The Rise of the (Financial) Machines 403
BartlebyScrivener writes "A New York Times Op-Ed quoting Freeman and George Dyson wonders if Wall Street geeks and 'quants' outsmarted themselves with computer algorithms to create the current financial debacle: 'Somehow the genius quants — the best and brightest geeks Wall Street firms could buy — fed $1 trillion in subprime mortgage debt into their supercomputers, added some derivatives, massaged the arrangements with computer algorithms and — poof! — created $62 trillion in imaginary wealth. It's not much of a stretch to imagine that all of that imaginary wealth is locked up somewhere inside the computers, and that we humans, led by the silverback males of the financial world, Ben Bernanke and Henry Paulson, are frantically beseeching the monolith for answers.'"
The quoted essay from George Dyson is available at Edge.
This American Life (Score:5, Interesting)
Second, I don't think the current financial problem world wide is the quants' fault. I think this credit crisis and market failure (although it might have a little to do with the quants) can be directly attributed to the world market investing heavily in the subprime mortgage bubble. Now, there's still software to blame, but it's not the quantitative analysis guys, it's the software in the hands of people who were in charge of buying bad loans and shipping them off to Wall Street to be sold to investors with a monthly mortgage check paying a huge return.
There was a This American Life episode on this sometime back that dealt with explaining the global subprime mortgage financial crisis (now known as a worldwide credit crisis). About 26 minutes into the first episode [thislife.org], you hear them talk about exactly this (you can stream the shows from these links or look at transcripts). Alex Blumberg & Adam Davidson are two producers of the show interviewing those involved. Enjoy this dialog from the show on the no doc loans these idiots were handing out like candy to anyone:
Alex Blumberg: But Glen didn't worry about whether the loans were good. That's someone else's problem. And this way of thinking thrived at every step of this mortgage security chain. A guy like Mike Francis, from Morgan Stanley, he told me he bought loans, lots of loans, from Glen's company, and he knew in his gut they were bad loans. Like these NINA loans. ... we did it
because everyone else was doing it.
... didnâ(TM)t seem worried at all:
Mike Francis: No income no asset loans. That's a liar's loan. We are telling you to lie to us. We're hoping you don't lie. Tell us what you make, tell us what you have in the bank, but we won't verify? Weâ(TM)re setting you up to lie. Something about that feels very wrong. It felt wrong way back when and I wish we had never done it. Unfortunately, what happened
Alex Blumberg: It's easy to ignore your gut fear when you are making a fortune in commissions. But Mike had other help in rationalizing what he was doing. Technological help. Mike sat at a desk with six computer screens, connected to millions of dollars worth of fancy analytic software designed by brilliant Ivy league math geniuses hired by his firm, which analyzed all the loans in all the pools that he bought and then sold. And the software, the data
Mike Francis: All the data that we had to review, to look at, on loans in production that were years old, was positive. They performed very well. All those factors, when you look at the pieces and parts. A 90% NINA loan from 3 years ago is performing amazingly well. Has a little bit of risk. Instead of defaulting 1.5% of the time it defaults at 3.5% of the time. Thatâ(TM)s not so bad. If Iâ(TM)m an investor buying that, if I get a little bit of return, Iâ(TM)m fine.
Adam Davidson: Wait Alex. I want to step in for a moment because this is a very important piece of tape. A big part of this story, of this whole crisis, is that a lot of really smart people, people who knew better, fooled themselves with this data. It was the triumph of data over common sense. Can you play that tape again?
Mike Francis: All the data that we had to review to look at, on loans in production, that were years old, was positive.
Adam Davidson: As we now know, they were using the wrong data. They looked at the recent history of mortgages and saw that foreclosure rate is generally below 2 percent. So they figured, absolute worst-case scenario, the foreclosure rate may go to 8 or 10 or 12 percent. But the problem with is the
Re:This American Life (Score:5, Insightful)
YES! I whole-heartedly agree. I do not claim to be a financial maven, but I have been following the markets for a number of years and have some familiarity with the terms that have been bandied about as of late. But, these two shows did an INCREDIBLE job of taking arcane financial products and bringing them into focus with concrete examples. They showed how this crisis built up and is now unwinding.
As painful as this is, I do take some comfort in the crisis happening now rather than a year or two from now when even more leverage would have been injected into the system. That would make things FAR WORSE. Don't believe me? Let me repeat the links that eldavojohn [slashdot.org] provided: The first episode [thislife.org] sets the stage extremely well and explains how the mortgage crisis got going. The second episode [thislife.org] built upon the first and so clearly explains how the leveraging of these financial instruments got us into the credit crisis we are in today.
Listen to those. If you do nothing else today, LISTEN TO THEM.
More Leverage.... (Score:4, Informative)
I'm confused, and wondering what you're talking about.
The original leverage ratios were set by Basel, which pegged them at 8% (or 12.5:1). In 2004, this was updated. It's still 8%, but now assets are risk-weighted.
Claims on depository banks were were given the following risk weights:
AA- 0%
A- 20%
BBB- 50%
B- 100%
(worse) 150%
Unrated 100%
And to make matters worse, claims on securities firms were defined to be the same as claims on banks.
And the kicker, claims secured by residential mortgages were weighted at 35%.
As such, though the leverage ratio was officially 12.5, somebody who held nothing but mortgages could be levered up 35:1. And if you owned some bank issues, you could get nearly infinite.
But I'm wondering... what makes you think that these limits were going to be further increased?
Re:More Leverage.... (Score:5, Informative)
You obviously know more about these details than I. What I was working from was what I heard in the second program: Another Frightening Show About the Economy [thislife.org]. You can download it for free at the moment from: here [thisamericanlife.org].
Here's the summary for part 2:
The segment was so well done, it's hard to summarize, but I'll do my best. In essence, "Credit Default Swaps" (CDS) were presented as a form of insurance that a lender could by so as to minimize the risk that a loan would default. So far, so good. Then, somebody realized they could by a CDS for a loan they did not even own. So what? It got out of hand when someone realized they could make money by buying a CDS for something that was questionable. How so? Like buying life insurance. Like buying life insurance on somebody ELSE. Who is old and feeble. I have an opportunity to buy a policy for, say, $1M on this person. And YOU have an opportunity to buy the same kind of policy from your agent. The sicker the person, the more of an incentive there is to buy in.
Now, replace "old and feeble person" with "Lehman Brothers". And for "insurance company", try "AIG". And multiply just You and Me with hundreds or thousands of CDSs in play. With many, many other companies. As I understand it, there was no regulatory limit on how many CDSs could be purchased on the exact same debt issue. And, because there was no mandatory reporting or the like on what CDSs were out there, we really don't know just how many of these are out there. With all the repackaging of these as securities, sliced and diced and sold as yet more instruments, we don't know just how bad the situation is.
Again, I cannot do the show justice. Listen to the podcast. I'd love to hear your take on it once you have done so.
Re:More Leverage.... (Score:5, Insightful)
They would have been increased as long as no one got hurt.
I think there is going to be a very long lesson here. We have lost much faith in the Stock Market and our financial overlords. In order to keep this nation, and most nations, from coming politically unglued it will become necessary for the governments to assume a heavy hand over the Markets to either limit, validate, or guarantee the financial overlords.
I live in a society where it is extremely difficult to obtain a 1:1 leverage. It's possible to explain a 2:1 leverage to most people. But trying to explain how you can roll this out to 20+:1 leveraging merely results in a torches & pitchforks response. Anyone in their right mind knows this is too much.
Or rather, I should say, anyone who is not trained in the ways of financial genius will simply not comprehend this idea the first time around.
Leveraging is a must. But somewhere there has to be a real limit that upholds under the simplest scrutiny. If I can't show you a dollar in my hand, then I do not have a dollar. That's the point of reference that we are (almost) at today.
