Alan Greenspan: idiot or savant?
For years, Alan Greenspan was thought to be a genius, responsible for keeping inflation at bay and encouraging our booming economy. He fine-tuned interest rates to make sure all this was going smoothly, and to the best of my recollection he earned resounding praise from almost everyone.
Well, it turns out this emperor had no clothes after all. But when he finally realized something was fishy, somewhere around late 2005, he says there was nothing he could do about it:
“If we [had] tried to suppress the expansion of the subprime market, do you think that would have gone over very well with the Congress?” Mr. Greenspan said. “When it looked as though we were dealing with a major increase in home ownership, which is of unquestioned value to this society—would we have been able to do that? I doubt it.”
Funny thing, I happen to agree with him. That doesn’t mean he shouldn’t have tried, though. Nor does it excuse the rather shocking disclosure of the limits of his understanding of derivatives and the mortgage market and what it all meant.
One of the most interesting quotes from Greenspan is this:
We could have basically clamped down on the American economy, generated a 10 percent unemployment rate,” he said. “And I will guarantee we would not have had a housing boom, a stock market boom or indeed a particularly good economy either.”
In other words, we could have suffered then instead of suffering now. There is no free lunch; ever hear of it? I wonder if Greenspan has.
When a bubble is created, it must burst at some point, because bubbles are inherently fragile things. But just try telling it to Congress, then or now.
[NOTE: House of Eratosthenes expands on these ideas.]
You’re kidding, right? Lurching from bubble to bubble is not an economy.
And common sense regulation on a trillion-dollar, little-understood, completely unregulated, potentially disastrous sector of the financial industry (credit default swaps & associated derivatives) is hardly ‘clamping down.’ It’s called governing.
It is simply amazing how often we learn, after the fact, that the Wise Men and Gurus who soothed our doubts really had no clue.
Confession. I have no financial or economic acumen to speak of at all. I suffered through Econ 101/201 and Accounting 101/201 and decided it would be easier to fly airplanes–more fun too. But, around October 2007 I looked at my investments and thought, we have enough to cover our needs. I then looked at the market volatility and the go-go credit economy and I thought, this can’t last. I thought, I should contact our financial adviser and tell him to go defensive. Then I decided to stick with the experts; after all that is why I was paying them.
Now, even if the casual observer began to have serious doubts based on nothing more than common sense, what were those Wise men and Gurus thinking?
kamper: you seem to have a problem with reading comprehension. Do you actually think I’m advocating a series of bubbles?
And do you really think the Democrats would have prevented this?
And remember, Greenspan was bipartisan, holding his post through administrations from both sides.
Bad as it is, the magnitude of the subprime meltdown by itself was not enough to endanger the financial system. What really created the problem was leveraging off balance sheet side-bets about housing prices that multiplied the size of the financial institution losses to the point where capital sufficiency was in danger.
The behavior of the banks here is the real rebuke to Greenspan’s theories about market efficiency.
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Yep. Just about everything has a trade-off.
The difficult choices are usually not between good and bad, but between bad and less-bad, or bad-now and bad-later.
I must say I always had this disconnect with Greenspan, back in the day when everybody kowtowed to his economic genius brilliance. After all he was a Ayn Rand fanboy, which is truly weird.
But then he was the renown expert, what did I know?
Now I find that he didn’t know the fundamentals of economics, or of human systems, that nothing is infallible, not even the holy of holies, the Market.
And his excuse is that had he tried to reign in the over exurberant subprime mortgage market or warned about the opaque financial instruments i.e. derivative, CBOs, CDSs, etc, he would have blamed for the negative effects of those actions. So he went along to get along. Like everybody else, it seems.
I lost more than a third of my retirement investments, built over 20 years, this past fall. And I could have save most of that loss if I had listened to my own instincts rather than to my financial advisor at Morgan Stanley. I told her that since I was nearing retirement age, I thought it would be wise to transfer my IRAs from various stock mutual funds to the more conservative bond funds. She persuaded me to keep more than half of them in the stock funds, that over time, they gave a greater return. She had idea that the stock market itself was a form of bubble, that it was all a house of cards.
