[hotShot]

Actually I don't think the loan area that is the problem.
The problem is that banks could create "papers" that were sold to people (even professionals working in other banks) who did not really understand the risks they where taking.
There where bundles, "bets" on rising or dropping prices or stocks and heard someone say, there more than 5000 kinds of such papers. There was a kind of stock market for these things and I think at some point they where treated like stocks and nobody thought about the attached risk.

I think things took the wrong turn, when people stopped knowing what risks they are actually taking.

[PassedOut]

Winstonm, on Jan 31 2010, 03:47 PM, said:

PO,

IMO it is a systemic problem now and thus needs a systemic overhaul.

Sorry for being so dense, Winston, but I still don't get your meaning. What would a systemic overhaul look like?

[mike777]

Again, I am not so sure that these loans were reckless to begin with. So you are trying to fix a problem that does not exist.

Think about it why in the world should the largest, smartest most exp. bankers want to make lots and lots of reckless loans? Why should the owners of these companies be willing to risk their life savings in the name of recklessness? So they can lose their investment?

If the largest smartest bankers want to make these loans, and richest, smartest want to buy them, and millions want to borrow the money, how in the world is the government going to do a better job?


Otherwise you guys start with the assumption, hey lets make lots of reckless loans to lots of reckless people.....cool.

[barmar]

PassedOut, on Jan 31 2010, 11:05 AM, said:

I agree also. Risk takers must face the consequences of their choices or nothing will rein them in.

That's fine if there are a small number of excessive risk takers. But if most of the big players are taking the same risks, is that a realistic solution?

And what about all the innocent bystanders? You put money in a bank, they take a big risk with your money, and the risk doesn't pay off. Do you deserve to lose your deposit?

[mike777]

barmar, on Jan 31 2010, 08:52 PM, said:

PassedOut, on Jan 31 2010, 11:05 AM, said:

I agree also. Risk takers must face the consequences of their choices or nothing will rein them in.

That's fine if there are a small number of excessive risk takers. But if most of the big players are taking the same risks, is that a realistic solution?

And what about all the innocent bystanders? You put money in a bank, they take a big risk with your money, and the risk doesn't pay off. Do you deserve to lose your deposit?

Banks are heavily regulated, very heavily regulated.


Yet you seem to say if banks, all banks with reckless owners basically take reckless loans to reckless people at the same time that even more government regulation will help?

My take/guess is the system cannot even handle the regulation that is has now.
I mean I have dealt with regulations/SEC/FDIC etc etc for decades....most do not have any idea what they are doing, they just show up and punch the clock.

I have told this story often here, the SEC does reviews all the time, no one passes them. They review again a year or two later and again no one passes them. The SEC does nothing.


btw just note the SEC just came out saying they are going to focus on global warming in a huge way....so much for reckless fraud etc.

http://online.wsj.com/article/SB1000142405...1340842392.html

[barmar]

It's a difficult problem, I admit. The people making and enforcing regulations need to be smarter than the people they're regulating. But if you're that smart, you'll get a job ON Wall Street, not overseeing it, since that's where the big money is. So when the brilliant minds on Wall Street say "We have this great idea to make lots of high-return loans, but batch them up and insure them so that the risk is abated", there's no one qualified to tell them "There's no such thing as a free lunch."

[mike777]

barmar, on Jan 31 2010, 09:15 PM, said:

It's a difficult problem, I admit.  The people making and enforcing regulations need to be smarter than the people they're regulating.  But if you're that smart, you'll get a job ON Wall Street, not overseeing it, since that's where the big money is.  So when the brilliant minds on Wall Street say "We have this great idea to make lots of high-return loans, but batch them up and insure them so that the risk is abated", there's no one qualified to tell them "There's no such thing as a free lunch."

yes and if lots and lots of very rich, very smart people want to buy them....SOLD!

I mean we have laws against fraud, con games...etc......


I mean poor people do not buy this stuff, they are poor.


We have FDIC to protect the poorest of the poor.

[Winstonm]

PassedOut, on Jan 31 2010, 04:51 PM, said:

Winstonm, on Jan 31 2010, 03:47 PM, said:

PO,

IMO it is a systemic problem now and thus needs a systemic overhaul.

Sorry for being so dense, Winston, but I still don't get your meaning. What would a systemic overhaul look like?

No OTC derivatives - make it a regulated industry and transparent.

It is also not enough to set up a rescue fund for I-banks that penalizes risk - the risk itself must be reduced by again regulatory control over capitalization requirements to minimize leverage use.

That would be a start.