Re: (Score:3, Insightful)
I don't think we've lost faith in the stock markets. The public said the same thing back in 2001, and yet the market recovered to drop again another day. It happens. There are tons of people right now insisting that people have given up on the market while there's a (probably smaller group), who's patiently waiting with a pile of cash for the market to hit bottom so they can take advantage of the glorious opportunity that has been presented to them. The stock market is a long term game. Those who play
wrong-o, blame Moody's (Score:5, Interesting)
The people who made this a catastrophic mess (as opposed to just a nasty mess) are the credit rating agencies (Moody's et.al.) who pretended there was any way to make a security (mortgage-backed or otherwise) exactly as low-risk as a U.S. Government obligation. Far fewer folks would have been legally allowed to purchase these products if the ratings had reflected the actual risk inherent in them and thus the potential impact to the economy of a failure in MBSes and CDS insurers would have been far, FAR less.
Moody's played exactly the same role in this debacle as Arthur-Anderson played in Enron's and I personally think they *ought* to suffer the same fate AA did so that future ratings agencies understand that failure to perform due diligence jeopardizes their company's existence. Wall Street understands Moody's role in this and the broad market continues to tank in spite of Bernanke's and Paulson's actions because we don't trust the ratings given by Moody's to other financial products or even companies so nobody knows how much risk they are really sitting on.
Let me say this clearly -- the heightened leveraging of the investment banks caused some problems but it isn't the leveraging that made this a catastrophic problem. The problem is catastrophic only because (a) folks who shouldn't have been allowed at all to be exposed to these risks were allowed to buy in and (b) folks who should have been allowed to take these risks weren't prepared through proper compensation for the risks they took on. All because the credit rating agencies did garbage-class work.
Until the credit rating agencies get as scared of the consequences of their negligent actions as accounting firms were post-AA this will continue to be repeated every time some finance person imagines up a new way to pretend to eliminate risk from investments which are fundamentally risky.
Re:This American Life (Score:4, Interesting)
Re:This American Life (Score:5, Interesting)
I have a good friend who is in Upper Management at one of the major banks affected by the sub-prime/securities collapse. He told me a year and a half ago what was going on and used a great analogy to illustrate the point. This isn't necessarily breaking news, just an easy way of understanding a complex situation which the media tends to spin way out of context. Obviously, there's much more to it than this and I'm certainly not an economic expert...
All the major banks (6 at the time) were purchasing enormous blocks of "bad paper" (high risk "AAA" mortgage loans) from each other. They would in turn, back the bad loans with their own securities investments or even securities from other financial institutions willing to assume a percentage of the risk.
Billions of dollars of this bad paper, which everyone knew was bad since it was over extended by weak securities, was being passed around like a hot potato in a game of musical chairs. They all knew the music was going to stop and someone would be caught with their pants down. At times, particular banks in ownership of the paper would only hold on to it for hours or days - just long enough to make a fractional profit from the bulk interest. Although incredibly risky, this method would collectively work for everybody involved except one - like playing a single round of Russian roulette. My friend said the day to day business for the past 1.5 years was to simply find a buyer if you were holding the paper, or try to be next in line to purchase as quickly as possible, then sell again as quickly as possible.
Simply put, he said this just isn't the way the banking industry is supposed to operate. The level of irresponsibility wasn't really about the high risk sub-prime mortgages that were issued to questionable applicants. The true irresponsibility lays in the C-Level/Executive Management teams of all the major banks, who encouraged and practically mandated the daily buying and selling of high risk bulk paper at a volume that would collapse even the strongest of banks. The key here is the volume of risk - literally enough to crush any bank.
The first bank who got caught was Bear Sterns in January 2008. For some illogical and unbeknownst reason, the industry assumed a major financial institution like Bear Sterns would never be the one caught without a chair when the music stopped. The psychological ripple effect of this sobering event just made the stakes higher and increased the speed at which the game was played, rather than putting the brakes on.
He said that initially it was almost a relief when Bear Sterns collapsed, because he and many other people in the industry thought the game was over and they had made it through unscathed. But, to his astonishment everyone continued to play this dangerous game with a gambler's mentality. Each time Fannie Mae/Freddie Mac cut the rates, the banks took it as a sign to play another short term round of the game. Eventually when the larger, more conservative banks realized this was well on it's way to failure (the tip-off was the Fed stopped cutting rates) they ceased backing the paper with their securities and the game ended for everyone leaving the smaller banks, securities firms, and finnancial institutions with the highest debt/risk scrambling to recover from losses. Lehman Brothers was the odd man out this time around.
just my 2 cents... oops 1.5 cents now...
Re: (Score:3, Insightful)
That's certainly a good description of what happened at the end of this asset / debt bubble. I suppose the point I was trying to make is that a crash or recession was inevitable. The economy was fueled by people continuing to borrow more and more money, at a faster rate than the growth of the economy. Eventually it had to stop and should have stopped some time ago. There was a point where banks stopped buying *cough* "good" debt, and started buying "bad" debt. To keep the debt induced euphoria going, they t
Anti-math/science witch hunt (Score:5, Insightful)
Re:Anti-math/science witch hunt (Score:5, Insightful)
It's not really even "math" that's at fault here. It's "formal modeling" which is what all the quant and rationalist people use to set up their statistical regressions. When all else can be held equal, formal modeling can give you very powerful insights into causal mechanism and prediction.
The problem is, that in reality very little can be held equal. Formal modeling abstracts away too much of reality in order to come up with its parsimonious causal and predictive insights. In an economic equilibrium state formal modeling will do just fine. But if internal contradictions arising out of strategic behavior (endogenizing the formal models of your competitors into your own formal models in order to out-compete them) begin to mount, or if fundamental changes in economic structure change institutions that were previously used as assumptions (changes in the regulatory law, for instance), or if there's an exogenous shock to the markets then the formal models will be ill-equipped to explain much less predict.
Add to that the fundamental assumptions of rationalist formal modeling are highly suspect (i.e.: individuals and firms are rational maximizers of their economic interests; methodological individualism rather than herd behavior; rationality instead of bounded rationality in the more simplistic models; etc.), and you get a recipe for potential gross misinterpretation of socio-economic reality.
It's not the math that's the problem. 'Science' isn't really involved. It's the rationalist approach to formal modeling that is the center of the "machines on wall street" problem. It's the qualitative research that's not being done--the sociology and behavior of the actual people and organizations that their formal models are abstracting out with assumptions of rationality and individualism.
Re:Anti-math/science witch hunt (Score:4, Insightful)
Not quite. You see, numbers without science are just numerology. Numbers with Science are Mathematics.
Numerology has run rampant in financial circles since the general advent of computers. MBA's and traders, trained in the art of numbers, but not of science, led themselves astray with whatever concoction of forumlae pleased them most. Combine this with the connectivity of the internet, and the general mysticism surrounding computers in ordinary eyes, and you get an environment ripe for selling all kinds of fancy snake oil.
Quants were quacks. They still are.
Re:Anti-math/science witch hunt (Score:4, Insightful)
Let me be clear, however. I don't think that quantitative methods are snake oil or numerology. They can produce some very powerful insights, even counter-intuitive explanations that really increase understanding of phenomena. Quantitative is not inherently illegitimate.
The problem with quants is that they often rely on rationalist assumptions rather than solid political science or sociology. In order to make quantitative methods produce the best results, you need to do the concept-building, research design, and empirical legwork beforehand. Then you can set up a formal model (one that does less violence to reality), and run statistical regressions on that.
There would be nothing wrong with quant if it were based on solid political science or sociology rather than assumptions and uninvestigated data points.
The reality (Score:3, Insightful)
After all, the smart ones got paid very well and got big bonuses.
Sure some of them might be out of a job now, but since "everybody was doing the same thing, it wasn't their fault" AND it made their bosses rich too, so they'll soon be rehired to do the same thing all over again. After a nice holiday in the bahamas or something
It's the stupid ones who don't get it, and don't see how all this "fancy math" is actually just adding games to the casi
Re: (Score:3, Insightful)
I don't pretend to understand the formal model that was used to make mortgage investments. But HOW did the model not include some check on the underlying ability of the homeowner's ability to pay for the houses?
The ratio of home mortgage amount/owner's income is the PE of mortgage lending. How was it ignored?
