem? I think moving the conversation into cody's real world and out of what we hope the situation is based on our prejudices and predispositions would be a helpful move.

39Carnophile
Edited: Oct 4, 2008, 3:27pm

Stan J. Liebowitz has an amazing piece called Anatomy of a Train Wreck: Causes of the Mortgage Meltdown. It responds to most of the factual assertions in the two pieces that Oregon posted a few posts above. It is a chapter in a forthcoming book, but available in its entirety on Liebowitz's web site http://www.utdallas.edu/~liebowit/. Note: I have had spotty luck opening this web site with MS Explorer, but no problem with Firefox.

EDIT: An alternative url: http://wwwpub.utdallas.edu/~liebowit/

It doesn't just establish that the Federales were pushing, fangs bared, for lower lending standards. It also discusses some of the claims like default rates being okay for CRA loans. CRA, by the way, was just one part of a very large and pervasive change in policy that happened years ago.

Why this matters: If you type in a Google search along the lines of "Community Reinvestment Act", bailout, you'll get many hits to the effect of "CRA didn't cause the mess." My impression after skimming half the Liebowitz piece is that he kicks the crap out of these assertions, partly by refuting them, but partly also because he establishes that CRA by itself was only part of the overall enormous problem.

There are also two pieces in Economic Inquiry, a peer-reviewed Economics journal, from January 1998 about this. In retrospect some of the warnings therein are prescient indeed. One of them is by Liebowitz and Day; the other is by someone else. You might be able to access these if you connect to the Net from a subscribing academic institution. Otherwise you can get them from interlibrary loan I imagine. EDIT: The Day-Liebowitz paper from Econ. Inq. is also available at Liebowitz's web site. I have skimmed one of them and am going to read both some time this weekend.

40Carnophile
Oct 4, 2008, 8:59am

Gene, maggie - Who's blaming the victim? The article I cited blames the government.
Oh yeah, and "community activists."

41Carnophile
Oct 4, 2008, 9:43am

Blame it on ACORN, eh? Maybe it was sunspots.

Maybe it was!

There's a huge literature on "sunspot equilibria," some of it involving asset bubbles.

Note to the humor-impaired: No, this doesn't have anything to do with solar activity.

42Carnophile
Edited: Oct 4, 2008, 10:02am

A key paragraph from the Gramlich piece:

This evolutionary process was pushed along by various federal actions. The Community Reinvestment Act (CRA) of 1977, and later revisions to the regulation (federal laws), gave banking institutions a strong incentive to make loans to low- and moderate-income borrowers or areas, an unknown but possibly significant portion of which were subprime loans. The Federal Housing Administration (a federal gov't entity), which guarantees mortgage loans of many first-time borrowers, liberalized its rules for guaranteeing mortgages, increasing competition in the market and lowering interest rates faced by some subprime mortgage borrowers. Fannie Mae and Freddie Mac (originally government-created entities, and still government-sponsored entities), giant secondary market purchasers, sought to meet their federally mandated affordable housing goals by expanding into the prime and lower-risk segment of the subprime mortgage market. They now provide many direct mortgage lenders with other potential buyers for their subprime mortgages. Fannie and Freddie are both working on techniques to extend automated underwriting to the subprime market, an innovation that should further lower costs in this market.

The entire passage is relevant. The bold passage (my emphasis) speaks to the role of the secondary market for mortgages, which was - deliberately - expanded by federal gov't policies. I emphasized this part because Oregon has - quite correctly - mentioned that there is a moral hazard problem with underwriting standards when the loan will fly off the books soon after it is made.

43maggie1944
Oct 4, 2008, 10:19am

I am wading in over my head here but I think a major problem is the selling off of mortgages onto the secondary market; and the bundling of mortgages into packages no one can trace. I am hearing of people "in trouble" paying their mortgage who can not find any financial institution with whom they can discuss alternatives. There is no path to follow. Here's why I think "blaming the victim" is one of the major problems in analyses of the problems.

44Carnophile
Oct 4, 2008, 3:15pm

An appetizer.

My oh my. I had a bad image of the Boston Fed study in my head, but even I hadn't realized how bad it was.

Text: Liebowitz’s chapter "Anatomy of a Train Wreck: Causes of the Mortgage Meltdown," for a book that’s coming out in 2009, Housing America: Building out of a Crisis, eds. Benjamin Powell and Randall Holcomb. Page numbers cited herein are for the version of the chapter that was posted on Liebowitz’s web site.

P. 6 - 7: A description of the horribly mangled data that Liebowitz and a co-author found was used in the notorious Boston Fed study, which allegedly found rampant racial discrimination by lenders. (The study also used bad econometric practice, as another paper in Economic Inquiry Jan 1998 showed):

“A quick summary of the data problems: a) the loan data...had information which implied, if it were to be believed, that hundreds of loans had interest rates that were much too high or much too low...about fifty loans had negative interest rates according to the data; b) over 500 applications could not be matched to the original HMDA data upon which the Boston Fed data was supposedly based; c) 44 loans were supposedly rejected by the lender but then sold in the secondary market which, of course, is impossible; d) two separate measure of income differed by over 50% for over 50 observations; e) over 500 loans that should have needed mortgage insurance to be approved were approved even though there was no record of mortgage insurance; e) several mortgages were supposedly approved to individuals with net worth in the negative millions of dollars.
When we attempted to conduct the statistical analysis removing the impact of these obvious data errors we found that the evidence of discrimination vanished.”

Altogether this screams “Deliberate data falsification!” (Hell, item b) alone screams that.) It is really hard to believe that it could be caused only by extreme sloppiness. When your best-case scenario is extreme sloppiness, you’re in trouble indeed.

45Carnophile
Oct 4, 2008, 3:31pm

>43 maggie1944:
...I think a major problem is the selling off of mortgages onto the secondary market...

I'll refer you to post 42.

46Jesse_wiedinmyer
Edited: Oct 4, 2008, 4:46pm

Altogether this screams “Deliberate data falsification!” (Hell, item b) alone screams that.) It is really hard to believe that it could be caused only by extreme sloppiness. When your best-case scenario is extreme sloppiness, you’re in trouble indeed.

Kind of like Carter's assertion that Bush's handling of Iraq was either incompetence or dishonesty, no? One way or the other, I'm pretty sure I don't want to eat at that buffet.

47jmcgarve
Oct 5, 2008, 12:09am

There are two separate claims getting conflated here.

Claim 1: That the government and various politicians aided and abetted the banks, who wanted to issue loans to people whose ability to pay was in doubt, and who especially wanted to issue subprime loans because of their high rate of return. The government and politicians did this by minimizing regulatory oversight, especially of Fannie and Freddie, who were encouraged to repurchase dubious mortgages and to have inadequate capitalization.

Claim 2: That the government, especially via the Community Reinvestment Act, compelled the banks to make loans they did not want to make, to borrowers of doubtful ability to repay.

There is plenty of evidence for claim 1. I see no evidence whatsoever for claim 2, in any of the foregoing. The banks actively pursued these mortgages, especially subprime mortgages. I think that the appropriate role for government is to ensure, via regulatory oversight, that financial institutions follow sustainable policies. They did not do this. Conservatives opposed such regulations because they thought, and perhaps still think, that they are unnecessary and only cause harm. Some liberals opposed strong oversight of Fannie and Freddie because they viewed the growth in home ownership as a good thing, especially when it extended to minorities. Politicians of all stripes opposed lending regulations because of lobbying by developers, construction companies, realtors, and financial institutions, including Fannie and Freddie. So there is plenty of blame to go around.