[mike777]

Winstonm, on Jan 31 2010, 10:11 PM, said:

PassedOut, on Jan 31 2010, 04:51 PM, said:

Winstonm, on Jan 31 2010, 03:47 PM, said:

PO,

IMO it is a systemic problem now and thus needs a systemic overhaul.

Sorry for being so dense, Winston, but I still don't get your meaning. What would a systemic overhaul look like?

No OTC derivatives - make it a regulated industry and transparent.

It is also not enough to set up a rescue fund for I-banks that penalizes risk - the risk itself must be reduced by again regulatory control over capitalization requirements to minimize leverage use.

That would be a start.

leverage is regulated and has been forever. guys please.

perhaps we need new regulation but at least lets enforce and understand the old regulation first, please.


Keep in mind investment banks are not banks.....
and now basically there is no such industry.

[Winstonm]

Quote

Think about it why in the world should the largest, smartest most exp. bankers want to make lots and lots of reckless loans?

Gee, I wonder. Let me think...

These were not banks making loans and then holding the loans on their own books. These were banks (and others) who acted as loan originators (for fees) who sold the loans to Wall Street banks (for fees) who then packaged the loans (for fees) and got the ratings agencies to rubber stamp them AAA (More fees) and then sold the products all over the world (for more fees) and after collecting all these service fees did not have to hold the risk of default on their own books.

Nope, no reason there to make bad, reckless loans. It must have been that crafty, cagey Community Reinvestment Act borrowers who tricked the smartest bankers in the world into lending to people with No Income, No Job, and No Assets, the infamous NINJA loans. The fact that all the above smart, experienced, rich bankers could earn FEES had absolutely nothing, I repeat, nothing, to do with the smartest bankers in the world being duped by the crafty low-lifes who took advantage of them.

Now, take the fact that these briliant bankers then started leveraging up to 30:1 to buy their own crappy financial products, knowing the ratings agencies were not doing any due diligence of the ratings and doing no due diligence of their own about the quality of the loans, and I think the argument that these guys were the smartest bankers loses its validity.

In fact, I'd call that argument downright unsound.

The dynamo bankers may have been the most corrupt, the most greedy, the most arrogant, the most powerful, but they are nowhere near the "most smart" category. Smart were the guys who predicted and made fortunes from the collapse by betting against the banks.

Full disclosure: I am not in that final category, either.

[mike777]

Winstonm, on Jan 31 2010, 10:34 PM, said:

Quote

Think about it why in the world should the largest, smartest most exp. bankers want to make lots and lots of reckless loans?

Gee, I wonder. Let me think...

These were not banks making loans and then holding the loans on their own books. These were banks (and others) who acted as loan originators (for fees) who sold the loans to Wall Street banks (for fees) who then packaged the loans (for fees) and got the ratings agencies to rubber stamp them AAA (More fees) and then sold the products all over the world (for more fees) and after collecting all these service fees did not have to hold the risk of default on their own books.

Nope, no reason there to make bad, reckless loans. It must have been that crafty, cagey Community Reinvestment Act borrowers who tricked the smartest bankers in the world into lending to people with No Income, No Job, and No Assets, the infamous NINJA loans. The fact that all the above smart, experienced, rich bankers could earn FEES had absolutely nothing, I repeat, nothing, to do with the smartest bankers in the world being duped by the crafty low-lifes who took advantage of them.

Now, take the fact that these guys then started leveraging up to 30:1 to buy their own products, knowing the ratings agencies were not doing any due diligence of the ratings, and I think the argument that these guys were the smartest bankers loses its validity.

They may have been the most corrupt, the most greedy, the most arrogant, but I don't place them into the "smart" category. Smart are the guys who predicted and made fortunes from the collapse by betting against the banks.

no basically what you say in not true...


they were not banks.


most of this was by nonbanks.....with non deposits for the most part.


my guess is banks, real banks made for the greater part non "reckless Loans" and the recession killed them and they should be punished and their owners should be punished by losing billions if not trillions. Many have and many more will lose their jobs.


They should be replaced in the market by smarter bankers, and smarter owners.

You may be one...

But I Pray not by government officials making loan decisions.

[Winstonm]

Quote

The Gramm-Leach-Bliley Act allowed commercial banks, investment banks, securities firms and insurance companies to consolidate.

What are you calling a bank, Mike? Goldman Sachs was an I-bank and one of the Federal Reserve's primary dealers at the time. Are you saying tht GS was not a bank?

Look at Citigroup. Not really a bank, either, until Gramm-Leach overturned parts of Glass-Steagall and allowed the conversions to occur.