Re:Anti-math/science witch hunt (Score:5, Informative)
That's just the point. They didn't do the sociology of the people taking the NINA variable rate mortgages. A lot of them were speculators who were buying properties with no money down and then flipping them. This had two effects: driving the price up because they could; and, making it looks like NINA variable rate mortgages were getting paid off with only slightly higher risk than normal loans. Once the house-flippers got out and interest rates went up, the people with no assets and no income left holding the variable rate mortgages couldn't pay and the house of cards collapsed. The model was based on speculators flipping houses, not on real owners.
If the quant people had done the sociology instead of just running the numbers, they would know who was buying and why the data appeared the way it did.
Re: (Score:3, Informative)
When all else can be held equal, formal modeling can give you very powerful insights into causal mechanism and prediction.
Of course, as the very foundation upon which all the formal modeling is built is flawed, it's no surprise that it falls down. It's not math, it's not science, it's the very axiom of the banking system that's at fault.
Essentially every single thing that has gone wrong can be traced to, and derived from, fractional reserve banking and the central banks. Everything above that is built on th
Re: (Score:2)
Thanks much for these links.
Re: (Score:3, Interesting)
these two episodes gave me more information in two hours than I could gather watching every single major TV news show for weeks.
Couldn't agree more, and I've only listened to the first so far.
From a UK perspective, I've missed out on much of the information in this show - I knew of the sub-prime crisis, but had no idea of the reasons why so many bad investments were made. Most coverage here simply glosses over the fact that mortgages were given to people with bad credit and fails to delve any deeper.
I was also aware of how things were exacerbated because of the uncertainty of who owned which loans - the show was a huge eye-opener i
People are actually missing the entire point (Score:5, Insightful)
First let me say, I don't think your analysis is wrong per se. At the level of the mechanics of where the crisis happened and how it played out in the minds of the people in the middle of it, it is perfectly valid.
However, this whole line of analysis is very much like analyzing a car wreck and concluding that the cause of accident was the driver's excessive application of braking and over correction. The driver was dead drunk. The underlying cause was the fact that his reflexes were so shot he couldn't react properly. It is largely irrelevant what the details are of how he lost control of the car, he was bound to do so under the circumstances.
Likewise the so called 'financial crisis'. Think of our economy/financial system as a bit like a building. Every part of the structure both adds 'load' to the building, and also supports the weight of the other component parts. As long as enough structural integrity exists to support the load at every given moment, the building stands.
Unfortunately what our whole society from top to bottom has been doing is looking at this structure and saying to themselves "you know, it is a waste of money to have that beam be 150% stronger than the load it is carrying" and then someone comes along and removes the beam and replaces it with one that's only 105% strong enough so they can use the extra materials someplace else, make more return on their investment.
Well, that could only go on for so long, and naturally people got a bit nervous and engineers pointed out that the building maybe was a bit shaky, so we invented a way to tie all the beams together more securely "well, if one fails its ok, if we spread out the load enough then no one part of the building will be overloaded".
Until finally one day the wind started to blow... Once one single part, ANY part of this massively over leveraged structure reached its failure point there was no margin left anywhere to take up the extra load anymore! Every part was already stressed to the absolute maximum limits of its capacity. And as long as things had kept going on an even keel it was inevitable that the search for profit would create even more leverage until inevitably the whole structure became so intolerant of even the slightest disturbance that it had to come crashing down.
The really disturbing part of this is that, as any engineer can tell you, when you reach this kind of situation of critical instability any small problem results in a cascade failure of the entire system. Every industry, practically every business, is leveraged out so far that even the smallest dips in cash flow result in immediate insolvency, which then propagates down the supply chain and up the 'wage chain'.
This thing is like an avalanche coming down the side of a mountain at 300 mph. The snow all around it looks all nice and quiet, but that means nothing. This thing has momentum, large momentum, and there isn't any stopping it because there's no redundancy left in the economy to act as a brake. No bailout plan or insurance scheme or nationalizing of banks or any other action anyone can take now is going to stop it until it gets to the bottom of the mountain.
The sad fact is we clearly saw, or should have seen, it coming. The system gave us every sign of being ready to fail. What was the 97 Asian financial crisis except a localized version of the same thing? It just didn't get big enough to build up the momentum to smash the whole system. Only one wing of the building fell off that time. If we had exercised any prudence whatsoever we would have taken the hint. But 'This American Life' certainly has it right in the sense that greed and hubris overrode common sense.
And look at where we are now. Hope you all have a nice supply of canned goods stashed. Best case scenario is they're about to get a lot more expensive.
Re: (Score:3, Funny)
If you haven't listened to that show, I heavily recommend it (no matter where you live, if you speak English).
I'm sure the non-English speakers reading this appreciate the warning.
Evils of subprime (Score:5, Interesting)
Guess what, subprime defaults are still under 10%, and even if they rise to 25%, that still means that 75% of the people with subprime mortgages were able to buy houses that they weren't otherwise. So "blaming" subprime is silly... the problem is that the holders of the banks mistook the risks, but nobody cared because as long as prices went up, they WERE risk free.
The problem in the boom was people took 2/28 and 3/27 loans... these were priced at 30 year loans (for amortization), but after 2 or 3 years, they reset from the low "teaser" (often 1% - 2.5% higher than the prime mortgages) to a high rate that would be 10% - 11%... The people getting them often didn't know that if interest rates STAYED the same, their rate would go from 7% - 11%, and they were qualified at the 7%... they assumed that sure the loan rate would "reset," but if interest rates could go up, they could also go down...
Brokers, new in the field, said things like "prime rate is stable, long term rates shift," because you had a 2 year stretch without the Fed moving it's rates. If someone had a low credit score now, they weren't going to be better in 2 years, because new home owners underestimate the costs of owning a home... but on paper, if you had some blemishes on your report, in Fannie Mae conforming only REALLY looked back two years (looked at 4, but mostly at 2)...
If you had a business or health failure, and took a LOT of hits on your credit score from not paying bills but nothing before/after, maybe you were better in two years. Most subprime people have a bunch of problems that are permanent. But, even if your score didn't improve, you could always refinance with another 2/28 in two years, giving the brokers your new equity in the house to try again...
So nobody worried, because with the market going up, if you couldn't make the payments, you could refinance out of trouble.
Re:Evils of subprime (Score:4, Insightful)
You are correct. The problem wasn't sub-prime mortgages. It was how they were used.
Instituions like Bear-Stearns and Lehmans would get all these mortgages and package them into various debt instruments and derivatives. The problem is, these institutions usually used leverage to buy such products on their private little market.
It's the leverage that ended up being the problem. A subprime default rate of 10% can be absorbed with a fair amount of losses, but what happens when you're leveraged 10:1, 20:1, 30:1? Leverage limits were raised during the boom an people trading in these markets took full advantage of it in order to bost their profits.
No why would someone gamble like that? Easy answer: skyrocketing real-estate. People buying these mortgages viewed them as win-win situations. If the people could pay, great. If the couldn't, the owner of the mortgage would get the house and resell it at a profit. This was also the reason why they were letting anyone with a heartbeat get into a house since they couldn't lose.
However, defaults skyrocketed and prices of homes plummeted. That's when everyone started asking how much the debt instruments they were holding were really worth. No one really had answers since the securities were very opaque. That's hen panic set in and everyone tried to sell. No one would buy them. So they stayed on their books and as more mortgages defaulted the people owning the debt instruments backed by those mortgages took on larger and larger losses.
Add in the idiotic leverage that many were using and it's very easy to see how a few percentage points higher defaults could result in billions of dollars in losses.
This little black market that the institutions were running was leveraged up to $64 trillion, which is 3-4 times the GDP of the planet. What we are seeing is the unwinding process. No one is sure who is holding what. Banks are refusing to lend in fear of not being paid back. This is as much a financial crisis as it is a trust and confidence crisis.
It's likely to get worse before it gets better.
~X~
Re: (Score:3, Insightful)
That's not necessarily the case. You can make subprime loans available without playing Hot Potato, but you need to estimate the risks properly and set the interest rates accordingly. This probably isn't true of so-called "liars loans", but not all sub
Re: (Score:3, Insightful)
Uhhh...huh? Where are financial institutions required to make subprime and interest-only morgages available? They were doing these things because they thought it would make them money.