Words of wisdom from Bob Dylan
Don’t follow leaders, and watch your parking meters.
Oops.
She had NO idea that the stock market,etc.
I should proofread BEFORE posting.
Too funny… translation: We had the regulatory power but we could not use it for fear of the political branches of government….
Oblio Says:
“What really created the problem was leveraging off balance sheet side-bets about housing prices that multiplied the size of the financial institution losses to the point where capital sufficiency was in danger.”
I keep hearing… but never seeing… that.
The CDS are such BS that they can all fall down without a lot of real wealth being lost. A lot more funny money will be wiped out…. on paper… than actual.
I get a little tired about people complaining about credit default swaps (CDS). They are nothing more than insurance against default. There is nothing inherently wrong with insuring against default. The problem that developed was the insurance was under priced. But,the insurance price was based on the credit rating of the underlying securities. If their rating was too high, then the CDS was under priced.
As I recall, FHA and VA mortgages carried about a .5% uplift for insurance that the loan would be paid. If those mortgages had all been sub prime, .5% would not have been enough.
It is all about the same as Florida insurance after Andrew. It turned out the insurance was priced too low and many insurance companies either went out of business, left the state, or reorganized as a Florida only pool. There was no leverage though on the insurance.
Rick
Someone ought to do a riff on Humpty-Dumpty only with the “Progressives” trying to reassemble their precious bubble.
So, turns out the “Maestro” (who I always thought was vastly overrated), for all of his pretentious vocabulary, was really just a normal mortal, a cog in the wheels, and garden variety “tool” of the political opportunists. Now Bernanke is silent while congress, led by the Progressives, unleashes a socialist government bubble of monumental proportions. Ayn Rand would have rolled her eyes at the poor business and banking judgement shown with the housing finance culture which began with the so-called “Community Reinvestment Act” during the Carter regime. When the mighty fall they fall hard, and bring a lot of people down with them. We will pay dearly for Obama…
Neo,
What these postmodern marxists have done is what
the earlier iterations tried to do…seize the means of production. This is a worldwide economic war against
capitalism. And furthermore, Obama delenda est.
Without coming right out and saying, I think Greenspan believes he would have been branded a racist had he come right out with the housing boom problem on the horizon and who the “housing boomers” were. And he would have been, I’m sure.
Thomass, how would you see the off-balance sheet contracts? Believe me, I would like to be wrong about the role of credit default swaps, and I agree in principle they could help institutions insure against defaults.
But in practice, there is nothing to link the insurance to the asset on 1 to 1 basis. This is fundamentally different from the commodity markets, where contracts expire and must be delivered against in the real (physical) world. The first thing a commodity trader learns is this ditty:
“He who sells what isn’t his’n
Must buy it back or go to prison.”
That was emphatically not the case in the CDS market. It just doesn’t seem possible for the magnitude of subprime defaults to wreck the balance sheets of Lehman, Bear, Wachovia, Citigroup et al without some mechanism to magnify the losses to the point of capital insufficiency.
If someone else knows a different mechanism that could explain the panic, I’m all ears.
Imagine a precipice, high over a rocky seashore. It’s dangerous to stand on the precipice, but the view is spectacular. People love to stand on the precipice and admire the view, but occasionally someone will slip and fall. Every year there are one or two deaths.
Since the precipice is unsafe, the city puts up a railing. The newly improved viewpoint becomes much more popular. People get into the habit of leaning on the railing to get a better look.
Then, one day, ten years after the railing was installed, a wedding party is taking place. Everyone decides to have a group photo taken at the viewpoint. All 150 guests gather at the edge of the precipice and pose leaning against the railing. As the photographer fiddles with his camera, the railing breaks under their combined weight, and they all fall to their deaths.
Number of deaths in the ten-year period before the railing was installed: 15
Number of deaths in the ten-year period after the railing was installed: 150.
Oblio,
IMO, you are correct. These companies balance sheets should not have been wrecked by the sub-prime problem. At least not the banks and insurance companies. The investment banks had leveraged themselves way too much. (30 to 1 is what I see bandied about.)