But there is still no evidence at all for claim 2, and plenty of evidence, already cited, that it is false.

48Carnophile
Oct 5, 2008, 9:03am

"I see no evidence whatsoever for claim 2..."

I haven't gotten to much of the good stuff yet, although you can see post 42 for an hors deouvre (sp?) if you're peckish.

"But there is still no evidence at all for claim 2, and plenty of evidence, already cited, that it is false."

?
I'm not sure what you mean here, but never mind. There will be more coming along, with juicy, specific quotes from regulators themselves, in the near future.

49geneg
Oct 5, 2008, 10:47am

Where can I get one of those negative interest rate loans?

50Carnophile
Oct 5, 2008, 11:32am

Give Hank "Moneybags" Paulson a call... if you happen to run a large financial institution.

51Carnophile
Edited: Oct 5, 2008, 11:42am

From Liebowitz’s “Anatomy of a Train Wreck”:

Page 2: “After the government succeded in weakening underwritng standards, mortgages seemed to require virtually no down payment...few restrictions on the size of monthly payment relative to income, little examination of credit scores, little examination of employment history, and so forth. This was exactly the government’s goal.” Liebowitz provides the detailed specifics of this last assertion later in the chapter.

P. 4 - 5: A description of some ways the federal government has tried to increase home ownership.

P. 8 et seq.: The Boston Fed, shortly after its outrageously dishonest (there’s no other way of putting it) study, published a manual to er, help lenders comply with regulators’ desire for more loans to certain groups (it’s not just a matter of the CRA, which many liberals are straining to exonerate). Liebowitz quotes the Fed document, “Closing the Gap: A Guide to Equal Opportunity Lending,” April 1993. Before disbursing its advice, it made sure lenders knew why should care what it thought:

“Did You Know? Failure to comply with the Equal Credit Opportunity Act or Regulation B (see; Oregon, jmc; it’s not just the CRA(*)) can subject a financial institution to civil liability for actual and punitive damages in individual or class actions. Liability for punitive damages can be as much as $10,000 in individual actions and the lesser of $50,000 or 1 percent of the creditor’s net worth in class actions.”

There are other penalties too, by the way, such as refusing a request for a merger.

*Reg B stated the Fed’s specific policies for its interpretation and implementation of the ECOA. The ECOA was about non-discrimination on the basis of race, marital status, etc. The Fed basically interpreted any disparate result as discrimination. E.g., if minorities or single mothers or whomever couldn’t make a downpayment, then downpayments were essentially interpreted as ipso facto discrimination.

After showing some fang to get lenders’ attention, the document laid out what was acceptable and what wasn’t:

“In reviewing past credit problems, lenders should be willing to consider extenuating circumstances. For lower-income applicants in particular, unforseen expenses can have a disproportionate effect on an otherwise positive credit record.”

Well, of course! That’s why one wants to be careful about lending to lower-income applicants! The document continues:

“In these instances, paying off past bad debts or establishing a regular payment schedule with creditors may demonstrate a willingness and ability to resolve debts.”

Lord, this is priceless. I.e., they defaulted in the past, but that’s okay because they eventually paid it back...late. For you finance whizzes, the delay of the payments reduces the present discounted value of the payment stream, i.e., time is money. Even more amazing is “establishing a regular payment schedule with creditors...” That means they defaulted, can’t make the payments they originally contracted to make, and now have re-organized with the creditor to make smaller payments over a larger period of time. That reduces the value of the loan to the lender: If that’s what the lender wanted, that’s what the lender would have contracted for in the first place.

More:

“Successful participation in credit counseling or buyer education programs is another way that applicants can demonstrate an ability to manage their debts responsibly.”

Hey, I have inadequate income and no down payment. But that’s okay! I took a class!
How does taking a class provide an adequate income or a down payment? Boston Fed (meaningfully tapping its sidearm, i.e., power to fine you, oust managers from the bank, etc.): “Don’t you think that is kind of an impolite question? Why don’t you step out into the back alley with Auditors Rocco and Twitchy and they’ll explain the benefits of a more...mellow...approach to lending standards.”

Liebowitz remarks (p.9-10) “There is no evidence whatsoever that ‘credit counseling’ helps applicants avoid mortgage defaults,” and cites a paper on that topic.

52Carnophile
Oct 5, 2008, 11:46am

Rocco's bad, but Twitchy's worse.That guy will deliberately "confuse" your accounts receivable with your accounts payable. Bad to the bone, he is.

This is the patented Carnophile humor to lighten the mood before we proceed, folks. You only get the A-list material here on LibraryThing.

Shall we continue?

53Carnophile
Edited: Oct 5, 2008, 11:56am

The Fed:
“Obligation Ratios: Special consideration could be given to applicants with relatively high obligation ratios who have demonstrated an ability to cover high housing expenses in the past. Many lower–income households are accustomed to allocating a large percentage of their income toward rent. While it is important to ensure that the borrower is not assuming an unreasonable level of debt, it should be noted that the secondary market is willing to consider ratios above the standard 28/36.”

Liebowitz comments:
“Again, the first sentence seems reasonable enough. But then the tone shifts and it suggests that many lower-income households can handle high obligation ratios, not just those applicants who have demonstrated an ability to handle high housing expenses in the past... The secondary market obliquely referred to in the last sentence of the quote is basically Fannie Mae (my emphasis. - C.) and it was willing to stretch the obligation ratios since it was an enthusiastic advocate of relaxed lending standards.”

The Fed:
“Down Payment and Closing Costs: Accumulating enough savings to cover the various costs associated with a mortgage loan is often a significant barrier to homeownership by lower–income applicants. Lenders may wish to allow gifts, grants, or loans from relatives, nonprofit organizations, or municipal agencies to cover part of these costs. Cash–on–hand could also be an acceptable means of payment if borrowers can document its source and demonstrate that they normally pay their bills in cash.”

Liebowitz:
“This quote mixes legitimate and illegitimate sources of extra income in a dangerous way. Cash and gifts from relatives seem unobjectionable. But what this paragraph opens the door to is the ‘gift’ from a builder wishing to sell his housing. Since these guidelines went into effect it has become commonplace for builders of low income homes to ‘gift’ the downpayment to the mortgage applicant... the price of the home is raised by an amount equal to the cash gift...”

Actually, my understanding is that it’s even worse than Liebowitz thinks. When my wife and I bought a house a few years ago, the lender told us one reason the down payment was desirable is that it makes the borrower feel invested in the purchase, which makes them less willing to “walk away” from the mortgage. For this reason our ability to use a gift as part of the down payment was specifically prohibited or at least limited. And of course we weren’t allowed to borrow it. (The “relaxed lending standards” didn’t apply to us because our credit score and income were high enough that it wasn’t an issue.) That is, allowing gifts and loans for the down payment destroys one of the main reasons for the down payment!

54Carnophile
Oct 5, 2008, 12:00pm

The Fed:
“Sources of Income: In addition to primary employment income, Fannie Mae and Freddie Mac will accept the following as valid income sources: overtime and part–time work, second jobs (including seasonal work), retirement and Social Security income, alimony, child support, Veterans Administration (VA) benefits, welfare payments, and unemployment benefits.”