Re: (Score:3, Informative)
the CRA did not compel lending to bad credit risks.
what it did do was compel banks to actually assess people based on credit rather than arbitrary geographic area.
Re:This American Life (Score:4, Interesting)
Interest only loans exist for perfectly good reasons. They just aren't good reasons when applied to something like a home mortgage, that you're SUPPOSED to pay off over time. Consider a business line of credit. Lets say I run a business which I want to expand. This will require me to carry debt for a short period of time. Commercial paper is what they call it, but an interest only loan is basically what we're talking about here. I do something, or sell something that has an expense to create. I need to spend the money now but it'll be 30, or 60, or 90 days before I get paid for it. So fine, in 90 days I'll get paid, and it will cost me say $10 to produce the product and $2 in interest, but I'll make $15 once it gets paid off. When the choices are make $3 or make $0 becuase I can't afford to produce it in the first place, it makes sense. So it's going to take 90 days to get paid, but in 30 days, I need to crank out another product. That means more loans. In fact, that means I'll virtually ALWAYS have a loan out, which I'm paying interest on all the time, but never paying off. Of course, I could use my profits to pay down the debt, and if I'm not growing, requiring further up front expenses, then I certainly will pay it down. But for a company that's growing, a long term interest only loan makes perfect sense, as it provides them with the ability to make money. The bank certainly has no problem with it.
The difference here is, a house that you're living in doesn't make any money. At least, it's not supposed to. Oh sure, if you maintain it well it shouldn't lose any value, and if you spend $40k to add on a couple rooms, it might increase in value proportionately, but you're doing good if you sell your house for 6% more than you bought it for. Just enough extra to pay off the realestate agents and not consider it a loss.
All of that changes though when you consider that a house might increase in value, not because it generates revenue, but because the housing market in your area increases and suddenly your house is worth more... just because it is. The bank now thinks that this is safe collateral on a interest free loan as they'd be able to recover their investment through a foreclosure. That's why we had a subprime mess to begin with. The banks simply didn't care if the owner could pay the loan back as the house would be worth more later anyway.
There's another way to look at it. Interest payments on home mortgages are tax deductible. If you're constantly carrying around $20k in credit card debt, it makes perfect sense to refinance your home and pay that off. First off, you'd have a lower interest rate, and secondly, interest payments on the cards were not tax deductible and now those payments are. So if you're the type that's sitting with maxed out credit cards and you keep them maxed out, it might just make sense to transfer that debt to your mortgage, cut up the cards, and make interest only payments and pay cash for everything else for now on. Of course, that represents and requires a level of responsibility that you're probably not going to be able to live up to in the long run, and ultimately that's a big part of the problem. If people were more fiscally responsible in the first place, didn't purchase beyond their means, everything would be perfectly peachy right now.
-Restil
TFA perpetuates voodoo explanations (Score:5, Insightful)
Thanks, New York Times. Does your average reader have the reading comprehension of a 9 year old these days?
Here's what happened in simple English: investment banks invented various ways of packaging mortgages into securities. They then convinced ratings agencies to give these new securities AAA status even though the ratings agencies didn't understand them. This gave mortgage brokers a license to commit fraud because they could give a mortgage to anyone with or without a pulse and there was a sucker just dying to buy that new mortgage from them. With such easy money available, real estate agents were able to pump and dump properties (strong-arming housing appraisers was a favorite tactic) like there was no tomorrow and convince people that housing prices only go up in a straight line. In the final act of the play, the investment bankers, mortgage brokers and real estate agents that caused this retire in the Cayman Islands while taxpayers are left to clean up the mess while we hope our economy doesn't literally implode.
I don't see what's so complicated about any of this. It's pure and simple fraud on the most massive of scales.
Re: (Score:2, Insightful)
Ohhh, the rating agencies understood them just as well as anybody else.
There was a big data hole, static pool loss curves. They didn't have any for exotic loans being pushed to lower credit people, since all of the exotic loans had original uses for high-credit obligors. Thus, their loss estimation was too low, the multiple was too low, and thus, the credit enhancement was too low.
Nobody is retiring to the cayman islands, I think you need to get that fantasy out of your head. They were just as caught up
Re: (Score:2, Troll)
And here is some NYT contributer who wants to blame computers and the nerds. Sure, blame the scary robotic overlords. The financial collapse can't be the fault of ordinary humans, no sir!
This is just some attention-whoring author trying to use the financial crisis in order to sell more books (even though his book has nothing to do with the crisis). Nothing to see here, please move along.
Re: (Score:3, Informative)
Don't be so touchy. The point is not that the crisis is the fault of "the nerds", but that the risk was effectively masked by the conversion of mortgages into ill-understood derivatives. Everyone along the chain could ignore it because it would always be the next guy's problem. The models that evaluated the risk of default were based on historical data, and failed to take into account that both the quality of the mortgages and the nature of the housing market were changing rapidly.
Re: (Score:2, Insightful)
It's an op-ed, not an editorial or a column. An op-ed is one step above a LTE, and is generally lightly edited. So it's hardly fair to blame the NYT for some specific stupidity of an op-ed or an LTE; their main concern is publishing a broad spectrum of well-written opinion.
Re:TFA perpetuates voodoo explanations (Score:5, Insightful)
You forget the underlying problem: the bubble in housing prices. As long
as the house prices kept rising any idiot could take a 0% interest adjustable mortgage and make money 3 years later by reselling the house. Of course, analytical models showed the repayment rate on such mortgages to be high leading to lending more money.
Once the house prices started sliding the party was over.
Re:TFA perpetuates voodoo explanations (Score:4, Insightful)
Re:TFA perpetuates voodoo explanations (Score:5, Insightful)
people assume and have been told for years that real estate will *always* increase in value
And you know who told them this?
Every one of those people had a clear financial interest in the general public believing that house prices always go up. The good news is that for the next 20-50 years, there will always be somebody handy to call bullshit when this lie gets trotted out.
Of course, nobody will actually learn the deeper lesson: to be skeptical of things that "everybody" believes, especially when they are appealing to you and lucrative for somebody else.
For better NYTimes coverage... (Score:2)
This particular piece is pretty bad, but I heard one of the more lucid explanations of the whole mess and bailout response by NYTimes reporter Gretchen Morgenson on NPR's Fresh Air with Terry Gross. That was back on September 23. You can find the podcast here [npr.org]; it's a little stale now as the baleout has evolved since, but Gretchen Morgenson won me as a fan that day.
Re: (Score:2)
its more complicated than that when you sart to factor in how they got round the regulatorary rules. Banks must hold some liquid asset to cover themselves if their leveraged investments go wrong, and they used to count how much they had using a 'mark to market' approach - where you figured out how much you had by seeing how much it was worth on the open market right now. So they changed that to a 'mark to model' approach where you count what it might be worth in the future when you came to sell them.....
You
Re: (Score:2, Interesting)
While most securities are traded openly using an intermediary, market maker or a broker, in this case the banks originated and purchased these things hidden from the open markets. They also conveniently pushed them off the balance sheet onto strange accounting entities (SPVs etc) whose purpose was solely to hide what they were holding. They did this so as to avoid the fluctuation of prices on their balance sheet
Re:VaR anybody? (Score:5, Informative)
Re: (Score:2)
Is it just me, or does that sound more like fire insurance? :)
Re:VaR anybody? (Score:4, Insightful)
"Yes, it's called in-sewer-ants"
Re:VaR anybody? (Score:4, Informative)
Now, there are several ways you can do this. One is to run a massive monte-carlo simulation on all the input data, something that all financial software supports. There is a problem with this though, and that is that it requires some massive CPU power. Even a smaller bank would require many hundreds if not thousands of CPU's chugging away for 12 hours or more to come up with the proper numbers.
The solution they've come up with is called "historical VaR". What they do is to use the historical market data for the last year instead of random data which would be used otherwise.
The obvious problem with historical VaR is of course that it doesn't take unexpected market movements into account. If a drop such as the ones that we have seen recently haven't happened in the last year, VaR won't take such a scenario into account.