It is my impression, and I may be as clueless as the new Secretary of Treasury seems to be, but what happend was the forced write down (mark to market) of the Mortgage Backed Securities (MBSs).
These instruments were supposed to be safe, boring investments. You bought them, locked them away in the vault, and collected the income stream until all the mortgages were retired. What went wrong was a much higher than expected default rate. As defaults increased the financial companies knew they had to revalue the MBSs for accounting purposes, but did not know how to do it. The SEC and FASB directed that they had to “mark them to market.” This was an unfortunate (stupid?) ruling to make because there was not and never had been an auction market for MBSs. By this time the word was out that these MBSs were crammed full of defaulting sub-primes. (Not actually true, but that was what was circulating.) So, some MBSs were put up for sale and the best offer they could get was 22 cents on the dollar. This then became the new value for MBSs throughout the financial world. It meant a loss of 78% of the capital base that was in those instruments. Normally, the banks and insurance companies would have been able to raise more capital to replace what they had lost, but the word was out that the banks were in dire straits. The shorts pounced on the stocks driving the capital further down and no one would buy common, preferred, or bonds from these institutions. Thus they became undercapitalized and were in danger of going out of business until the government stepped in with the TARP.
A little bit of back of the envelope figuring will show you why the bid of 22 cents on the dollar is ridiculous. For simplicity’s sake lets say you have an MBS with 100 mortgages in it each for $100,000 and the security for each is a house worth $100,000 when the mortgage was made. So here we have 100% financing of each house. (An unlikely scenario, but simple to grasp.) Now let’s say that 50% of all the mortgages default (an incredibly high and unrealistic default rate by the way.) Now let’s say that all the defaulted houses were resold at auction for $20,000 – an 80% loss. (Which is a ridiculous loss because no realty market in the country has had that kind of losses.) So, now what is the value of the MBS? Well, 50% of the mortgages are still performing and you expect to eventually recover the full value as the mortgages are paid off or refinanced. And you have recovered 20% 0f the value of the defaulted mortgages. By my lights the value of the MBS is 70 cents on the dollar. For an MBS to be worth 22 cents on the dollar every mortgage (100%) would have to default and the value of the houses would have to decline by 78%. That is such an unlikely scenario that you can see why the banks are loathe to sell these instruments at those prices. I’m certain that all the financial instuitutions could unload these securities at those prices, but the bankers are smart enough to see that would be a stupid thing to do. But the government does not want to overpay when they buy them. (Which was the original intent of the TARP.) The problem is, each MBS is unique and can be given a true value only by taking it apart and looking at each mortgage – a time consuming process. With the banks undercapitalized and unable to raise new capital, there was no time. Thus the TARP. TARP I, as they call it, has been like sticking a finger in a leaky dike. It has slowed down the decline of the banks, but it has not shored up the balance sheets so they can raise new capital and resume business normally. The only way to do that is to get the MBSs (Toxic assets!) off the books.
One possible solution for the problem would be to suspend mark to market for illiquid instruments like MBSs for a couple of years, have some financial whizzes sample a number of the MBSs in detail, and then have a statistician look at those samples and estimate a range of values, say 65 to 80 cents on the dollar, which the companies could use for accounting purposes while they then took the time to evaluate each and every MBS in detail. The problem with this is that many people would scream that they were “phony” values which provide no confidence in the balance sheets. So, until the banks found the true values and thus shored up confidence in these instruments the crisis of confidence would continue.
I hope Geithner really is brilliant enough to solve this. Thus far I’m underwhelmed.
One possible solution for the problem would be to suspend mark to market…
That’s what they are looking at, and I believe they will do so before we are out of this.
According to Brian Wesbury, an award-winning economist, the stock market tanked after Geithner’s speech because there was a rumor he was going to announce the end of mark to market, then didn’t.
Wesbury tends to be a bit too optimistic IMO, but he does have access to what goes on behind the curtain.
Jimmy J. Says:
Jimmy,
What you said is what I understand happened too. It was not the CDSes.
