Global Financial Crisis (Was: Subprime Meltdown)

[ewmayer]

"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works"
-- John Stuart Mill


“Behind every great fortune there is a crime.”
-- Honoré de Balzac


"The problem these gentlemen had to solve was to readjust the proportion between their wants and their income; and since wants are not easily starved to death, the simpler method appeared to be to raise their income."
-- George Eliot, The Mill on the Floss


"A lot of what is called innovative is simply a way to find new technology to do what has been forbidden with the old technology ... There are a certain number of tested Wall Street scams that have been forbidden by regulation. If you can find a way to use technology to revive one of these scams, then you are an innovator and you get paid extremely well for the five years these techniques work, and then you go away."
-- Martin Mayer, June 2008 interview with Institutional Risk Analytics

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Post links to articles and news about this, and your thoughts, here.

The particular angle I'll be pursuing by way of background-color is how what actually did and will occur contrasts with the I-knew-nothing fairy tale spun by one of the key regulatory players [in this case actually a non-regulatory player], ex-Federal-Reserve chairman Alan Greenspan, in his new memoir. [Which, to me, verges on what I like to call "autohagiography".]

I'll start with a pair of recent op-ed pieces by the NY Times' Paul Krugman, accompanied by choice excerpts:

Gone Baby Gone - October 22, 2007

It pains me to say this, but this time Alan Greenspan is right about housing.

Mr. Greenspan was wrong in 2004, when he sang the praises of adjustable-rate mortgages. He was wrong in 2005, when he dismissed the idea that there was a national housing bubble, suggesting that at most there was some “froth” in the market. He was wrong last fall, when he suggested that the worst of the housing slump was behind us. (Housing starts have fallen 30 percent since then.)

But his latest pronouncement — that the market rescue plan being pushed by Henry Paulson, the Treasury secretary, is likely to make things worse rather than better — looks all too accurate. [Full article]

A Catastrophe Foretold - October 26, 2007

...much if not most of the subprime lending that is now going so catastrophically bad took place after it was clear to many of us that there was a serious housing bubble, and after people like [the Federal Reserve's Edward] Gramlich had issued public warnings about the subprime situation. As late as 2003, subprime loans accounted for only 8.5 percent of the value of mortgages issued in this country. In 2005 and 2006, the peak years of the housing bubble, subprime was 20 percent of the total -- and the delinquency rates on recent subprime loans are much higher than those on older loans.

So, once again, why was nothing done to head off this disaster? The answer is ideology.

In a paper presented just before his death, Mr. Gramlich wrote that "the subprime market was the Wild West. Over half the mortgage loans were made by independent lenders without any federal supervision." What he didn’t mention was that this was the way the laissez-faire ideologues ruling Washington -- a group that very much included [ex-Fed chairman Alan] Greenspan -- wanted it. They were and are men who believe that government is always the problem, never the solution, that regulation is always a bad thing.

Unfortunately, assertions that unregulated financial markets would take care of themselves have proved as wrong as claims that deregulation would reduce electricity prices.

[Full article]

------------------------ More Greenspan-Related Links: -------------------------------------

Extraordinary Popular Delusions and the Madness of Crowds: The Classic History of Popular and Financial-Market Folly by Charles Mackay, first published in 1841

Cafepress.com: The Alfred E. Greenspeuman "What, you should worry?" memorial line of fine apparel and housewares, courtesy of the funnybones at Capitalstool.com

Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve: Latest book by Bill Fleckenstein of MSNBC Contrarian Chronicles fame

[rogue]

I am not surprised by the problems in the mortgage financing industry. If it was obvious to me a few years ago that there was a bubble (and I am not involved in the industry in any way), it must have been even more obvious to the lenders. I feel absolutely no sympathy for them and their predatory practices.

I do feel sorry for some (albeit a small percentage) of the borrowers who got caught up in this, but not all. Some borrowers probably lost jobs or faced financial crises out of there control, such as a death or illness. I suspect many borrowers were looking to make a quick buck when housing prices jumped as dramatically as they did. Others certainly borrowed to the limit of their means. I have heard of people who put so much money into a mortgage payment that they cannot even furnish their house. I know of others who don't save either for retirement or for emergency reasons and some of these are people who have a family income over $100,000. They assume that the government will take of them when they retire.