So, in short, VaR only really works in "normal" market conditions. It doesn't take extreme movements into account.
Re: (Score:2)
My colleague who stated he has an A Level in Economics asked where all the money came from for the bail outs?
Education is a waste of time.
Re: (Score:3, Insightful)
We'll all be paying for this for decades (unless we're among the hundreds of thousands in the UK, and probably millions worldwide, who will end up unemployed as a result of the bonus-chasing pinstriped bastards who caused all this), and the same situation will arise again when another bunch of fraudsters figures out a way to multiply money in a totally fictitious manner.
Re:Slaves to Debt (Score:5, Insightful)
Gold is useless except as decoration. It only has value because people have been conditioned to think it does. The same is true for dollars, euros, or any other currency. The gold standard is no less abstract than any other form of currency, since the value a gram of gold has is entirely arbitrary and not inherent in any way.
Re:Slaves to Debt (Score:5, Insightful)
The gold standard is no less abstract than any other form of currency, since the value a gram of gold has is entirely arbitrary and not inherent in any way.
It is less abstract in at least one very important way - the amount of work it takes to extract another gram from the ground and put it in a vault.
Modern currency has effectively zero marginal cost to make more of. There are pluses and minus to that fact - as in money can now represent something like the total value of the economy of the country rather than be limited to a pile of metal in a vault somewhere.
On the other hand it also makes it really, really, really tempting for the government to just print more money in response to any fiscal crisis with the obvious long term effect of devaluing all the money had been previously printed.
Re: (Score:3, Insightful)
Except that if you create more money, as you said, all money becomes worth less. This loss of value by the existing money IS the marginal cost of creating more money. This means it isn't all that tempting to print more money. Which is why our government typically doesn't use that method to pay more more spending. Instead they take out debt (a problem in and of itself), which actually has the effect of _removing_ liquidity.
Re: (Score:3, Insightful)
Gold is useless except as decoration.
Tell me, sir, do you own a computer?
Sorry to tell you.. (Score:3, Insightful)
This effect is called the "money multiplier", and it's been around LONG before anyone went off the gold standard.
Without the money multiplier, the industrial revolution would not have gotten very far.
The reason we're facing massive economic collapse is not because of debt defaults per say, but because the markets are so skittish that nobody is lending, thus the money multiplier is being squished into nothing.
This is exactly what happened during the depression, though for slightly different and more severe r
Ah, liberals are at fault. (Score:3, Insightful)
I see where you're going with this. You're blaming the "Community Reinvestment Act" (CRA) that basically forces banks to lend to people they wouldn't otherwise lend to (i.e. people with bad credit) because they have to fulfill racial quotas.
I agree with you that this is part of the issue. But this whole problem is so far beyond liberal/conservative or Republican/Democrat. The problem is that we have a fairly corrupt syst
Re: (Score:3, Informative)
see this:
this:
Its the Economists, Stupid! (Score:3, Insightful)
If civil engineers refused to back up their calculations with formulas derived from physics, they'd be liable when their structures fail. That's why they are lucky physicists -- at least the classical physicists upon which they base their calculations -- were fundamentally competent. The "quant geeks" are similarly limited -- but their problem is that their "physicists" are better than Court Astrologers -- but not by much.
Re: (Score:3, Interesting)
The point is that there was no consensus model adhered to by the vast majority of economists that produced a consensus prediction.
The creation and transfer of funny money (Score:4, Insightful)
But they can. They did. The '90s tech bubble burst. The funny money that was created in the run up was promptly transferred into real estate. Lenders, overcome by a similar greed that overcame retirement investors, lent to people they knew they shouldn't have (or should have known). And voila. We have a horrible mess - basically, we think we have a lot more money than we actually do. The only viable solution? We need to realize the loss. It was never our money in the first place.
Re:The creation and transfer of funny money (Score:5, Interesting)
I've read my history. The gold standard places a dangerous deflationary bias in place on economies, often turning recessions into much more dangerous depressions. Anyone advocating such a policy has NOT read any history worth reading.
I'd suggest the following:
Golden Fetters: The Gold Standard and the Great Depression, 1919-1939 (NBER Series on Long-Term Factors in Economic Development), Barry Eichengreen, 1996, ISBN 0195101138
Re: (Score:3, Informative)
The main problem with the gold standard is that it ties the amount of money available to the economy to the amount of gold available to governments. Well guess what this has nothing to do with the size of the economy. Especially in an economy that is very service oriented. Gold is a natural resource that is becoming increasingly difficult to dig out of the ground. People tend to hoard gold (see Roosevelt's gold confiscation in 1933) taking it out of circulation. Gold has other uses - jewelry, inert plating
Pure speculation, your honour. (Score:2, Insightful)
This might make an interesting defence for the crooks and gamblers who caused the problem through their greed and incompetence, but I'm not sure it deserves a place on what is generally a science/IT website.
This is ridiculous (Score:4, Insightful)
Risk analysis of property lending (Score:5, Funny)
1. House prices and property keep on rising. If you buy a house now you can sell it next year for say 15% more. Gear up, buy and then let out your property to make even more money. Look at all the TV proggys on making money from houses to prove this point. Whatever price you pay is not an issue. Borrow at 7 times your earnings and 125% of the said value of the property is no problem. Fill your boots and make a ton of money, guaranteed. No risk.
(Don't listed to those old type bank managers who were so unhelpful and whom banks fired years ago in favour of salesmen selling whatever they could. They knew nothing).
If in the unlikely event someone could not pay their mortgage (very rare event) the property would absolutely be worth more than their mortgage arrears. Even better sell the loans to some other sucker. No risk here.
2. As you all know interest rates are undeniably under control and will never significantly rise as our central banks are such clever chaps (and chapesses) and have everything under control. So we will see a low interest rate environment for many years, so no risk here.
3. Inflation is absolutely under control and will never get out of hand, again thanks to the geniuses managing our economy. So no worries here.
4. Gearing is good and isn't risky, if you are really clever. Gear up as much as you want and to make even more money at little risk. Better still borrow in say Yen at very low rates. The Yen will never rise against the $/£ to any degree, so no risk here.
5. Banks and bankers are very clever people and know what they are doing. Look at their pay and bonus packages to see how astute they are. Shareholders would never allow incompetents to have such large pay packages if they were not undoubtedly geniuses. With the bankers at the helm nothing can go wrong, obviously. No risk here.
Risk Calcs = 1 + 2 + 3 + 4 + 5 = naff all risk so fill your boots.
What could possibly go wrong?
Douglas Adams gets it right AGAIN! (Score:5, Interesting)
They've obviously been using Reason - no, not the virtual synth package, but the one described in Dirk Gently's Holistic Detective Agency:
Gordon's great insight was to design a program which allowed you to specify in advance what decision you wished to reach, and only then give it all the facts. The program's task, which it was able to accomplish with connsumate ease, was simply to construct a plausible series of logical-sounding steps to connect the premises with the conclusion...
...The entire project was bought up, lock, stock and barrel, by the Pentagon.
Douglas Adams
Shesh... and the guy also predicted Wikipedia and Microsoft (or did he *cause* them?)
(Since DGHDA also contained a fair bit about computer music, I assume that the name of the synth package is no coincidence).
Ever wonder where 'money' comes from? (Score:5, Informative)
Check out this 47 minute video for a very easy to understand and clear explanation.
http://video.google.com/videoplay?docid=-9050474362583451279 [google.com]
Unless you've been through university on some Economics degree - you were probably unaware of this.
Re:Ever wonder where 'money' comes from? (Score:4, Insightful)
Exactly, that's how one can easily arrive at 62 times the original amount. Truth be told it's probably worse. If you look at some basic numbers; the world production is measured to be about $50 trillion.
The secondary money market (known as derivatives) in the US, is $500 trillion. This means that the primary lending source (banks) sells the loans to someone else. Who incidentally, unlike banks, are totally unregulated. Who in turn then sells it too, and so it goes...