– Karl Marx – 1867
I believe Rick Caird has it correct when it comes to the proximate cause of the problem, which is an overly rosy credit rating of the securities in question. The ratings were based on a Monte Carlo model of the performance of the underlying securities that was based on the assumption that subprime mortgage defaults would be statistically independent from each other; a correct assumption when talking about prime mortgages in an ordinary market, but false when dealing with subprime mortgages especially in a declining or collapsing market. You can see that this problem was noted in this study:
http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6VCY-4B3MTRT-5&_user=10&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=01137742c8f375a45383a948f5c39e64
from back in 2003, but apparently the credit rating agencies didn’t factor default correlation into their models.
Of course, the underlying problem here is the credit rating agencies are paid by the institutions whose securities are being rated; a conflict of interest. Changing this is something that I believe ought to happen — I haven’t heard much discussion of this. It would have a salutary effect on the stability of the market.
I think Oblio is also correct that the problem was greatly magnified by the CDSes and the many levels of securities involved … so many meta-levels that it became quite difficult to correctly assess the risk level of any given security. But if the models had been more realistic at least the bubble may have been a bit less pronounced.
The fact is, however, bubbles happen in markets of all types — Japan’s lost decade came from an ordinary real estate bubble. It seems to me that overleveraging is usually involved in every disastrous bubble, from the one that precipitated the Great Depression to Japan’s disaster to Sweden’s to our current one. On the other hand, there were institutions that managed to avoid the worst of it (Goldman Sachs) despite being heavily leveraged — so leverage alone doesn’t necessarily create a problem. I’m not sure what the ideal solution is — however, it does seem likely that some degree of enhanced government oversight is warranted.
During Greenspan’s tenure in office, the Economist repeatedly denounced him as being incompetent.
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Many good posts here. Hat tips in particular in Jimmy J and Mitsu. Mark-to-market rules clearly create some leverage for catastrophe. Mitsu points out that in a panic, all the correlations go to 1. So what we have here is a perfect storm.
And the magnitude of the storm has bankrupted not just the names I listed above but also Iceland, the UK, and enormous institutions outside the US such as Royal Bank of Scotland.
The implication of Jimmy J’s post is that someone is going to make vast fortunes buying distressed mortgage-backed, since the distressed prices don’t reflect the underlying values.
I am concerned to see talk of “nationalization of the banks” beginning to pop up in the political pages of the NYT and the Post. When E.J. Dionne starts writing about banking, you know there is a lot of chatter on this topic among the Democratic politicos. I see the financial system problem as more technical than political. Nevertheless, I am aware that in Washington, EVERYTHING is political first and last.
Some bright people come in here and comment.
But it’s Monday morning, isn’t it.
The bill is passed and crammed with pork, my grandchildren and their kids are in debt for life, seems the moochers and looters are the beneficiaries while the everyday folks at middle to upper middle income levels, again and as always, get the shaft. The real shame is there’s nowhere to go, no way out.
Madoff may be confined to his penthouse, but I’ll bet he still orders in, groceries get delivered, has telephone, cable, internet and even maid service, etc. I doubt he does his own laundry. And I’ll bet he gets laid more than I do.
A lot of the founding fathers argued against the idea of one “central” bank for the very reason that it would have too much ability to exert influence on the economy. So though many reasons can be argued for the cause of the current economic dilemma (notice I did not say catastrophe) is the same with so many other problems in this country – “social engineering” .
Oddly enough president Bush had a pretty good idea to help minority home ownership (from the very bottom) and that was to allow people who were receiving rent assistance to use (for a period of years) those payments toward house payments with on the down payment. He said that would give people the feeling of ownership and the pride that goes along with it. I could have worked if done correctly. Unfortunately, there was a move afoot among the liberals to rapidly expand minority home ownership and in order to do that they had to “intimidate or entice” banks to through out their credit standards (and everyone pretty much knows how they did that).
The big problem with all of this was the human nature factor. And this doesn’t apply to just “Minority” home ownership. If you don’t have to work had and often sacrifice for what you get then you are not going to be willing to make the sacrifices necessary to keep it.
Greenspan’s comment about “how do you feel the congress would have felt about that?” is totally self serving and disingenuous. In his position he was basically untouchable. He should have done what was right for the economy. So along with the mortgage situation a HUGE contributing factor to the collapse was the Fed keeping money too cheap for too long.