I do not want the government to bail out the lenders, but it would be nice if they could help lenders refinance the more stable borrowers that have an ARM to get a fixed rate loan. I suspect that most people with ARM loans are in that boat. It would be a win-win situation for both the lenders and the borrowers, although it would just mean more of our tax money to make it happen.

[Prime95]

Originally Posted by rogue

It would be a win-win situation for both the lenders and the borrowers.

Of course it is a win-win for the borrowers and lenders. Seize money from the taxpayers smart enough not to mortgage themselves to the hilt and give it to the idiots that could not manage their own risk or give it to the banks that bankrolled too many foolish loans.

How 'bout this for a bailout: If and only if the government needs to step in to avoid a "banking crisis", we approach the banks with the ruthlessness of a venture capitalist smelling blood. If a bank needs $100 million of bailout cash it will cost them $500 million worth of newly issued preferred stock. Sure, the current shareholders will be screwed but thats the risk they took when they invested. On the plus side, the shareholders will demand management's heads on a silver platter.

My only bailout for homeowners: It is my understanding that in some cases current law prevents loans from being renegotiated - even if it is in the best interest of both the bank and the homeowner. Foreclosure becomes the bank's only option. If possible, pass a law making renegotiation in as many cases as possible.

[S485122]

Originally Posted by Prime95

How 'bout this for a bailout: If and only if the government needs to step in to avoid a "banking crisis", we approach the banks with the ruthlessness of a venture capitalist smelling blood. If a bank needs $100 million of bailout cash it will cost them $500 million worth of newly issued preferred stock. Sure, the current shareholders will be screwed but thats the risk they took when they invested. On the plus side, the shareholders will demand management's heads on a silver platter.

I fully agree : banks, the agro industry and others welcome subsidies or bail-outs when things go wrong. In such cases they favour socialisation (of losses), when things are going well for them they oppose taxation and want the privatisation (of profit.) This is blatant in Europe as well, the state heavily helps failing industries, giving taxpayer money, rebates on social security fees to companies, but they never ask for a stake in the profits. The whole farm subsidy program in the European Union profits the big players : industrial farming, intermediaries, not the small farmers nor the consumers (the food prices are higher in the EU than on the world market.) Of course if the state would ask for a share of the shares in return for aid, it would be considered a disguised nationalisation and that is something utterly taboo nowadays.

Jacob

[rx7350]

Most mortgages are packaged together and sold as investment vehicles (CDOs) to 'investors'. If the terms on the mortgages are changed (re-negotiation of rates or re-payment schedules, etc) then the investors have the option to force the mortgage lenders (Country-wide, Citigroup, etc) to take back the loans. This is what the mortgage lenders fear most, since the amount of 'problem' loans exceeds $800B (for starters). Thus, the creation of this superfund is to keep these loans from being priced to market, casuing every problem loan (not just mortgages) being priced realistically.

As bad as it's been so far, the worst is yet to come. The 'worst' loans will re-set in three phases in 2008, and the face-value amount of those dwarfs what has occurred so far.

My 19-year old son has been inquiring about buying a house lately. My 'education' to him has been that, there are a hundred different ways to buy a house, but there's only one 'best' way. If a young adult can understand the basics of mortgages (read the fine print), and do simple amortization schedules on a calculator, any one else can also (or ask someone who knows).

There is simply no excuse for people not knowing what they're getting into - no excuse for having a 'deer-in-the-headlights' look on their face when a mortgage broker sells them a no-down, no-documentation loan, whose payment exceeds 40% of their income.

The borrowers should not be bailed out - the lenders should not be bailed out. It is unconscionable to use taxpayer $$ to protect greed-mongers and idiots from themselves. Capitalist 'constructive destruction' should be allowed to work here. That would get the crisis resolved sooner rather than later. Any bailout is just going to prolong and worsen the problem.

[fivemack]

Originally Posted by rx7350

There is simply no excuse for people not knowing what they're getting into - no excuse for having a 'deer-in-the-headlights' look on their face when a mortgage broker sells them a no-down, no-documentation loan, whose payment exceeds 40% of their income.

On the other hand, it would seem wise also to smite the mortgage-brokers with the largest available smiting device; no professional broker, and indeed no honourable person, should have sold such a person such a product.