This is done with loans so many times over that we 10X the worlds total production. Think about that. A country's currency is really worth what the country produces. Just like any persons worth is what he has made. Countries used to say they are worth their weight in gold but that fact is only in history books. (Don't tell those who speculate because they make money on other people's work by driving it up and down.) Not gold on hand or anything like that. Which the Fed has all but lost anyway. The dollar is so overrated at this point it's not going to be pretty once the world starts looking closer.
My guess it's going to occur right around the time gold starts its climb back up. Gold has been going down for a long time. As I see it, all stocks and bonds are going to be worthless soon, and gold will be the only thing not only retaining value, but with currencies going down gold will go up.
Increase the score for mrbill1234 for the above link. Congress would do well to see it too. Too few people bother to learn what is going on, and now we pay the price for our ignorance.
If you have paid attention last week to the news a representative of the Federal Reserve actually came out and said it. For every dollar the bank has - 10 is lent out. His point was that removing 700 Billion means they lost 7 Trillion. Which is not correct because they just make more for each loan. It has nothing to do with Congress, that's just how the banking industry works.
With some simple research you can discover how the international banking world caused the -29 crash, and the two leading up to it as a business move. A move that let them come in as the saviors and start the Federal Reserve. This they said will stop it from happening again. You'll find for example that Pres. Woodrow Wilson on his death bed declared that he had sold out his country when he signed it into law. (Federal Reserve.)
Everybody figures that someone else is keeping an eye on things. As it was, our Sec of Treasury, and the Federal Reserve, went out and significantly lowered the requirements to get a home loan. Allowing people who could never afford it, to get a house loan. That's what I call creating a problem.
Re: (Score:3, Informative)
It's worse than that:
Re: (Score:2)
Ugh. I'm about half way through this and it's incredibly patronising, doesn't tell me anything I didn't already know, and oversimplifies a lot of things to push an agenda based on a flawed economic model. Does it actually get in to discussing the concept of liquidity ever, or does it just cover kindergarten economics?
Economy is Fundamentally Buggered (Score:5, Insightful)
The real problem is that Greenspan and Bernanke seem to have failed both basic economics and remedial math. Also, they must have been absent on the day that Keynesian monetary policy was explained.
As unpopular as it may be with some people, what you are seeing today are the fruits of Reagan-era economic policy, "Reaganomics" or as G.H.W. Bush called it "Voodoo Economics."
Basically, the Fed. has kept their lending rates artificially low for the past 20+ years. They have kept this rate well below the rate of inflation. Banks are paying and charging interest using this rate as the basis, since this rate essentially determines the "cost" of money.
Keeping this rate below the inflation rate encourages spending and borrowing rather than savings. After all, why save at 1% when inflation is 8% and you can borrow at 6%? By borrowing now, you can increase your buying power immediately, and get more for the same amount of money, instead of losing money in a savings account.
That's all fine, assuming your wages increase along with the inflation rate, but for most people, they haven't. When wages are not increasing to match the rate of inflation, then people are effectively getting a cut in pay and can afford to buy less stuff. (Obvious, right, but many people need this simple fact explained to them.)
So, as mentioned above, the low Fed. rates encourage borrowing, and even with the modest income increases most people can afford to keep on borrowing, but only for so long. Unless wages make a dramatic increase, borrowing consumers reach the point where they have borrowed all that they can afford to borrow. They reach the point where they are making minimum payments on their loans, paying bills, and for food, energy and other essentials, and there is no money left over. Upon reaching this point, even the most obtuse consumers will cut back on spending and borrowing. Those who don't will default and go bankrupt, whether they file papers to seek bankruptcy protection or not, they will for all intents and purposes be bankrupt.
This is, essentially, what has happened to the U.S. economy. The orgy of spending and borrowing has ended because the sun has come up and all the drunkards are staggering home after the party with massive hangovers.
This is also why injecting $700 billion to buy "bad" debt won't solve a thing. Even if the gov't buys the debt, the consumers will still owe that debt, and the conscientious ones will still try to pay it. As long as the consumers have to pay that debt, spending in the short term will be curtailed.
In the short term, there is no easy fix. In fact, many would think the cure to be worse than the disease. The long term cure is to return to the days of higher interest rates, less spending and more saving. Quite simply, Greenspan's little experiment on the American people has failed to produce the endless growth that he promised.
Wrong diagnosis but right fix. (Score:2, Insightful)
As unpopular as it may be with some people, what you are seeing today are the fruits of Reagan-era economic policy, "Reaganomics" or as G.H.W. Bush called it "Voodoo Economics."
This has nothing to do with Reagonomics. The idea behind Reagonomics was to lower the upper tax brackets from 70% down to a flatter rate so that people would be encouraged invest to invest their money and thus create a greater supply of consumer goods. This did exactly what it was supposed to do, as a whole the prices of consumer g
Everyone misunderstands Voodoo Economics... (Score:5, Interesting)
The Voodoo Economics attack was at the Laffer Curve, which claimed that there is a ideal point of taxation that maximizes government revenue, and above that, people don't do economic activity and therefore taxes decline. Reagan predicted that his tax cuts would increase revenue, which was NOT the case, but it did free up capital, got the economy going, and tax revenues DID increase in time. Also, we have really cut taxes... I'd like them lower and flatter, but we can't do that without cutting the government. Taxes are running around 17% of GDP and governments expenditures at 20% of GDP... I'd like to see those both around 10% or less.
The real thing that Reagan cutting taxes did was:
A) transfer wealth to current savers (money in 401k and tax deferred annuity programs) had deferred 70% (or 90% at some point) taxes, and could now take it out at 30% in the early days
B) allow middle class people to build wealth... middle class people get paid a wage/salary, whether that wage/salary is 20k or 250k, they pay taxes on their labor, and if the rates are high, they can't build wealth, if they are low, they can work overtime/part-time second job, and use that extra money to build wealth, at 70% - 90% taxes, they can't
C) stopped the real estate only system... the tax code HEAVILY favors real estate investors -- you can tax defer the capital gains forever by buying a new property (important when Capital Gains rate was 40%, where Obama wants it, less important at the 15% it is now -- and you can depreciate property... if you can buy a building for 3M, and depreciate it over 30 years, you have 100k in "losses," so if you are making 100k/year in profits renting it out, it's tax free... sure your depreciation gets paid back when you sell the property as a capital gain (so you convert ordinary income, taxed at 40% with FICA into capital gains at 15%), and can be deferred on an exchange
The problem is Obamanomics is that it is NOT Clinton-style populism and fiscal conservatism (at least when paired with a GOP Congress), it is NOT FDR/LBJ New Deal/Great Society program heavy, it is European style socialism... heavy on regulation, income redistribution, etc... capitalism produces more gains/growth, but also downturns... Americans suffer more in economic downturns, but we benefit more in upturns... You can't have the upside without the downside, which is what people apparently want.
let me break the news to you (Score:5, Insightful)
and let me break another news while im at it : there is a third concept : balanced economies. economies in which existentially critical services are controlled by government (like military, police, justice, healthcare) and all the remaining sectors are properly regulated so that no self interest group, criminals, fraudsters, scamsters can do stuff to break the entire system.
what im describing is europe.
judging from the success of europe in the last 20 years (in all respects, including better distribution of wealth), and the extent that u.s. sank ( to the point of sinking ENTIRE world economy with itself), i'd say that that holistic economic rant of yours have no substance anymore.
so please, stop it at least from now on, and conceive something new. reagan, republican eras are dead. and they wont return. neither the stupid 'let businesses be' 'youll kill jobs' 'market can solve' stupidity and accompanying wild west behaviour will.
Re: (Score:3, Funny)
i dont give a damn about shift key and capitalism.
Fixed.
Re:Wrong diagnosis but right fix. (Score:4, Insightful)
What we have ended up with under Reaganomics is an economy that invests far too much of its money in non-productive consumer goods. Worse still, we buy most of those non-productive consumer goods from offshore factories. The net-result of this has been an economy based largely on the service sector, where an increasingly large sector of workers are employed in Mc-jobs. This is a massive misallocation of our labor force. Huge numbers of otherwise intelligent and capable workers are imprisoned in jobs that only require the intelligence of a twelve-year old. Meanwhile, our best and brightest go to work for huge financial corporations as lawyers and analysts, where their job descriptions can largely described as "gaming the system in favor of the company". Whatever happened to going to work for NASA?