That’s okay though we will make up for it soon. I’m seeing a return to the double digit inflation and high teens (at least) interest rates.
This is NOT an example of the failure of the market. A market is not a philosophical system, such as socialism or capitalism; rather, it is a description of reality — an aggregation of millions of individual decisions to buy and to sell. A thing is worth what a willing buyer would pay a willing seller in exchange for it. Period. It can never be worth more because nobody will be willing to buy, and it can never be worth less because nobody would be willing to sell.
Regulation causes market distortions, because it artificially overvalues or undervalues something. Speculation artificially increases a thing’s price because it involves people making a bet that the thing will increase in value. The ultimate result of speculation is a bursting of the bubble, when people realize that the thing really isn’t worth what people used to be willing to pay for it. When a bubble bursts, people are afraid to purchase the thing in question, and its value drops like a rock — usually to a point well below what it is inherently worth.
When the federal government, by regulation, forced banks to lend money to people who were poor credit risks, it forced the creation of worthless mortgages. Banks then created derivative securities and placed bundles of mortgages into those securities to insure against the risk of default, which was unacceptably high on certain of the loans that the federal government forced banks to make. The price of mortgages went up and the price of land went up as a result of speculation that real estate was a safe bet.
Now we have a situation in which we have a large number of derivative securities that nobody knows how to value because nobody knows how many mortgages in any particular security are worthless mortgages. That has made the derivative securities worthless and has made everybody afraid of mortgages. Thus, a mortgages that is actually being repaid, and is likely to continue to be repaid, is worth less than the discounted cash value of all of the payments that will be made on the mortgage — because of fear.
The “mark to market” rule exacerbates the problem because a bank that makes a loan immediately takes a hit to its balance sheet — it gives cash for a mortgage that has a market value less than the amount of cash surrendered. This means that the amount of credit the bank can extend decreases, and there is a contraction of the money supply. A contraction of the money supply is recessionary, so businesses cut back on what they are doing and consumers cut back on spending, deepening the recession.
At some point, somebody will take a bet that the recession has ended and spend money on something. When enough people do this, and the banking system figures out which mortgages have failed and writes them off, the situation will correct itself. In the long run, the best thing for the government to do probably is NOTHING AT ALL. Let the problems shake out on their own, and we will bounce back. Also, get rid of the regulations that started this whole mess, such as rules requiring banks to make loans to people who cannot repay them and mark to market, and impose a few common sense rules, such as elimination of derivative securities that are backed by bundles of mortgages.
Spending a trillion dollars on this or that is likely to simply prolong and deepen the pain, as the debt will either have to be repaid or depreciated via inflation. If we absolutely must spend a trillion dollars, it would probably be best spent taking the bad mortgages off of the books of the banks and transferring them to the government, so that the financial system remains sound. Extending welfare or unemployment benefits certainly helps those who receive the benefits, but it does nothing to shore up the banking system of help society as a whole.
What we have here is a market doing what markets do — rebuking those who spent unwisely or be incorrectly.
And yet most politicians and citizens still do not understand that the source of the instability that greatly contributed to this housing bubble was the interpretation of the 1977 Community Reinvestment Act which evolved after 1992’s Boston Fed study on minority lending. When Bill Clinton and Jaime Gorelick, in 1995, told the banking community to shitcan sensible underwriting standards and open the spigot, it was only a matter of time before the derivative paper that was supposed to diversify the risks was so watered-down that the very concept of risk indemnification was a fiction.
If you insure crap it does not change the nature of the crap.
I knew once flipping became THE game in town it was only a matter of time before the game was up. I noted the very same thing going on in the tech and dot.com bubble in the late Nineties.
Bubbles burst and that is the nature of capitalism. There has to be a corrective pricing mechanism in order for the system to work. We we don’t want a pricing equilibrium to take place, it just magnifies the whole crisis when the thing become unsustainable.