Liebowitz:
“As with the other proposals, this one is a mixture of the reasonable and the outrageous. Second jobs, for example, can be held indefinitely and thus are reasonable sources of income. Unemployment benefits, on the other hand, are time limited and it is a mistake to include temporary sources of income when the mortgage is not temporary. The fact that Fannie Mae and Freddie Mac accept these sources says more about these agencies’ attempts to water down underwriting standards than it does to prove that such watered down standards make sense.”

Fannie Mae wrote an approving report on Countrywide, one of the lenders who participated in “innovative lending standards” most, um, energetically. Fannie Mae:

“When necessary—in cases where applicants have no established credit history, for example—Countrywide uses nontraditional credit, a practice now accepted by the GSEs.

(Emphasis added.) GSEs means “Government-Sponsored Enterprises,” which means Fannie, Freddie, and/or Ginnie.

55Carnophile
Oct 5, 2008, 12:04pm

What about lenders who made moronic loans even though they weren’t directly covered by the CRA? This is getting long, so I’ll just suggest reading page 13 of the Liebowitz piece. I can’t resist this snippet, though:

“...if it is understood how universal the idea of ‘flexible underwriting standards’ had become, how dangerous it was to suggest anything else (and risk being labeled a racist) (Ahem.)... it becomes possible to understand... To understand this it is useful to examine the sales pitches that were made. I was able to find a 1998 sales pitch from Bear Stearns, a major underwriter of mortgage backed securities, for loans banks undertook to fulfill their CRA obligations... this sales pitch for loans based on relaxed lending standards generally follows the script laid out by the Boston Fed and followed by the entire regulatory apparatus surrounding the housing industry.”

What about the rating agencies? Government played a role there, too; see Liebowitz’s first (non-quoted) paragraph on page 15.

For the next few pages Liebowitz quotes a Bear Stearns document boasting of its relaxed lending standards. Bear Stearns is was a private organization of course, but was only saying what the entire federal gov’t apparatus - Rocco, Twitchy, Freddie, Fannie, Ginnie, the Fed, the CRA, the EOC, Regulation B, etc., etc. - basically the entire federal government - were ordering them to say.

56Carnophile
Oct 5, 2008, 12:09pm

This is getting long. I have another page plus of material, but I suggest reading Liebowitz's piece. To read it is to be convinced that the government either single-handedly caused this bubble or badly exacerbated it.

57jmcgarve
Oct 5, 2008, 9:59pm

>56 Carnophile: The government badly exacerbated the bubble. The decline in underwriting standards, promoted by the government, is a big reason for the failure. The government certainly did not cause the bubble, at least not by itself. There are plenty of villains in this story, and the banks were very active participants.

The banks far exceeded any government recommendation for relaxed mortgage standards, as shown by the very high percent of "liar loans", i.e. loans on which the mortgage issuer did not require documentation of employment or any other evidence of creditworthiness. We also see that a majority of the subprime loans, and in fact the vast majority of the defaulting loans, were issued by institutions not under the supervision of the CRA. (These facts disprove claim 2 above.) We see the very active participation of investment banks -- see the many references to Bear Stearns in the Liebowicz article -- including a recommendation by Bear Stearns that the banks not hold capital to cover default. We also see the very active participation of the bond rating agencies.

We do not see any institution being pressured to issue loans they did not want to issue as being in any way a source of the problem. The banks were all in on it, and the officers of the banks earned very high salaries for participating.

There are several reasons why the government failed to regulate and also abrogated any oversight of lending. I cited these in a separate post ... but to those reasons we must add the neoliberal, pro-financier attitudes of Clinton treasury secretary Robert Rubin and others in the Clinton administration. "Neoliberal" in this case, really means laissez faire, classical economic liberalism, rather than supportive of regulation, which is a legacy of the American progressive movement of the early 1900s and also of the New Deal.

It worries me that Obama is still turning to Rubin as well as other economists of a neoliberal bent, notably Austan Goolsbee. We need New Deal economists in charge now, and we need them badly. Obama does have some New Deal style economists also advising him: Bernstein, James Galbraith ... but the real direction is not clear.

58oregonobsessionz
Oct 6, 2008, 12:55am

Certainly the explosion in subprime loans contributed to the current financial crisis. However, a few things are being overlooked here:
1) Subprime loans were not exclusively a minority or low income problem. Many non-minority buyers were using low down payment loans, adjustables, 125% loans, and other nonstandard types of loans to buy houses they could not afford once the interest rates adjusted.
2) The practice of packaging these loans and selling them off allowed the lenders to reduce the reserves that should have provided a safety valve when loans began to fail.
3) Many of the secondary markets thought they were hedging their risk by purchasing CDOs. In reality, some financial institutions found themselves with obligations on both sides of bad loan portfolios.

Here is a layman's explanation of some of the complexities, from a surprising source. This American Life usually focuses on the oddities of life, but this is their second program on the financial crisis.

59geneg
Oct 7, 2008, 7:47pm

For all of you who poo-poo'ed my assertion that oil prices were a function of speculation, it sure is interesting how their tumble seems to correlate to the current banking crisis.

Or have we what, increased production by 50% over the last two weeks?

60Amtep
Oct 7, 2008, 8:03pm

I don't see how speculators can affect the price of oil unless they're buying and holding it and keeping it off the market. Where are their vast stockpiles of oil?

I suspect that the 'speculators' were simply businesses stocking up for the coming year, who all figured they'd buy now rather than later. Now they're expecting a slowdown of the economy so they figure their current stocks will be sufficient.

Even small changes in supply and demand will have a big effect on the oil price. It doesn't take anywhere near a 50% shift.

61Carnophile
Oct 7, 2008, 8:49pm

>57 jmcgarve:, 58
I have made most of the points I wanted to make and we are just going in circles now. I will see you crazy kids on another thread.

However, I asked a question about credit derivatives and we got sidetracked from that after Oregon posted some material pertaining to them. I haven't gone back to that material, but a thought:
Credit derivatives - like securitization, by the way - are used in many markets, not just the mortgage-related markets. This point makes me sceptical that credit derivs played an essential role in the current meltdown. As to whether they played any role at all, I think the facts about AIG that Oregon pointed to speak eloquently on that. But they can't be the essence of the problem, or every other market that uses them (lots) would have gone through problems similar to what hit the mortgage-related markets.

Addendum: Of course, lots of financial markets are experiencing a rough ride now, but that's because the problems bled from the mortgage-related markets into other areas.

62jmcgarve
Oct 8, 2008, 12:44am

>59 geneg:, 60 On the falling price of oil: I think it is caused by:

(1) Falling world demand as the recession hits (biggest factor) and as high gas prices make people conserve more
(2) Some small fields in India and China coming online, so that they import less
(3) Some gulf refineries were offline for a while because of Hurricane Ike, so they couldn't use the oil
(4) Iraq is pumping more
(5) People properly inflating their tires
(6) I always suspect that the Saudis increase production at election time because they think it helps the Republicans. This suspicion is not based on any real evidence.

As Amtep points out, small changes in supply vs. demand can have big effects on price, because the supply and demand curves are inelastic, at least in the short term. People can't easily stop using oie, and it's hard to find more.

>61 Carnophile: Credit derivatives are widely used, but bankers don't make big bets on them, except for mortgage backed securities. We have seen a few rogue traders who caused banks to fail by making long bets on hedge funds, but this was contrary to bank policies. On the other hand, all these financiers thought the mortgage backed securities were safe and stable, because (a) home prices only go up, and (b) the bond rating agencies said so.