[ewmayer]

Why on earth, Fortune's Allan Sloan asks, should we protect banks from their mistakes?

http://money.cnn.com/2007/10/26/maga...ion=2007102910

Very much along the lines of what George says above:

Citi clearly screwed up with its SIVs. When a financial institution borrows short term to buy long-term assets, it's supposed to have a plan for when its bet goes bad - rather than just whining about "disorderly markets."

Citi now says it has put together enough borrowings to carry its SIVs through year-end, which may be why [Treasury Secretary Hank] Paulson told us the problem "isn't urgent."

If Citi's only problem is that it can't liquidate its SIVs without a profit hit, too bad. If Citi's very existence is at risk, I don't think we dare let it fail, because that would drag down institutions throughout the world. But if the bank needs help, its shareholders should have to pay. Bigtime.

Step one would be to eliminate its common stock dividend, currently more than $10 billion a year. Step two would be to force Citi to raise the capital it needs by selling new stock at a price well below its recent $42 a share. That would force holders to either ante up or have their Citi stake diluted. That just might inflict enough pain on shareholders that someone other than underlings would pay for Citi's SIV sloppiness.

In any event, if we believe in markets, Citi should have to take its chances. We small fry take chances when we borrow, and we pay the price if we're wrong. Big fish should have to do the same.

==========

Edit: And in related news...

The $915B bomb in consumers' wallets:

http://money.cnn.com/2007/10/29/maga...ion=2007103013

One nitpick with the above article:

To be sure, there are key differences between the subprime market and the problems brewing with credit cards. The first is that while rising mortgage delinquencies were apparent for months before the subprime market blew up, credit card delinquencies are actually coming off unusually low levels.

That doesn't inspire confidence, because IMO the "unusually low default levels" are likely because of the recent tightening of US bankruptcy laws, which caused many overstretched credit card holders to file under the old more-forgiving system before the law took effect, lading to a one-time wiping-clean of huge amounts of credit card debt. Interestingly, the credit card issuers [in many case the same large banks that were most-aggressively pushing the subprime mortgages] went on a spree in the wake of that, in which they specifically targeted the above wave of bankruptcy filers with new-card offers, many at usurious rates, since (a) the newly-bankrupt were in a position to run up new debt much more rapidly than pre-bankruptcy, and (b) the new bankruptcy laws are much more favorable to the credit card issuers, thus giving them a high incentive to encourage people to max out their cards, since now they know they've got you over a barrel, as it were. [Exactly this happened with my current housemate - he was maxed out as a result of divorce and his own financial mismanagement, did a last-minute filing under the old law, and has been getting bombarded with credit card offers ever since.]

[ewmayer]

http://money.cnn.com/2007/11/01/real...ion=2007110112

New York's attorney general accuses First American and Washington Mutual of using appraisers to overstate the value of home loans.
November 1 2007: 1:30 PM EDT

ALBANY, N.Y. (AP) -- New York Attorney General Andrew Cuomo said Thursday a major real estate appraisal company colluded with the nation's largest savings and loan companies to inflate the values of homes, contributing to the subprime mortgage crisis.

"This is a case we believe is indicative of an industry-wide problem," Cuomo said in a news conference. [Full Story]

Note to self: Never trust an appraisal done by an outfit that can't even correctly spell "appraisal."

[ewmayer]

Responsible loan payers are crying foul about the breaks that delinquent borrowers are getting:

http://money.cnn.com/2007/11/01/real...ion=2007110511

[Xyzzy]

We bought a new townhouse in 2005 at 5.875% on a 30 year fixed loan. We bought what we could afford and not what the sales people told us we could afford.

We have the same thoughts as the woman in that article.

[xilman]

Originally Posted by rogue

I do not want the government to bail out the lenders, but it would be nice if they could help lenders refinance the more stable borrowers that have an ARM to get a fixed rate loan. I suspect that most people with ARM loans are in that boat. It would be a win-win situation for both the lenders and the borrowers, although it would just mean more of our tax money to make it happen.

FWIW, the UK mortgage has been based on adjustable interest rates for many decades. It is certainly easy to get a rate which is fixed for a shortish period -- 3 to 5 years say --- but even that is a relatively recent invention (25 years perhaps) for the majority of mortgage lending.

There's nothing intrinsically right or wrong with either fixed or adjustable mortgage rates, AFAICT.

FWIW, my 25-year mortgage expires at the end of 2008. It's been on an adjustable rate since it started.

Paul