The parent post makes the classic error of many right-wing analysts, of looking mainly at the financial numbers, while failing to acknowledge the reality on the ground.
Re: (Score:2, Interesting)
Usually when a government goes bankrupt (or significantly loses money) , no one would buy their bonds . This means that no one is willing to lend them any more money - this should cause them to pay a higher interest rate. In the case of the U.S.A, it is the exact opposite. When US government announced that it was going to print $700 bn more of money and use it on an dubious plan, the rest of the world should
Computer models do what they are told. (Score:5, Insightful)
Look, if you live in an environment where you are under pressure to sell loans regardless of the risk, then you are likely going to wind up with computer models that tell you that it is going to work.
Computer models always carry the assumptions of the authors and those assumptions can be altered to suit climate. In the case of Wall Street, the assumption was likely the number of defaults on an M.B.S. as a function of credit score... and the thing is, that I bet that is spooking everyone is, that, credit score may not be a good predictor of repayment. I bet a lot of people had a decent credit score, right up until they mailed in the keys to their house.
Re: (Score:3, Insightful)
Look, if you live in an environment where you are under pressure to sell loans regardless of the risk, then you are likely going to wind up with computer models that tell you that it is going to work.
The problem is not that individuals were given ARM & NINJA loans/mortgages.
The problem is not that the individuals were unaware of the exact nature of the loan terms they were receiving.
The problem is not even that the housing market collapsed and fucked over those individuals.
The problem is not that, instead of holding onto those loans, banks bundled that shit up and sold it.
The problem is that Moody's, Standard & Poor's, Fitch, and other financial rating agencies said "we rate these high-risk bund
Re:Computer models do what they are told. (Score:4, Interesting)
When analyzing a disaster, "the problem" is not one of the things that, if changed, could have prevented it. It's all of those things.
There are a bunch of relatively dumb things that made this disaster possible. It only happened because people were looking at the system as if were static, and assuming that their change was the only change.
To create this crisis took venal lenders, dumb borrowers, shitty loans, sloppy packaging, too-cheap money, weak modeling, corrupt ratings agencies, excess leverage, poor transparency, unchecked greed, perverse compensation structures, rampant lobbyists, irresponsible government, and incompetent regulation.
We shouldn't fix just one of those. We should fix all of them.
Re: (Score:2)
No fucking duh. That's why this is called a credit crisis. The normal measures of who will be able to repay a loan and who won't have totally broken down. Car dealers can't buy cars to put on the lot, because they can't get any credit, because the banks are afraid no
Re: (Score:2)
The normal measures of who will be able to repay a loan and who won't have totally broken down.
Well, FICO is stupid. It bases its decisions on how much to lend based on whether or not you are paying the debt you already have, based on the hope that this asymptotic borrowing curve is the same as knowing one's ration of income to indebtedness, and it just isn't.
Geeks are not to blame (Score:3, Interesting)
I am a quantitative analyst. True, there were many modeling flaws with the way ABS and MBS were priced, which made it appear that they were very safe and had good returns. Now when that happens what do you do ? You borrow short at a low rate, and invest in that secure product which produces a higher rate.
On a free market, this will quickly rise the short term interest rate (demand increase and the supply of saving is finite) and slowly drive down the return on mortgages as more house are being built.
On the US market it will not rise the short term interest rate because it is set by the FOMC, it will instead create inflation. Thus, the money used to invest in those mortgages will not be lended by someone, it will be printed. There is no direct mechanism by which the lending dry itself out... the guys at the FOMC have to figure there's going to be inflation.
So yes, there have been many mistakes in modeling, but such mistakes are bound to happen, in any industry, and they will have bad consequences (they're mistakes!)
The problem is the federal reserve system which magnifies the effect of financial mistakes by a few order of magnitude by disconnecting the interest rate market from reality.
Re: (Score:3)
How about you judge my arguments instead of doing simple ad hominem ?
Imagine a team of engineers are asked to come up with plans for a boat. They come up with the plans, but they make an error and the boat has a flaw. At this point the government decides to build 200,000 of these boats and too load as much people as possible on them. All the boats sink killing hundred of million of people.
Engineers are to blame for the flaw, but government is to blame for the tragedy.
Unfortunately (Score:5, Insightful)
The author has a fundamental disregard for the actual underlying causes of the current economic crisis - the housing bubble. It cannot be that housing prices inflate over 300% (yes THREE HUNDRED PERCENT) in a mere ten years, while real inflation adjusted income remains the same. Sub-prime mortgages don't exist because there's a new generation of people out there who suddenly decided to default on their loans. They exist simply because no one can afford a house anymore.
Whoever you want to blame: "greedy" banks who made "irresponsible" loans (yeah, who ELSE were they going to loan the money to? There were no more buyers able to afford homes at those prices), the Fed for continuing to mismanage monetary policy (but the Federal Reserve has a history of doing this, dating back to its inception in the early 20th century), or creative accountants who tried as hard as they could to hide the shortcomings in these new "structured investment vehicles", the driving force behind today's (and tomorrow's!) economic woes is the pop of the biggest housing bubble in history.
The interesting thing is that the government has opted to print money to try to "save" the financial system and keep housing prices artificially inflated - as if anyone cares. The only person who cares about the price of their home is the person who wants to sell it. If you wanted to buy a house this year and sell it in 2 years for near 100% profit, well, welcome back to the real world again. This move on the part of the government will soon result in a collapse of the dollar.
But I was laughed at by some in July [slashdot.org] when the market was close to what many thought was a "market bottom" for saying the stock market was going to plunge lower. Guess what folks - we're still not at the bottom, despite being very near post-dot com bust lows. As a trader I watched the Dow drop 700 points in 5 minutes on Friday, only to bounce back positive, and then plunge again. This kind of volatility is NOT indicative of a bottom, it's indicative of a move to NEW lows. Housing prices should (if past bubbles are any guide) drop around 50%, which means they still have another 30% to go. Government interference in this correction will only serve to bankrupt an already insolvent US government, and destroy the US dollar's desirability on world markets.
The only people who are to blame are the greedy individuals who thought that the path to riches lay in buying real estate and "flipping" it a year or two later, with minor renovations - as well as a monetary system that is designed to spend today and pay tomorrow.
Re: (Score:3, Insightful)
Why would you blame "greedy" individuals?
Because "bubbles", be it Dot-coms, tulips, south sea trading companies or real estate, are always powered by human greed. Rationality is NEVER part of a bubble - only the expectation that prices for the good in question will continue to rise forever. This is not rational thinking at all.
Expecting people to make sub-optimal financial decisions so that they can collectively improve the situation at a macro-scale is silly.
No,
Rules and Regulations (Score:2)
there was noone to tell them 'hey you cant create new assets out of those assets', because the rules to judge and act were not there and set.
as a result these people simply did what they did. its not the fault of computer systems. after all they are just tools. they could have done that with black ink and paper too, through the books.
a stretch (Score:2)
Um, yes it is a stretch. Word to the wise: prefacing any statement with "it's not much of a stretch to imagine..." does NOT mean the ensuing statement automatically becomes valid. (Related concept, illustrated in Talladega Nights: pre
This is at least the third mess made by quants (Score:4, Interesting)
The first mess was the stock market crash of 1987. They came up with something called "portfolio insurance". They combined program trading, futures, and options into an incomprehensible stew that was supposed to allow a mutual fund to buy highly profitable, highly risky stocks but insulate itself from their risk. It went haywire and the market crashed.
The second time was Long Term Capital Management in the mid-to-late 1990's. It isn't clear what they were doing, but it almost caused a worldwide financial collapse and required government intervention.
This time it was financial deregulation, predatory mortgage lending, collateralized debt obligations, and credit default swaps. None of this stuff was understandable, including the mortgages and all the derivatives. Many mortgages violated Truth in Lending laws. They misled the prospective homeowners about the terms, and put them in fine print that an average person couldn't understand.