That said, I think financial markets were way overstretched and undercapitalized anyway. A few lending defaults to developing countries or a bad recession would probably have tipped the house of cards over too.

63Carnophile
Edited: Oct 9, 2008, 1:13pm

>62 jmcgarve:

At the Federal Reserve Board, Michael S. Gibson has some interesting things to say. This was eventually published in the Atlanta Fed’s Economic Review in 2007, but I’ll use the online version to facilitate discussion here. Gibson page 6-7 of the online version:

“Non-agency residential mortgage backed securities (RMBS) have been a rapidly growing market for securities underwriting in recent years. In 2006, $574 billion of securities were underwritten and issued in this segment... Beginning in mid-2004, dealers began to trade credit default swaps on asset-backed securities (referred to as ABS CDS). By mid-2006, industry estimates put the size of the ABS CDS market at more than $125 billion in notional amount outstanding and growing rapidly.”

Gibson remarks in a footnote that mortgage-related assets aren’t even all of the ABS CDS class of credit derivs, although they’re most of it. So the actual figure is even smaller. So for 2006, the figure for mortgage-related credit derivatives is something less than 574 + 125 = 699 billion, comfortably less than $1 trillion.

Now after this period (i.e., mid 2006) the growth of this market continued, but the seeds were planted at this time and earlier. In other words, the defaults that are happening now aren’t mortgages that were made last month, but that were made in the last few years. Indeed, some people were already starting to worry about the mortgage markets in 2006.

Now if you hunt about on the Net you will see estimates of all credit derivatives - not just those pertaining to mortgages - ranging from $40 trillion to $100 trillion. So most of them are not-mortgage-related. If we accept the lower figure of $40 trillion it’s 0.699/40 = 1.7% of all credit derivs, and if we accept the upper figure of $100 trillion it’s rather less than 1%. These reflections strengthen my skepticism that credit derivatives are the essence of the problem here. Most credit derivatives are not written on mortgages. Why haven’t the other assets with credit derivs written on them experienced similar problems? Why haven’t the 98+% of all other credit derivatives led to massive problems in their markets, e.g., the sovereign debt and corporate debt markets?
Now this 1% figure seems surprisingly small to me - I like to get figures from at least two sources when possible, and I haven’t done that (yet). But even if it’s five times that large, say 5%, then the question is still, why haven’t the 95% of these derivatives in other markets led to problems similar to the mortgage meltdown?
Credit derivs may have played some kind of role - they may have been a shock propagation mechanism, for example - but that doesn’t explain why the shock occurred in the first place.

64eromsted
Oct 9, 2008, 4:27pm

In an article on the problems at Fannie and Freddie the NYT published a graphic on the rise of the mortgage securities market. The rise in investment after 2000 is simply extraordinary. It is this great flow of money that I think needs to be explained if we are to understand the current crisis, and yet it was left unmentioned in the article, and is rarely mentioned anywhere else.

As to Fannie and Freddie, I do tend to think that government secured home loans are rather bad way to invest in affordable housing and it is clear that the F&F managers were playing fast and loose with the books. But in general, I suspect their problems were more a result of the crazy influx of capital into the housing market than then the cause.

As the housing market bubbled F&F's charter of backing loans to low-income home-buyers became inherently more risky. On top of that, the extra private dollars gave primary lenders, like Countrywide, an additional market for their better loans and created an incentive to push the riskier loans onto the government-backed creditors (which apparently they did).

Community groups like ACORN and certain Democrats may have been pushing for banks to stop racial red-lining and to make more loans to low-income minorities, but these efforts, and the few legislative successes like the CRA have been around since the 1970s. No new action on this front times with the explosion in housing market investment after 2000. It makes far more sense to see the rash of risky loans as an attempt by the banks to find somewhere to put all of the money that was poring in, and all the complex financial instruments as a way to cover their asses.

65Carnophile
Edited: Oct 9, 2008, 6:13pm

There was a big push by regulators and the GSEs for lowered lending standards years after the 1970s, in the 1990s and early 2000s. See the Liebowitz piece linked in post 39 above.

66jjwilson61
Oct 9, 2008, 6:59pm

63> I'm not sure that the percent of mortgage credit derivatives vs. all credit derivatives is relevant. The point is that many home mortgages, bad and good, were bundled into these derivatives which tended to hide how risky they were to the ultimate buyers of them. There may well be other kinds of derivatives but are they based on as risky an investment as real estate?

67Carnophile
Oct 9, 2008, 7:29pm

JJ - Junk bonds for example are generally regarded as more risky than mortgage-related debt (or were until recently), and they are the subject of both securitization and credit derivatives. The same is tue of the sovereign debt of nations that have significant credit risk.

The argument that Oregon (and I think jmc; it's hard to keep track) has been making on this thread is not about the opacity of derivatives. It's that there's a moral hazard problem with both securitization and credit derivatives (not the same thing). That is, the fact that you can get an asset off your balance sheet (securitization) or buy insurance against the possibility that it defaults (credit derivatives) makes you less careful in acquiring that asset (e.g., making a loan) in the first place. That creates incentives for riskier loans.

My point is this: There's no reason that this phenomenon should be confined to mortgages. It should apply to all assets that are the subject of securitization and in particular (the topic of recent posts) credit derivatives.
That's why percent of mortgage credit derivatives vs. all credit derivatives is relevant: If the moral hazard problem is the core problem, then we should have seen a meltdown in all markets using credit derivatives, most of which have nothing to do with mortgages. But we haven't.

68Carnophile
Oct 9, 2008, 7:34pm

For clarification: I'm not disputing that moral hazard is, in itself, a valid concept.

69eromsted
Edited: Oct 9, 2008, 10:43pm

>65 Carnophile:

So I went and read the Liebowitz article. I'm not convinced. First, he cites a small number of documents at great length without showing that a wide number of people actually acted on these documents. Second, yes there were changes which loosened regulations on initial home loans to try to encourage a higher home ownership rate. I think this is bad housing policy. However, Liebowitz conflates these changes with an internal loosening of standards for both second mortgages and for the repackaging and reselling of loan securities. Bankers and financiers undertook these changes on their own.

Third, in his final section on sub-prime vs. prime loans he discusses percent changes without looking at the absolute numbers and he fails to consider changing rates in the making of various types of loans when looking at eventual foreclosure rates. These sorts of confusions hardly make me trust his analysis.

For a different explanation lets look for a bit at the change in the value of housing (I'm getting this from Liebowitz's graphs) and the change in the value of mortgage backed securities as reported by the NYT in the graphic I linked above. Between 1995 and 2005 home ownership increased by 8%. The average house value increased by 80%. Put these together (1.08*1.8) and you get about a doubling in housing value. The NYT graph is a little hard to read precisely, but even low-balling the mortgage backed securities market increased by over a factor of 4 in the same time period. It hardly seems like this flood of money was simply being drawn into the market by increasing home ownership and house value.

Liebowitz argues that it was the increasing rate of home ownership that drove up housing prices, but more than half of increase in home ownership since 1995 occurred before the price rise even began. However, the price rise tracks nicely with the expansion in the securities market.

I would restate my theses that the driving force of the bubble was the flood of money pouring in at the top, looking for somewhere to go and encouraging risky behavior on the part of the lenders and bankers. Loosening government regulations didn't help, but I have a hard time believing it drove the bubble.