You cannot argue from a pristine midsize commercial bank example when the problems were not caused by midsize commercial banks.

[mike777]

Winstonm, on Jan 31 2010, 10:46 PM, said:

Quote

The Gramm-Leach-Bliley Act allowed commercial banks, investment banks, securities firms and insurance companies to consolidate.

What are you calling a bank, Mike? Goldman Sachs was an I-bank and one of the Federal Reserve's primary lenders at the time. Are you saying tht GS was not a bank?

Look at Citigroup. Not really a bank, either, until Gramm-Leach overturned parts of Glass-Steagall and allowed the conversions to occur.

You cannot argue from a pristine midsize commercial bank example when the problems were not caused by midsize commercial banks.

ya investment banks were not basically commercial banks......I make that distinction.

gs investment
citi, commercial....


that is my cut off point.

gs could have 40-1 leverage
citi no not close. I grant citi was not a typical retail bank but still...
I note citi has been saved what 3 times, 4 times in the last 40 years?

in any event you missed all of my main points.

[Winstonm]

The smaller commercial banks were forced by securitization to adopt more commercial real estate lending after being basically shut out of the home loan markets - it was the lending on saturated CRE that is causing most of the small-to-midsize commercial banks to founder now that aggregate demand has collapsed.

I think I see your main point - that existing regulation needs to be enforced before new layers are added - and I would agree. But that is part of the systemic problem. The Federal Reserve itself failed miserably in their fiduciary duties as regulators and even allowed increases in leverage for off-balance sheet items months before the meltdown.

[mike777]

Winstonm, on Jan 31 2010, 10:56 PM, said:

The smaller commercial banks were forced by securitization to adopt more commercial real estate lending after being basically shut out of the home loan markets - it was the lending on saturated CRE that is causing most of the small-to-midsize commercial banks to founder now that aggregate demand has collapsed.

if you are saying the recession hurt small banks, a large decrease in economic activity ok....

I am just not sure how more regulations can stop that.

but none of that has to do with "reckless" loans by small banks management, their loan officers and their owners.

[kenberg]

When a good many loans go belly-up or get saved by government intervention and renegotiation, the burden of proof is on those who think the loans were responsibly done. In the early days of the collapse I would listen to NPR and there would be these sob stories about someone with a truck driver's income not being able to meet the new rates on his ARM for a five bedroom house sitting on three acres. To someone like me, unable to grasp the wisdom of it all, the loan seemed nuts on both ends. It still does.

It's a free country. If a guy wants to buy stupid and a bank wants to lend stupid, fine as long as it's they, not those like me who buy what we can afford, who have to deal with the fallout.

My understanding is that now the majority of foreclosures come about because of the large number of people who have lost their jobs. Unfortunately, most of the government rescuing does not seem to apply to them. It's the guy who bought what he can afford, and the banks that wrote the mortgage, they are the ones getting the help.

[phil_20686]

There is so much here that I want to say, I'm not even sure how to organise it

1) Winstomm said:
The problem I have with Chicago School economic thought is that IMO it is ideology rather than theory, a political dogma that resists close inspection. How can anyone take seriously a concept that smart apes act rationally and panic-prone markets made up of buy/sell decisions by those same smart apes are efficient?

Obviously, markets are not completely effficient, but the concept of a panic prone market is one that needs further insight. In times of great upheaval markets can become extremely variable, but this is not a sign of a broken mechanism, merely the market is telling you that the future is uncertain, and a large uncertainy translates into high variance. However studies have repeatedly shown that even in such times the market estimates risk far better and more efficiently than groups of experts, or other, supposedly rational, risk estimators. One must merely accept that there is a large variance in the perceived risk, and therefor the price can fluctuate widely.

On a side note, I have noticed often that many people do not understand the idea of a market, and the actual reasons why they work well. Many people seem to, for exmaple,think that an election is like a market, and relate it in their heads to voltairs dictum about the wisdom of crowds. This is manifestly not what a market does. A market is not efficient because a crowd chooses better than an expert, it is better because the experts dominate the market. A better analogy for a market is a poker game. Suppose I want to know the expectation for success on a given hand/betting strategy. If I take a poll on the first round of a tournnament with 1000 tables, i will generally get a much poorer answer than if I wait till there is only one table left, as all those people who answered badly are generally less skilled and have generally been knocked out. This is what happens in a market, those who play it will accumulate wealth, and the more wealth they have, the more votes they have in determining the price of something. Thus a market is somewhere between an expert panel and a poll of random people, and works better than either as it makes full use of widely distributed knowledge.