The underlying problems are these:
1. Financial derivatives. They take stocks, mortgages, and bonds and bundle them into other financial instruments, such as index instruments, and mortgage bundles. They do other things like splitting the interest from the principal and putting them into separate instruments. They then create futures, options, and options on futures for the bundled instruments. Options on stocks and bonds are reasonable and understandable. Futures on real commodities are understandable and valuable to producers and users of the real commodities. The rest of the derivatives add more and more complexity.
2. Allowing derivatives to settle in cash. This turns the derivatives into side bets on the real financial instruments. This is how 4 trillion dollars in mortgage and other bonds turned into 62 trillion in credit default swaps. A speculator doesn't have to hold the bond to buy "insurance" that the bond will pay off. A speculator doesn't have to hold a stock or borrow and short it (creating an obligation to buy it to close the loan) to place a bet on its price.
3. Arbitrage trading strategies that connect the derivatives side bets to the real market. The side bets don't remain side bets. The trading strategies do things like enabling speculators to drive down the prices of stocks while bypassing the discipline of the short sale procedures (which were also relaxed due to financial deregulation). These procedures include requirements for the stock price to go up on the transaction preceding the short sale (the "uptick" rule), and requiring the short seller to actually borrow the stock before selling it.
4. Financial deregulation that allowed all of the above problems to fester, and in some cases explicitly placed some of the financial instruments outside the scope of regulation. We can thank Phil Gramm, John McCain's best economic buddy, for this part of the problem.
5. Allowing some derivatives to be traded in unregulated markets and concealed in financial reports. The scope of the problem was allowed to be invisible.
6. Faulty models of the derivatives markets. The quants' algorithms were based on faulty models. Based on an op-ed in the Washington Post, the models appear to assume simple linear market behavior and normal random variability. They are most likely based on faulty economics like the "efficient market hypothesis" that is a fundamental principal of "free market conservative" economics. Markets simply are often not efficient. Charles Mackay (author of Extraordinary Popular Delusions and the Madness of Crowds) is every bit as good a describer of markets as Adam Smith. Since the derivatives and quants became more central in the markets, we have had more Mackay markets than Smith markets.
My suggested solution is to require any derivatives to settle in the underlying financial instruments or commodities. No purely cash settlements would be allowed. As a transitional provision, I would suggest immediately imposing a stiff tax on any derivative settlements that are made stric
Computer algorithm (Score:3, Insightful)
The problem at the heart of financial crises is fractional reserve banking. The empirically "stable" fraction is roughly 9.5% right now, and as "wealth" increases, that fraction decreases because real value isn't created to balance it out. The banks simply negotiate the most aggressive numbers they can get away with, and since all wealth is purely electronic, they can fabricate it out of thin air - they don't need to print it anymore!
The fact that money is so far removed from the concept of value, is the very reason the system has collapsed - you can only build so high on any given foundation.
Re:Yes, let's blame the geeks (Score:4, Interesting)
Or the Gov't and certain social engineering groups forcing the banks to make loans to people who wouldnt normally qualify under any circumstances...
NY Times praising the new program in 1999 [nytimes.com]
Bill Clinton admitted the democrats stopped any oversight of Fannie and Freddie: [newsbusters.org]
"CHRIS CUOMO, ABC NEWS: A little surprising for you to hear the Democrats saying, "This came out of nowhere, this is all about the Republicans. We had nothing to do with this." Nancy Pelosi saying it. She signed the '99 Gramm Bill. She knew what was going on with the SEC. They're all sophisticated people. Is that playing politics in this situation?
BILL CLINTON: Well, maybe everybody does that a little bit. I think the responsibility the Democrats have may rest more in resisting any efforts by Republicans in the Congress or by me when I was President to put some standards and tighten up a little on Fannie Mae and Freddie Mac."
Im not completely blaming the democrats, but they certainly set up the framework for the housing bubble and the subprime mess we are in now
Re: (Score:2)
To the best of my understanding, the current mess is the combination of two toxic factors:
Bad loans - at least partially stemming from political pressure.
Fancy financial instruments - which replaced sound risk management and created the current mess where nobody truly knows where the bad loans are.
That's my 2c.
Re: (Score:3, Insightful)
Calculating the values of the debt swaps as if they had independent risks, when they did not, is a bigger part of the problem.
Re: (Score:3, Insightful)
Of course Im a troll... If you want to ignore the truth...
Democrats, Republicans, Banks, Home Builders, Brokers, Speculators, Greed all played a part in this, and if you want to ignore this then... how does that saying go...
"Those that fail to learn from history, are doomed to repeat it."
Re: (Score:2)
"Forcing the banks" is bull. There are many banks that didn't get caught up in the greed and are doing fine, thank you. Why weren't they "forced" into making bad loans too? Have you heard of mass Credit Union failures? These are the banks that are more exposed to the mortgage market than any.
This is all about greed and lack of regulation; assuming unsafe amounts of leverage and risk to chase increased returns on assets and a complete failure of free markets to make the right decisions.
Re:Yes, let's blame the geeks (Score:5, Interesting)
from the 1999 NYT article above...
"Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits."
as you mentioned its not the small credit unions, or the smaller banks, its the large national banks that are having trouble, becasue they were afraid of politics from people like ACORN who would publicly deride them as racists if they didnt loan money to the poor...
Re:Yes, let's blame the geeks (Score:4, Interesting)
Riiiiight, the large banks are such big pushovers that they would rather face bankruptcy than be publicly derided.
Sounds ridiculous when it's phrased like that, huh? The funny thing is the CRA loans you're all whining about tended to have lower interest rates and be safer investments than the other subprime mortgages. They were less likely to be packaged into the securities that actually caused the crisis.
I know you really would rather blame black people than admit the free market failed, but the free market failed.
Re: (Score:3, Insightful)
You say the banks were forced into making bad loans by the CRA, and faced lawsuits for not doing so.
Then you cite a case where THE CRA IS NOT EVEN INVOLVED. Did you actually READ what you cut and pasted?
I'm used to having to get proper cites to disprove people, you just made it easy.
Re:Yes, let's blame the geeks (Score:5, Insightful)
Quite a few of the larger banks avoided this mess too. JP Morgan, Bank of America and Wells Fargo are among the most notable. It is clearly a case that badly managed banks who ignored historically proven risk management practices to chase increased returns got burnt. NOBODY WAS FORCING THESE BANKS TO DO THIS.
Yes, it was public policy to encourage lending into inner cities. But NINAs, interest-only, HELOCs and ARMs? I DON'T THINK SO, and the fact is that these wacky loans are the biggest part of this.
Re:If only people had listened to Ron Paul (Score:5, Insightful)
The new Pledge (Score:2)
I pledge allegiance to Goldman Sachs, and to the conspiracy for which it stands, one racket under Paulson, Communist and indivisible, with eviction and poverty for all.
Re: (Score:2)
The Inventor(s) of Mortgage Backed Securities Should be found and put on trial immediately.
What legal offense are you going to try them with? Or is this to be a Stalin-esque show trial where the verdict and sentence is known beforehand?
Re: (Score:2)
They were invented in 1938... by the US government, which created an agency called the National Mortgage Association of Washington (later the Federal National Mortgage Association -- Fannie Mae) to issue them. I think you'll find the actual people who came up with them are mostly dead or in their dotage by now. In any case, there's nothing wrong with the concept of a mortgage-backed security. Problems occ
Re:The million dollar question is... (Score:5, Informative)
Nice try though.
Appraisals were not necessarily accurate (Score:3, Informative)
A huge point is completely missing: all of the houses were appraised at the values the mortgages were offered. These appraisals were done at market value and were accurate - if you can sell your house for $500,000 today, then it should be appraised at $500,000 today.
Uh no. The fact that a house sold for $500,000 does not mean it is worth $500,000 to another buyer. The whole point of appraising for loan qualification was to assure the lender had a good chance of getting their money back in case of a loan default. What happened was that appraisers were generally pressured into approving sale prices if they wanted business from the real-estate agents.
My take is that there were too many people involved in the process that were making money without any long term respons