70oregonobsessionz
Oct 9, 2008, 11:01pm

The market had a lot of funds looking for a place to go, after the tech bubble collapsed. Much of it went into mortgage-based derivatives. I wonder if some of that money moved into oil futures when the housing bubble began to collapse. Would be interesting to pull together some statistics and graphs, to see whether any correlations exist.

71jjwilson61
Oct 9, 2008, 11:34pm

JJ - Junk bonds for example are generally regarded as more risky than mortgage-related debt (or were until recently), and they are the subject of both securitization and credit derivatives. The same is tue of the sovereign debt of nations that have significant credit risk.

Yes, but people have a pretty good handle on how risky junk bonds are. These mortgages, which basically had no checking that a borrower could pay it back, were being sold as less risky then they actually were. Securitization just magnified the problem.

72geneg
Edited: Oct 10, 2008, 9:14am

re: #63, so tell me Carny, is this $100,000,000,000,000,000 of credit based derivatives why a $.75 gallon of milk costs $5.00 these days?

ETA: When I was a young whippersnapper a person making $1,000 a month was more than affluent, they verged on wealthy. My first professional job paid $525/mo.

Can we have three cheers for Reaganism?

No matter how much shinola you put on this shit it still stinks.

73geneg
Oct 10, 2008, 11:22am

For all you older auditors, I have one question, Is the economy a banana, yet?

74Carnophile
Oct 10, 2008, 5:01pm

>62 jmcgarve:
That said, I think financial markets were way overstretched...

I don't know if this is what you're referring to, but I believe the Fed increased the money supply quite a bit during the 1990s and early this decade, which (if it's a big increase in the money supply) is another way of just begging for an asset bubble. Some enterprising person could check my memory online, because iirc this is all at either the Fed's Board of Governors web site, the New York Federal Reserve Bank web site, or the Saint Louis FRB web site.

If they increased the monetary base as much as my memory tells me, the only miracle is that the bubble wasn't even more widespread across sectors.

75Carnophile
Oct 10, 2008, 5:07pm

tell me Carny, is this $100,000,000,000,000,000 of credit based derivatives why a $.75 gallon of milk costs $5.00 these days?

Yes. Yes it is.

76Carnophile
Oct 10, 2008, 5:14pm

>71 jjwilson61:
I think you're missing the point that Oregon has made in several posts and that I made in 67. The point about "moral hazard" is that if a lender or bond buyer can protect itself from default, then it will be less careful about default risk when making loans/buying bonds. Now there's no reason that this effect should be confined to mortgage loans.

You say that everyone knows how risky junk bonds are. What?! That's not true at all! Almost always, in fact, buyers of these rely on the rating agencies for risk assessment, and everyone from jmc to Liebowitz has unkind things to say about them.

77oregonobsessionz
Oct 10, 2008, 9:20pm

Peter S Goodman at the New York Times: Taking Hard New Look at a Greenspan Legacy.

Includes an interesting graph showing the growth of derivatives. (Can't link the graph, as it opens in a pop-up box.)

78eromsted
Oct 11, 2008, 12:11am

But the box has a web address so you can make a link. Here's the graph.

79Carnophile
Oct 11, 2008, 10:04am

Was securitization the problem? One could engage in a very long discussion of this, but here’s the short version:

Securitization of mortgages has been around since the late 1960s.

80Carnophile
Edited: Oct 11, 2008, 11:36am

The Spectator in conjunction with Liebowitz addresses the question of whether the CRA was relevant. A quote from The Spectator:

“The national banks, responsible for the remaining quarter of the current subprime loans, were put under a different kind of pressure by the Clinton team to boost their low-income and minority lending too. Changes were made to the Community Reinvestment Act to establish a system by which banks were rated according to how much lending they did in low-income neighbourhoods. A good CRA rating was necessary if a bank wanted to get regulators to sign off on mergers, expansions, even new branch openings. A poor rating could be disastrous for a bank’s business plan.”

Liebowitz page 19:
“There are two points that need to be kept in mind. First, preliminary evidence (Mian and Sufi, 2008) indicates that the increase in defaults was driven by those areas populated by poor and moderate income borrowers. Further, Figure 10 below (this is a typo; he means Figure 9 - C.) and the discussion surrounding it shows that poor and moderate income areas had the largest share of speculative home buying and speculative home buying will be seen, later in this chapter, to be the leading explanation for home foreclosures.”

And page 32:
"The type of speculation described here might sound like a middle or upper class activity. In fact, the areas where this type of speculation seems most common are lower income areas... Indeed, speculation is more strongly negatively related to income of a census tract than is subprime mortgage origination (where subprime is defined mortgages with above normal interest rates)... The point of this comparison is to show that speculation is more strongly related to an area’s income than is subprime lending. Indeed, speculation occurs at more than twice the rate in low income areas than in wealthier areas."

Edited to add this from the Wikipedia article on the CRA:

“CRA was affected by the United States Congress passing the Federal Housing Enterprises Financial Safety and Soundness Act of 1992. It required the Federal National Mortgage Association, commonly known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, commonly known as Freddie Mac, to devote a percentage of their lending to support affordable housing. This in part, contributed to increased Fannie Mae and Freddie Mac pooling and selling of such loans as securities , (i.e. securitization), and expanded the secondary market for those loans.”

81Carnophile
Oct 11, 2008, 11:47am

eromsted at 69:

So I went and read the Liebowitz article. I'm not convinced. First, he cites a small number of documents at great length...

The main document he discusses is a Federal Reserve document about new lending standards. Since the Fed is the major banking regulator, that one document alone would suffice.

...without showing that a wide number of people actually acted on these documents.

That’s pretty much all he does. That’s the topic of the half the paper. It was a bank regulator telling banks what they had to do! Hellooooooo!
(So if a liberal mentions, say, the Gramm-Leach-Bliley Act, I don’t have to address their points by discussing that Act or anything else? I can simply say “Well, it was just one Act. And you haven’t established that many people actually read it and acted on it...” Really now!)

Also, if you’re going to say that regulated firms will just ignore regulations, that pretty much nukes the case for more regulation!

Overall, my reaction to this

...he cites a small number of documents at great length without showing that a wide number of people actually acted on these documents.

is “Oh my God, he can’t be serious.”

Second, yes there were changes which loosened regulations on initial home loans to try to encourage a higher home ownership rate. I think this is bad housing policy.

They sued banks who didn’t play ball, forbade mergers because of insufficient lending to certain groups, in certain neighborhoods, etc. This is lightened regulation?

However, Liebowitz conflates these changes with an internal loosening of standards for both second mortgages and for the repackaging and reselling of loan securities. Bankers and financiers undertook these changes on their own.

Oh please! The federal government implemented a comprehensive push for lowered lending standards. Then lending standards fell. Eromsted: “These two events are unrelated.” Oh for...Is this a troll?

Third, in his final section on sub-prime vs. prime loans he discusses percent changes without looking at the absolute numbers and he fails to consider changing rates in the making of various types of loans when looking at eventual foreclosure rates. These sorts of confusions hardly make me trust his analysis.

Can’t tell what you’re talking about here. What does “percent changes” mean? What does “changing rateas” mean? Changing interest rates? Changing rates of home ownership? He does discuss changing interest rates, p 29 et seq, if that’s what you mean.