However, not everyone knows everything, and acting rationally on the information that you have can lead you to a wildy different expectation from someone else who knows different things. Thus explaing why a market full of rational people can fluctuate widely.

This brings me neatly onto my second point:
2) There have been a lot of discussion of both "rational actors" and "systemic failings". I wish to discuss both these concepts.

Firstly, "Rational actors". Generally, a man is considered to be acting rationally if he acts in his own self interest. This is the very genius of capitalism, that it turned man's selfishness into a productive force. It makes sense then to defince a systemic failure as one where "The needs of the comany are no longer aligned with the self interest of its employees". It is often assumed that what is in the best interest of the company is in the best interest of its employees, but it only takes a little thought to see how , for example, a bonus culture can represent a systemic failure. Say for example that i will be rewarded with 5% of the money that I make for the company on top of my base salary. Then it might well be in my self interest to take a 45% bet at 2:1 odds, for, say, $1bn. Afterall, if it loses I still get my base rate, if it wins I am made for life, so why not take that risk with someone elses money?

Obviously, in real life people have other priorities, and many people would consider this the height of unethical behaviour to risk other peoples money in a way so blatantly sellfishly, still it makes a useful example of the care that is needed in making regulation. (This is, for example, why team building is so beloved of the multinationals, they want to try to acheive loyalty, which will naturally align the employees behaviour with the interests of the company)

This leads me neatly onto the regulatory failings
3)There are many technical regualtory failings, but essentially, these dont matter very much in teh broad scheme of things. The most important things is that the regulations create a framework inwhich the self interest of the companies is aligned with the self interest of the country at large. In general the regulatory framework should not regulate things like the bonus culture as anything that negatively impacts the successfulness of the buisness will represent a competitve disadvantage that the market has proved exceptionally efficient at eliminating. However, it should concern itself with the buisness-buisness interactions. It is here that the gornement really has to shoulder some blame. Firstly, there was a supreme court decision that made it illegal (on grounds of inequality) in america for banks to lend on different terms to poor people and rich people. The government should have moved immeadeately to quash this or legislate around it. However, for whatever reason, they didnt, and thus
banks who wished to make large loans and morgages on good terms to upper class and professional couples were forced to accumulate large amounts of bad debt from poor citizens who were likely to default. In the past american banks hand accounted for the higher risk of default by charging a higher rate of interest to poorer people - effectively an insurance premium against default. This was the first and most important failure of government.

Now banks were loaded with poor quality debt that was damaging their balance sheets, and they looked for ways to get rid of it. Thus they bundled them up in lots of different ways into what were effectively groups of morgages, and thus the bundle as a whole had a lower apparent risk than the morgages that it was individually made up of. Its easy to see how this is the case. If i take a 100k loan at 5% and pay off 10k per year, i will end up paying back around 150k. So this loan would break even provided that less than 1 in 3 people defaulted. Real morgages are often even more profitable than this(!). Thus these SPO's were rated as very good investments by the credit ratings agencies, and were thus traded as high value objects. Its still unclear whether the credit ratings made a mistake in evaulating the risk of these objects, I would guess not. It seems like most of these "toxic assets" will actually turn a profit, I realise this is counter intuitive and to understand how profitable assets can nevertheless cause a bankruptcy needs some understanding of accountancy practice.

4)Regulatory failings 2
Banks are required by law to keep a certain portion of their money in "safe" investments, and their balance sheets should not carry too much risk etc. Moreover, they are required by accountancy practice (since enron), to use the "current market value" of their assets. Let me say first of that i think this is sensible, before you had been able to put your assets on your balance sheets at the price that you paid for them, eg if you bought gold when it was expensive and kept it you could put it on your balance sheet either at gold's current price or at the price you originally bought it, which is obviously open to abuse. The problem was, that when interest rates rose and people started to default, the credit ratings agencies suddenly woke up and said wait a minute, we don't actually have any idea what is happening with these things or how safe they really are, and made what was almost certainly the worst error of the whole debacle, when they decided they would downgrade the credit ratings of these SPV's. Thus banks woke up one morning and suddenly their balance sheets looked unacceptably risky, so they had to sell their SPV's and buy "safer" investments inorder to copmly with their legal obligations. However, instantly, every bank was trying to sell something that only banks had really been buying, and their market value plummeted, even though they still represented profitable investments. This acted as a double whammy, as their balance sheets were required to estimate their assets using current market value which was dropping like a stone, their balance sheets started to look a bit sick, and thus the value of the bundles that they didnt want to sell was also dropping. Since banks had been assuming that these were fairly stable things (they had good credit ratings) and that people wouild generally be prepared to buy them to raise capital, they had counted them as short term investments, that were easily traded and thus part of their liquidity, when their value collapsed, the banks became "illiquid", and could no longer lend money to each other, so they hand to stop lending inorder to renew their capital cushions.