Again, I think it’s unfortunate that a sober, pragmatic analysis of this has to always give way to partisan attacks. There were mistakes on both sides. However, the Community Reinvestment Act was not the source of this debacle, by a long shot. The actual loans made under the auspices of the CRA have, in fact, generally performed well:
http://www.federalreserve.gov/newsevents/speech/kroszner20081203a.htm
“Over the years, the Federal Reserve has prepared two reports for the Congress that provide information on the performance of lending to lower-income borrowers or neighborhoods–populations that are the focus of the CRA.3 These studies found that lending to lower-income individuals and communities has been nearly as profitable and performed similarly to other types of lending done by CRA-covered institutions. Thus, the long-term evidence shows that the CRA has not pushed banks into extending loans that perform out of line with their traditional businesses. Rather, the law has encouraged banks to be aware of lending opportunities in all segments of their local communities as well as to learn how to undertake such lending in a safe and sound manner.”
The problem came from a whole slew of factors, some of which we described above, some which came from deregulation, some which came when Freddie Mac and Fannie Mae got into the securitization act, etc. Some mistakes made by Democrats, some by Republicans. It’s a giant mess.
When Greenspan, an Ayn Rand devotee, said he had not considered the impact of “greed” in his analyses, I thought, oh my god, yet another cover-my-ass coward! Just wish his wife would get the same comeuppance.
It seems to me that Greenspan had no good choices. If he told the truth, it could have been more damaging than keeping quiet. If he had done it just right, with his usual skill at hints, maybe it would have created a situation that Congress would have had to respect, but I defer to the old wisdom (Twain?): No man’s life or property are safe while the legislature is in session. Though these days it could be also said of various Supreme Courts and Courts of Appeal.
There should always be a preference for the truth. The problem comes, as Merton said, when we use one truth to deny another. “You need glasses” becomes “You’re weak and ugly and deserve to be picked on by your classmates.” Sometimes it’s the fault of the speaker, sometimes the fault of the listener, but it never has a good outcome.
No, mitsu, I am not letting you get away with the aspersion that I’ve assigned “political” blame in my post. It is a DOCUMENTED fact that in 1995 Jaime Gorelick threatened the banks with prosecution if they did not alter their standards and push more money at low-income minorities. The securitization process was an attempt, by Fannie Mae and Freddie Mac, to relieve the lending institutions of the risks they were taking. So, implicitly they knew what they were doing was very risky. We had no warnings about this from President Clinton. We did from President Bush. And now we have a POTUS who got campaign money from Fannie Mae and Freddie Mac. But this program was begun, originally, under President Carter’s watch and has passed through administrations from both parties. It is true that there is enough blame to go around.
But you can’t ignore tipping points. And I’m in the business of appraising risk and value. I understand the internal, ineluctable logic of how this was set up. While there are complicated, exotic instruments involved, they all rest on a foundation. The structure was made of a basic transaction. Everything else was about how to make something dangerous palatable to investors.
The tipping point was Gorelick’s actions. Look at chain of command, if you want to assign responsibility.
Sure, Gorelick does seem to have a share of the blame, here — as I said, there were both Democrats and Republicans involved at many levels in this disaster. I’m simply saying the CRA per se was not a cause of this, as subprime loans made under the auspices of the CRA performed nearly as well as prime loans.
FredHjr, you need to give Mitsu credit here. This is a story where there is a lot of blame to go around. Some of it is undoubtedly around the way CRA considerations affected Democratic responses to subprime regulation, or the lack thereof. Some of it is about the way CFMA created opaque areas where the lack of adequate market checks and balances were not apparent soon enough. Some more is probably related to Sarbox and attempts to tighten up accounting standards post Enron. Some more is about the Fed’s inability to rein in borrowing in 2004. Mr. Greenspan clearly missed the boat, and he is not covering himself in glory now.
So, there needs to be regulation, but we can’t be sure that regulation in the abstract won’t do more harm than good. For example, if the government responds to political pressure in such a way as to force banks to act in counterproductive ways.
There is an interesting equation emerging on this thread to tie it all together. All the issues we talked about here are relevant in that equation. I suspect the winning policy will need to address asset values and discourage foreclosures, suspend mark-to-market rules for institutions under supervision of the Fed, sterilize off-balance sheet exposures, and increase equity supporting the banking system. The question is really about proportions: how much effort to put against each leg, and that in turn depends on the calculus of improvement that could be expected. All going well, banks might be able to write up some loan loss reserves sooner rather than later, and capital ratios will improve dramatically.