82Carnophile
Edited: Oct 11, 2008, 12:08pm

For a different explanation lets look for a bit at the change in the value of housing (I'm getting this from Liebowitz's graphs) and the change in the value of mortgage backed securities as reported by the NYT in the graphic I linked above. Between 1995 and 2005 home ownership increased by 8%. The average house value increased by 80%. Put these together (1.08*1.8) and you get about a doubling in housing value. The NYT graph is a little hard to read precisely, but even low-balling the mortgage backed securities market increased by over a factor of 4 in the same time period. It hardly seems like this flood of money was simply being drawn into the market by increasing home ownership and house value.

(I don’t really think the last sentence is the crux of the issue, but on that subject: Why not? That’s what happens in an asset bubble. First prices rise at an unremarkable pace, for whatever reason, then when people notice the rising prices, more money floods in, intensifying the price increase. Money going into the bubbly market is both a cause and an effect of the rising prices. That’s why bubbles are unstable: They constitute a system governed by positive feedback.)

Liebowitz argues that it was the increasing rate of home ownership that drove up housing prices, but more than half of increase in home ownership since 1995 occurred before the price rise even began. However, the price rise tracks nicely with the expansion in the securities market.

See Lieb figure 1. The price increase started in 1996, one year after your 1995 starting date and a few years after the intensified push for expanded lending. Of course housing prices wouldn’t react instantly. In fact, this is a classic asset bubble: First the price rises slowly, then more buyers flood into the market and the price rises faster. That’s exactly what one would expect to see. E.g., in the famous tulip bubble, prices actually rose slowly for more than two decades, iirc, before people said “Hey, prices are rising!” (*) and then there was a period of a few years in which they rose extremely fast. Same for the tech boom of the 1990s; look at a graph of the stock markets - especially the NASDAQ, which was relatively tech-heavy stock market. First you’ll see a slow run-up, then a very fast run-up, then the crash.

Very plainly, more demand for housing (because more people getting loans with which to demand housing) pushed the prices up. I’m baffled that anyone would deny this. The prices don’t “know” whether you got a loan that was then securitized (let alone that it would be securitized several months after the purchase). Also, on the subject of securitization, Fannie and Freddie were buying tons of the securitized mortgages (that is precisely why Congress created them). That’s why I say they exacerbated the bubble.

(*) It took them a while to catch on because this was in the early 1600s - not exactly the real-time info world we live in now.

83geneg
Oct 11, 2008, 12:37pm

re Carney #80. As I recall, get rich quick schemes based on flipping houses was one of the main items of viewing on Sunday TV. Isn't it the responsibility of those who know the trouble people are getting into to warn them off rather than enable them, especially in areas where they are being fed a pile of guff from start to finish?

The Democrats may have been soft on trying to get people into homes, but it is the Republicans who turned it into a crap shoot with loaded dice.

Two things stand out: George Bush's radical enabling of the "Ownership Society" and the Republican legislation that prevented the states from taking action to protect their own banking institutions. Not to mention the legislation that facilitated this flipping. Something about bankruptcy judges being able to adjust mortgages on the 2nd through N house one owns, but not on the first one, you know, the one most homeowners live in. Well, how's that working out?

Yes, there is plenty of blame to go around, but I figure it at about 30% Democratic and 70% Republican (a slavish adherence to Reaganism).

As we borrow yet more money, so far another $1,000,000,000,000,000, (it's possible there are not enough dollars in the world, we may have to just flat out try to print our way out of this) my household income will not go up, it will probably contract, but that gallon of milk will just keep going up.

As I've tried to point out on these boards since I got here nearly two years ago, Reaganism is a financial disaster and has done more to destroy this country than anything else. Contrary to popular opinion Ronal Reagan will NOT be seen as the Great American hero, but he will rank with the likes of Warren Harding. Once again, it's nearing time to close the airports.

If I barely got a "C" in Econ 101 why is it that I can put this particular two and two together and come up four while the high powered MBA's can't? It isn't that complicated.

Did anyone really believe it was possible to make real money from credit? Even the alchemist's weren't that stupid. They at least started with something and expected to get not more than the same amount of something else back.

Okay, this is getting into rant territory so I'll stop.

84Carnophile
Edited: Oct 11, 2008, 4:55pm

My favorite part of that post: "...getting into..."

My scorn to all politicians who tried to push home ownership in an imprudent way. My impression is that it was both Dems and Reps.

And Gene, the regulators weren't "soft" on getting people into homes; they were suiing lenders who weren't doing it energetically enough.

At one point Bush tried to rein in Fannie and Freddie, but was thwarted by Congress.

In fact, it was mostly Democrats in Congress, according to Thomas Sowell:

“It was Senator Dodd, Congressman Frank and other liberal Democrats who for years refused requests from the Bush administration to set up an agency to regulate Fannie Mae and Freddie Mac.
It was liberal Democrats, again led by Dodd and Frank, who for years pushed for Fannie Mae and Freddie Mac to go even further in promoting subprime mortgage loans, which are at the heart of today’’s financial crisis.”

There's an instructive NYT article on this from September 11, 2003. It quotes that ultra-right-wing guy Barney Frank:

''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

85Jesse_wiedinmyer
Oct 11, 2008, 8:03pm

1 VOTER, 72 REGISTRATIONS
'ACORN PAID ME IN CASH & CIGS'


CLEVELAND - A man at the center of a voter-registration scandal told The Post yesterday he was given cash and cigarettes by aggressive ACORN activists in exchange for registering an astonishing 72 times, in apparent violation of Ohio laws.

"Sometimes, they come up and bribe me with a cigarette, or they'll give me a dollar to sign up," said Freddie Johnson, 19, who filled out 72 separate voter-registration cards over an 18-month period at the behest of the left-leaning Association of Community Organizations for Reform Now.

86jjwilson61
Oct 12, 2008, 12:14am

84> During most of the Bush years the Democrats didn't have the numbers to stop anything that Bush wanted to do.

87Carnophile
Oct 12, 2008, 8:57am

Yes, Bush's power was completely unchecked. He got everything he wanted. (Rolls eyes.)

The point is, Bush, the dread "Republic" of geneg's nightmares, tried to tap the brakes on Fannie and Freddie.

He was thwarted by Congress. Maybe Sowell is wrong and almost all of Bush's Congressional opposition actually came from other Republicans, though I doubt it.

As I said above, "My scorn to all politicians who tried to push home ownership in an imprudent way. My impression is that it was both Dems and Reps."

88Carnophile
Edited: Oct 12, 2008, 9:45am

In Heroics for Beginners the Evil Overlord recalls how hard it is, when you’re just starting out:

“No man can be considered truly evil until he’s foreclosed the mortgage on an orphanage. Oh sure, some men have to get by with foreclosing on a family farm or an old widow, but they’ll never make it to the top. I knew that all the really famous Evil Overlords had foreclosed on at least one orphanage, and I was determined that I would join that elite group...The problem was getting my hands on an orphanage mortgage. The demand was high in the evil community, and speculators were bidding up the prices...”

89jmcgarve
Oct 12, 2008, 7:25pm

A pretty good summary, from Daniel Gross, on how the CRA had nothing to do with the financial crisis:

http://www.slate.com/id/2201641/

But most of the arguments had been previously stated above.

90jmcgarve
Oct 12, 2008, 7:26pm

>88 Carnophile: The congressional rejection of the Bush administration attempt to rein in Fannie and Freddie certainly hurt matters.