Hopefully this makes the roots of this financial crisis a bit clearer, in essence, the banks were hit with an unforseen problem when the value of their assets, and their risk profile, changed dramatically overnight. Moreover, despite the monniker "toxic assets" most SPV's will eventually turn a profit, the problem was only that since no one was buying them their "current market value" did not correspond to their absolute value, and thus balance sheets had to be "written down". The feds descision to buy them was very sensible, as 1) they are likely (I think, its still not completely clear) to make the fed quite a lot of money in the long run and 2)Dynmic capital markets are what allow small firmss to start up, and are the lifeblood of the economy.

We can see aswell that the idea of "reckless lending" is something of a red herring, while the loans were individually reckeless, still on balance morgages are sufficently profitable that they were expectation positive. The real "failure" was a combination of an inflexible accountancy practice and a poor piece of government, followed by dozing credit agencies. If any one of these factors had worked properly, then the crisis could have been avoided, and ultimately, none of them really falls on the financial sector, they just got crushed by exernal pressures distorting the market.


PS I dont really blame the accountancy practice. You either trust poelpe (I.e. have a flexible system where people have some freedom to `fiddle' their accounts) or you don't (Have an inflexible system which cannot respond to situations that are a little out of the ordinary).

[kenberg]

Let's say that I am willing to listen. Starting with the item that you mention as most important:"Firstly, there was a supreme court decision that made it illegal (on grounds of inequality) in America for banks to lend on different terms to poor people and rich people.".I suppose that isn't an exact statement of the ruling. I seem to recall prohibitions against "redlining", which as I understand it was making a mass judgment that if you lived in area X of a city then you would not be getting a loan or you would be paying extra for it. I can be as mistrustful as anyone about idealistic but unworkable attempts at enforced equality but asking that loan applications be judged on their individual merit rather than on their zip code seems fair enough. Am I mis-characterizing the decision? Or are you referrring to something else?

[Winstonm]

Quote

Firstly, "Rational actors". Generally, a man is considered to be acting rationally if he acts in his own self interest. This is the very genius of capitalism, that it turned man's selfishness into a productive force.

Sorry, don't have time now to respond to all but I have to say something about the above quote. It is exactly what I am speaking about when I say ideologically based thought. The rational actor belief system - for that is all it is - is simply a faith-based concept.

You quote a basic concept of the Chicago School as if it were an unrefutable ultimate truth. But it is not so. It is nothing but dogma. Your last line sounds like a quote from Atlas Shrugged.

The problems with ideas like these IMO is they forget there are two sides to an equation: the productive force of railroad selfishness did not produce much in the way of productivity gains shared for the Chinese used as labor. We so quickly forget the 14-hour days and 6-day work weeks and company stores that brought about not only labor wars and unions but revisions in society norms.

It's great to have the selfish run the world for the ultimate good of all, until you realize that we are only smart chimps and we will act like smart chimps and hoard and steal and fight to keep more than our fair share - but it makes for popular fiction to believe otherwise.

[Winstonm]

Quote

Firstly, there was a supreme court decision that made it illegal (on grounds of inequality) in america for banks to lend on different terms to poor people and rich people. The government should have moved immeadeately to quash this or legislate around it. However, for whatever reason, they didnt, and thus banks who wished to make large loans and morgages on good terms to upper class and professional couples were forced to accumulate large amounts of bad debt from poor citizens who were likely to default

Sorry, but thhis is absolute unadultrated bullshit. Give me a cite. Better yet, give me lots and lots of cites where banks were FORCED by the government to make bad loans.

If you pull out the CRA as evidence of coerced bad lending I will know you are nothing but an indeologue who is blowing discredited wingnut smoke out his ass.

Quote

The problem was, that when interest rates rose and people started to default, the credit ratings agencies suddenly woke up and said wait a minute, we don't actually have any idea what is happening with these things or how safe they really are, and made what was almost certainly the worst error of the whole debacle, when they decided they would downgrade the credit ratings of these SPV's

And this is pure fantasy - the ratings agencies didn't do any substantial downgrades of these products until well after the debauchle.

I agree that a panic sell off over-discounted the price, but these 2006-2008 vintage MBS were toxic waste worth virtually nothing. Yet still held AAA ratings from Moody's, Fitch, and S&P.