I just finished watching “HOUSE OF CARDS” on CNBC. It is an over dramatic, sensationalized version of what happened in the mortgage markets and the securitization of them. It concentrates primarily on Southern California, where too many mortgage brokers were willing to make any loan as long as they could sell it to Wall St. IMO too many people will get the impression that this was happening all over the country. Nonetheless, I think it is worth watching.
It will be shown tomorrow, 2/16 at 9pm & midnight, ET as well as 3/1 at midnight ET and 3/15 at 9pm ET. I recommend it for edification on how these loans got made and how/why they got bought by Wall St.
The one business that contributed the most to the bad loans was the mortgage brokerage business. As one investor asked, “What is the one business that does $1 trillion dollars of business every year with consumers and has no regulation? Answer: The mortgage brokerage business.”
I was shocked to see the way some of these Southern California brokers were operating. They knew the loans were shaky if housing prices went down, but their rationalization was that if they didn’t do the loans, someone else would.
The program examines CDOs in some detail – at least enough to get a feel for how complex they are. They also interviewed one of the quants that did the math to put the CDOs together.
To give an example of how poisoned the well is on these instruments there is the infamous story of Narvik, Norway. They borrowed to buy some CDOs that would pay them a nice stream of income to use to cover some city expenses. These CDOs are nearly worthless today even though they are not made up of mortgages but of corporate bonds, which, if the companies they showed as being in the CDOs, should still be quite viable. However, the CDOs cannot be sold for anything like what they paid for them, although I assume the income stream is still mostly unimpaired.
I live in the Puget Sound area and I have been active in owning investment property in this area since 1995. So, I have applied for and received several loans during that bubble period. I have been mystified by these sub-primes, alt-As, and “liar’s loans” because I have never been able to get anything but a fully documented loan. And that’s with a FICO in the high 700s. It shocked me to see what the brokers were doing in S. California. It bordered on the criminal. No, it was criminal. I can only assume that Las Vegas, Arizona, and Florida had similar high flying, gun slinging mortgage brokers doing the same things.
I visited a friend in Naples, Florida in 2005. There were many, many, subdivisions springing up there and people were buying houses before the foundations were poured. Then reselling them at a profit when the houses were completed. They never had the intention of moving into them. This was a sideline business for some people. I knew that such frenetic speculation could not continue forever, but a lot of people did. The underlying belief was that home prices would continue to go up indefinitely. As long as prices went up even a little each year, all would be well. It was contrary to every thing I had seen in real estate markets over 48 years – I bought my first house in 1960.
During that time I have seen home prices fall in Florida (once), San Diego (twice) and Denver (three times). On the other hand, all the prices eventually came back and went up further…..after a time. I sold all my rental properties in 2007 because things were getting a bit frothy here. But they were never like S. California. Puget Sound is now going through a decline in real property prices and slow sales, but nothing like California, Las Vegas, Arizona, and Florida.
Personally, I’m in favor of regulating mortgage brokers going forward. Secondly, I think Wall St. has got to rein in the quants and their very creative abilities to concoct more and more exotic securities.
Alan Greenspan is interviewed during the program. I agree with his observation about greed and bad judgment. It isn’t possible to outlaw greed or bad judgment. We won’t do anything this foolish again soon, but some bubble and accompanying bust will occur sometime down the road.
Back in 1997-98 I had some family problems that caused a lot of financial damage. I ended up selling my home and taking 18 months off work to be an at home dad as my kids were so young. Even in 1998, I could not believe what people were willing to pay for my house. I thought they were stupid, to be honest. I had people offering more on the side, under the table.
After a few years, the kids grew enough where I could head back out and try to “catch up”. I repaired my credit enough to go house hunting. I was shocked at the prices of houses. None – and I mean none – of the houses I saw were worth near the asking price. Yet people were buying homes at lightning speed, for the same reason a dog licks his crotch. If one of the two breadwinners lost a job, the house was up for sale in 3 months. There were brand new neighborhoods in my area of the time full of big expensive homes. For sale signs popped up as regularly as the mortgage payment became due.