91Carnophile
Edited: Oct 13, 2008, 7:54pm

>89 jmcgarve:
First, the CRA as such is a red herring because the issue is the government’s encouragement of the bubble, not any particular law or regulatory agency - there were lots of policies designed to increase lending to “underserved” groups. For example, from the Wikipedia page "Community Reinvestment Act":

“Although not part of the CRA, in order to achieve similar aims the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 required Fannie Mae and Freddie Mac, the two government sponsored enterprises that purchase and securitize mortgages, to devote a percentage of their lending to support affordable housing.”

This is relevant because it speaks to the allegation that securitization was a big part of the problem, and here we have the two major GSEs supporting the securitization (how many times do I have to make this point?) It also, though, speaks to the issue of non-CRA lenders making loans that have gone bad. Oregon has argued that this was a problem because securitization allowed them to make excessively risky loans and then sell them off so they didn’t have to worry about the risk. A lot of them were in fact making CRA-compliant loans, even though the law didn’t compel them to, because they could sell them to the government-created-and-sponsored enterprises. Also, the GSEs frequently guaranteed the loans, thus discouraging any concern for default risk. Again from Wikipedia:

“In October 1997, First Union Capital Markets and Bear, Stearns & Co launched the first publicly available securitization of Community Reinvestment Act loans, issuing $384.6 million of such securities. The securities were guaranteed by Freddie Mac and had an implied "AAA" rating. The public offering was several times oversubscribed, predominantly by money managers and insurance companies who were not buying them for CRA credit. (This last line is irrelevant - they were buying them because they were insured by Fannie and Freddie, who were insuring them because... (see above & below) - C.)
In October 2000, in order to expand the secondary market for affordable community-based mortgages and to increase liquidity for CRA-eligible loans, Fannie Mae committed to purchase and securitize $2 billion of "MyCommunityMortgage" loans. In November 2000 Fannie Mae announced that the Department of Housing and Urban Development (“HUD”) would soon require it to dedicate 50% of its business to low- and moderate-income families." It stated that since 1997 Fannie Mae had done nearly $7 billion in CRA business with depository institutions, but its goal was $20 billion. In 2001 Fannie Mae announced that it had acquired $10 billion in specially-targeted Community Reinvestment Act (CRA) loans more than one and a half years ahead of schedule, and announced its goal to finance over $500 billion in CRA business by 2010, about one third of loans anticipated to be financed by Fannie Mae during that period."

By the way, did you notice the presence of Bear Stearns in that passage? It by itself is an eloquent answer to Gross’s rhetorical bloviating at Slate:

“The Community Reinvestment Act applies to depository banks. But many of the institutions that spurred the massive growth of the subprime market weren't regulated banks. They were outfits such as... Bear Stearns and Lehman Brothers, entities to which the CRA...didn't apply.
...I await the Krauthammer column in which he points out the specific provision of the Community Reinvestment Act that forced Bear Stearns to run with an absurd leverage ratio of 33 to 1, which instructed Bear Stearns hedge-fund managers to blow up hundreds of millions of their clients' money...”

Notice the subject-changing dodging of the real issue. No, the law didn’t require Bear Stearns (or other non-CRA lenders) to make silly loans; rather government created-and-sponsored enterprises encouraged them to do so by buying and guaranteeing such loans. And part of Fannie and Freddie’s motivation for this activity was the CRA, as well as related legislation (see the above Wikipedia passage). So much for the irrelevance of the CRA.

I must close this, though, with a return to the important point, which is the role of government policy in general, not any single part of that policy in particular.

92Carnophile
Sep 30, 2009, 11:35am

Many left-leaning commentators, both in LibraryThing and in the broader world, have been asserting that Community Reinvestment Act (CRA) loans have not been especially poorly performing. The issue is in fact the general government push to lower lending standards, not any one particular law. But for those who are interested in the CRA, some Congressional testimony that cites excessively lossy CRA loans. This is the testimony of Edward J. Pinto - a former executive at Fannie Mae - before the House of Representatives September 16, 2009.
His entire testimony is quite damning, but among other things:
Third Federal Savings and Loan’s (Cleveland) has a 35% delinquency rate on its “Home Today” loans versus a rate of 2% on its non-Home Today portfolio. Home Today is Third Federal’s CRA lending program...

And:
Bank of America noted on its Q3:08 earnings call with equity analysts that while its CRA loans constituted 7% or $18 billion of its owned residential mortgage portfolio, they represented 29% of net losses.

93codyed
Sep 30, 2009, 12:03pm

Those are hate-facts coupled with hate-statistics.

94gregstevenstx
Oct 1, 2009, 11:15am

Sarcasm is a very addictive method of coping with having nothing intelligent to add to an argument.

95codyed
Oct 1, 2009, 11:18am

As opposed to moralizing about people who are sarcastic? Sweet. You're awesome.

96gregstevenstx
Oct 1, 2009, 11:20am

;-)

97gregstevenstx
Oct 1, 2009, 11:24am

No problem. ;-)

It actually jumped out at me only because it's an observation that recently occurred to me while listening to Rush Limbaugh.

Sometimes, he has actual arguments to support a conclusion, and when he does... he states them.

But whenever he is confronted with facts or arguments that contradict something he has said or believes, his default strategy is to mock or be sarcastic.

Rhetorically, it's wonderful because he never has to concede anything, admit anything, or even acknowledge it when someone who disagrees is correct about something. And if you're not really paying attention, it can seem as if he's had a "come back" and a response to every argument that has ever been put to him.....

But it's not true. He just hides behind sarcasm when he has nothing to say.

That's the only reason this jumped out at me.... because I was thinking, "I've seen this tactic before."

98codyed
Oct 1, 2009, 11:30am

You listen to Rush Limbaugh?

99gregstevenstx
Oct 1, 2009, 12:11pm

Morning, Stephanie Miller (radio).
Daytime, Rush Limbaugh and Sean Hannity (radio).
Evening, Chris Matthews, Keith Olbermann and Rachel Maddow (television).

100gregstevenstx
Oct 1, 2009, 12:47pm

post scriptum: .... which is why I'm always torn between being amused and annoyed when any broadcast personality makes the (implicit or explicit) assumption that "number of viewers/listeners" automatically translates into "number of supporters" or "number of people who agree."

101Carnophile
Oct 1, 2009, 12:49pm

Of course, two banks do not support a generalization by themselves, so I want to discuss two studies that used broad data sets. On one side we have the Federal Reserve System, arguing in a 2008 study that CRA loans are not particularly problematic. On the other side we have... the Federal Reserve System, arguing in a 2000 study that CRA loans are particularly problematic. Comparing the two studies is most instructive, but before I get to that I want to put forth some thoughts on the Fed’s credibility.

The Fed is credible when it is not embroiled in a political matter and when it has no incentive to engage in, pardon the bluntness, bureaucratic ass-covering.

(1) On politics, recall the notorious Boston Fed study that used falsified data. The authors, as far as I know, never retracted their conclusions even when it was shown that the “data” that produced those conclusions were nonsense. The Fed is a creation of Washington and is, not surprisingly, a political beast. As Mr. Dooley famously said, “Ben Bernanke follows the election returns.”

(2) Bureaucratic ass-covering: The Fed was one of the principal enforcers of the CRA and so of course, now that it has become a scandal, would try to exonerate itself. This is hardly the first time a defendant has said “I didn’t do it!” In this light, it is fascinating to see what the Fed had to say about the CRA before it became a scandal and they had any incentive to try to minimize the problem. (Next post.)

102Carnophile
Edited: Oct 1, 2009, 12:55pm

The Fed's 2008 study that seemed to exonerate the CRA focused solely on subprime CRA loans, not all CRA loans.

This is vital to generating the desired conclusion, because, in Pinto's House testimony (link above) he mentions that most CRA loans weren’t classified as subprime, even though they should have been by normal lending standards. The difference is huge:
Ninety percent of CRA lending was not classified as high-rate subprime, even though much of it had subprime and other high credit risk characteristics: This is because CRA lenders generally, along with Fannie and Freddie (the GSEs), did not classify CRA and affordable housing loans that had high risk characteristics (i.e. low FICOs, high LTVs, or high debt ratios) as subprime so long as they did not contain other features such as higher fees or higher rates, interest only or negative amortization, or low initial payment features with adjustable interest rates. Under this narrow and misleading definition, only an estimated 10% of CRA lending ended up being classified as subprime. Ironically, the reason that these were not high-rate loans was that the big banks and the GSEs were subsidizing the rates, as recent events have painfully demonstrated.
And the Fed’s definition of “subprime” in its 2008 study is (drum roll): Loans that had a high interest rate!

So the Fed excluded 90% of the problem from its study, then triumphantly announced that there was no problem!

Actually, that wasn’t good enough for the Fed, they go on to say that subprime loans in CRA areas do slightly better than those in areas just above the CRA income level.

Pinto demolishes this approach in his first footnote. There, he gives an example of how, if a bank’s lending wasn’t perceived as widespread enough by “community activists,” they would pressure it to expand its lending to more areas, never mind whether the zip codes were CRA zip codes.
Also, the Fed’s methodology of comparing lending in areas with incomes just above, and those with incomes just below, the CRA threshold doesn’t make much sense anyway. After all, income can be measured in various way and fluctuates from year to year. Is a bank going to play it right up the line, or are they going to play it safe and go over the line a little? Come on. This year ZIP code #1 is just above the threshold of the CRA. But next year its income could be lower and if we’re not lending enough in that area we’ll be out of compliance with the law! Yikes. So this methodology seems reasonable on the surface, but really doesn’t make much sense if you think about it.

Pinto was, by the way, an executive at Fannie Mae. So if anything, he has incentive to try to exonerate them.

What did they Fed have to say in 2000, before there was a scandal about lax lending standards? A rather different account.

The CRA at the Fed's Board of Governors: http://www.federalreserve.gov/boarddocs/surveys/craloansurvey/summary2000.pdf contains a summary. The summary is damning in two ways:

First, it finds that CRA loans did, in fact, perform worse than non-CRA loans.

Second, it finds the discrepancy is worse for larger banks: “a greater proportion of large banking institutions report their CRA-related home purchase and refinance lending is either marginally unprofitable or unprofitable than medium- or smaller-sized institutions.” Why does this matter? Because a few years later there was a regulatory shift to enforce CRA more strongly for larger banks! (*) It looks like larger banks did significantly worse with their CRA loans, and then the govt made it worse by strengthening the enforcement for those very banks!

Some details:
If you go to figures 1a - c, you can see the deleterious effect of CRA loans. Figure 1c reports that 56% of reporting banks found that CRA loans performed about the same and 44% (=19% + 25%) found they performed worse. However, as the Fed itself says in several places in that document, loans by institution aren’t necessarily the best measure anyway. Loans by dollar is a better metric. E.g., it silly to compare an FI that made 1,000 CRA loans and reported they performed poorly to one that made 1 CRA loan and reported it did fine, and then conclude, “Fifty percent of lenders say CRA loans were fine.” As an example, this quote from the study: “63 percent of the CRA dollars originated in 1999 were originated by respondents that report that CRA-related one- to-four-family home purchase and refinance lending is less profitable than other lending, higher than the 44 percent of institutions that report that CRA-related lending is less profitable on a per institution basis.” (Emphasis added.)

Not surprisingly, large lenders accounted for more dollars of CRA lending than small lenders. And this matters, because again, larger institutions had significantly worse experience with CRA loans than smaller ones.

Figure 2 present results by dollar instead of by lending institution and the results are even worse: only about a third (36%) of CRA dollars were “about as profitable” as non-CRA residential lending. The rest were less profitable.
Chart 8b: Only 42% of CRA lending dollars were profitable!
(If the metric is institutions (chart 8a), the figure is even worse: Only 29% of institutions had CRA lending programs that were profitable! Ouch! But I think dollars lent is a better metric, so let’s go with 42%.)

* John Carney, “The Phony Time-Gap Alibi For The Community Reinvestment Act” says the following. The first paragraph looks good for liberals, but keep reading to the end:
In early 2005, largely at the behest of the banking sector, the Office of Thrift Supervision implemented new rules that were widely perceived as weakening the CRA. Supervision of banks with under $1 billion in assets was loosened, and larger banks were allowed to voluntarily reduce the amount of regulator scrutiny of their “investment” and “service”––two long-standing categories of assessment under the CRA.
This had two unintended consequences that would later prove to be very costly. In the first place, it increased CRA scrutiny of larger banks, who were now the main focus of regulators. This put even more pressure on the banks to make CRA loans.

103geneg
Edited: Oct 1, 2009, 12:55pm

I've tried to do that, but I just can't take Limbaugh's preening, rude, narcissism. If I'm listening to Rush in the car I become a hazard, yelling at the radio rather than driving. I just can't do it.

There are times when I think Chris Mathews is the worst "interviewer" of all time. He allows his interviewees to talk as long as they stick to his script but if they try to make a point that is off script he rather rudely hustles them along. No free flow of information, just a regimented discussion.

I listen to Olbermann as an entertainer in the Rush/Beck mold, just taking the other side of make believe. I tune out his rants. Keith, I knew Edward R. Murrow, and you, sir, are NO Edward R. Murrow.

Rachel Maddow, while I watch her only rarely, seems to me to be the best of the air-shifters on MSNBC. She tends to be more fact oriented and less overcome with hyperbole, but she can still be strident.

Ed whatshisname conflicts with my favorite Food Network show so he doesn't get watched.

How sad is this next admission? I let you sort it out.

The only news I really think I can trust is on the Jon Stewart show, with Colbert thrown in for good measure. They show more about what the sausage is made of in their five minute sketches than any of the above do in an hour. What a sad commentary, the only reliable news is from the Comedy Channel.

Broadcast network news doesn't enter my house.

I read the Huffington Post for news, and get other news from Reddit. I routinely read Andrew Sullivan's blog and then balance it with Matt Yglesias. I read the online Foreign Affairs and several blogs from the Economist.

The paper of record and the WaPo are shills for the oligarchs, just as is the WSJ (has Murdock destroyed them yet, I hear he's close). I read the online English version of the Asia Times from time to time, just to get another perspective.

Getting accurate information with which to decide issues is practically impossible.

104reading_fox
Oct 23, 2009, 9:55am

#100 "post scriptum: .... which is why I'm always torn between being amused and annoyed when any broadcast personality makes the (implicit or explicit) assumption that "number of viewers/listeners" automatically translates into "number of supporters" or "number of people who agree."
"

You're on LT.

It's the same assumption Tim makes. You've catalogued a book hence you have an association with it, hence we'll treat it as if you like more than any other random book in all our calculations. Irrespective of the fact that you rated it 0.5 out 5 stars. Apparently some team won some money from Netflix because borrowing films, equates to buying books.