I never bought a house. Still don’t own one. Perhaps if they dropped even further, I would consider it. Of course now, I may be out of a job tomorrow.
Oblio,
Thank you for your above post. For the record, I agree with everything you have written. A few of your suggestions I have argued for elsewhere. But I still think the tipping point was Gorelick’s action (this toxic woman just keeps on giving us crap sandwiches, eh?).
Back in September I though they should suspend the mark-to-market rules for properties in trouble. I realize that a lot of people are managing to make their payments, despite the environment we are in. Just doing that step, alone, would greatly slow the deterioration of bank capital.
I continue to marvel over the fact that people still buy at the peak of the market, whether it be homes or shares of stock. My wife and I bought our first home in 1999. During that time we’ve seen the city of Rochester, NH assess the value of our property to more than double what we paid for it. It’s shocking how people are actually paying these prices for homes. But, many people believe the line that the realtors feed them: that housing prices are only going higher and higher, so suck it up and pay now!
Fred, many of us are trying to solve the problem, and I read your posts with great respect for your experience and insight. I’m trying to work on synthesis at this moment.
For the politicians, I’m afraid it’s a case of the Blind Men and the Elephant, compounded by political interests and fears. For the moment, I would rather have a solution than get distracted by partisan score-settling.
Having said that, Ms. Gorelick really is a piece of work: CRA, wall of separation on domestic counter-terrorism, 9/11 Commission, FNMA Board of Directors, and probably many other things than I can remember off the top of my head. She somehow emerges from all that with reputation intact, influence, and riches. Wow.
I have never been to Rochester, NH. I hope you don’t have to commute down to Boston.
s/b “can’t remember of the top of my head”
Alan Idiotspan was the Federal Reserve CHairman, he was the Gatekeeper of our finances. When he use to meet with the other “guru’s to deliver his assessments the kind of shoes he wore woould make the market go up or down, the media would report on what his farts smelled like! For him to say he didn’t have to power to stop CDO’s is him saying, I am above you all and there is nothing you can do about it! He like his cohorts told us all to “eat cake” so we need to yell “off with their heads”!
I few words I once read in a book that seems to scream, ” I told you so”!
“Then you will see the rise of the double standard — the men who live by force, yet count on those who live by trade to create the value of their looted money — the men who are the hitchhikers of virtue. In a moral society, these are the criminals, and the statutes are written to protect you against them. But when a society establishes criminals-by-right and looters-by-law — men who use force to seize the wealth of disarmed victims — then money becomes its creators’ avenger. Such looters believe it safe to rob defenseless men, once they’ve passed a law to disarm them. But their loot becomes the magnet for other looters, who get it from them as they got it. Then the race goes, not to the ablest at production, but to those most ruthless at brutality. When force is the standard, the murderer wins over the pickpocket. And then that society vanishes, in a spread of ruins and slaughter.
“Do you wish to know whether that day is coming? Watch money. Money is the barometer of a society’s virtue. When you see that trading is done, not by consent, but by compulsion — when you see that in order to produce, you need to obtain permission from men who produce nothing — when you see that money is flowing to those who deal, not in goods, but in favors — when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you — when you see corruption being rewarded and honesty becoming a self-sacrifice — you may know that your society is doomed. Money is so noble a medium that it does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half-property, half-loot.
Color me intrigued, Neo.
Are you slamming the quasi Austrian/Randian model of Greenspan’s economic viewpoint or are you lamenting the general lack of vision that he personally possessed to predict our current collapse?
I think Neo may find it interesting that Greenspan, an acolyte of Ayn Rand’s inner circle, would so willingly bow down to collectivism, group think, and “going along to get along”. Proof that no man is immune to corruption once in power.
Rather, the law has encouraged banks to be aware of lending opportunities in all segments of their local communities as well as to learn how to undertake such lending in a safe and sound manner.”
The fact that banks undertook more risky loans and more risky methods to make those loans obtain a profit is no social benefit nor economic benefit.