Saturday, November 29, 2008


Sam Smith, Progressive Review - There is something wrong out there. The fiscal crisis is supposedly primarily due to the collapse of sub prime mortgages. This argument places the blame squarely on the backs of stupid borrowers and predatory lenders. It also provides the Wall Street casino players with significant cover.

But let's ask one simple question: what if all the sub prime mortgages had been held by conventional banks and there had been no securitization, mortgage backed securities, structured investment vehicles or special purpose entities that, in the polite words of Wikipedia, "enabled large financial institutions to circumvent capital requirements, thereby increasing profits but augmenting risk."

The value of all residential mortgages is around $11 trillion. As of August about 9% were either delinquent or in foreclosure, or $1.1 trillion. Assuming all were sub prime and eventually foreclosed, assuming there has been a decline of 40% in the value of the homes since the mortgages were issued and assuming every one of these mortgages was for 100% of value, we would still have around $660 billion in real value and a loss of some $440 billion - considerably less than just the first bailout sum.

It is hard to get decent figures about the fiscal disaster but simple exploratory calculations - even those like the above, based on a worse case than reality - suggest that the story may not be quite as it has been presented to us.

There is no doubt that subprime mortgages played an important and even catalytic role in the fiscal disaster, but there also seems little doubt that the problem would have been far easier to cope with if it hadn't been merged with the most complex, covert and incautious gambling scheme ever devised.

Advisor Perspectives was one of the few to hit the target, and last February at that:

"The sub-prime debt that may eventually be written off represents a small corner of the financial markets. Yet its impact has been devastating. . . According to [Dan Gertner, an analyst with Grant’s Interest Rate Observer] the markets collapsed because of a loss of trust. 'One of the great innovations in structured finance was the reallocation of risk achieved by securitization,' says Gertner, adding that 'a consequence was that nobody knew where the risk was.' The markets woke up to the fact that [collateralized debt obligations] were a whole lot riskier than their AAA ratings indicated, and started to question the broader lending markets."

More recently, this - from an interview with Michael Lewis in Motley Fool:

Mac Greer: Michael Lewis, it is ugly out there. Where did it all go wrong?

Michael Lewis: The very short answer was the ability of Wall Street to repackage subprime mortgages as an investment-grade security. That is the heart of the immediate problem.

Then, having done that, [Wall Street] created alongside this market, which grew to a couple of trillion dollars, a casino in side bets where smart people could bet against the sub prime mortgages going bad -- which smart people did do -- this market in side bets, with many trillions more than the original market. So you have got -- because the subprime mortgages have all turned out to be, or mostly turned out to be kind of rotten -- you have got many trillions of dollars of supposedly investment-grade securities that are suddenly worthless. That is a traumatizing event for the global economy, but that is the very short answer. . .

Greer: How could this crisis have been prevented?

Lewis: If the financial regulatory system had controlled the leverage that investment banks were able to run, that would have dramatically reduced the amount of risk in the system. But they didn't, not properly. If the ratings agencies had done their job properly and not caved to pressure from Wall Street to . . . not allow themselves to essentially be gamed by Wall Street into putting investment-grade stickers on things that were essentially crap, then all of it would have been avoided.

In other words, what could have been a manageable crisis turned into an unmanageable disaster not because of the sub prime loans themselves but because of what happened after they were made. Wall Street turned poorly conceived loans into cards at a casino table. And sub prime mortgages weren't the only game being played. Consider the likelihood that billions of drug and other illegal profits were laundered through hedge funds. In the end, the problems created by poor sub prime loans were swamped by the effect of using them as an unprecedented form of gambling.


At November 29, 2008 8:46 PM, Blogger Joseph said...

So much for the power of positive thinking.

At November 30, 2008 3:29 PM, Anonymous Anonymous said...

"Consider the likelihood that billions of drug and other illegal profits were laundered through hedge funds."

It's just extraordinary how much damage the War on Drugs has done to America, not to mention other countries. There simply isn't any aspect of American society that hasn't been undermined by this insanity: the schools, the economy, social order, respect for the law, the list goes on and on. And now it's literally undermining the governments of Mexico, the US, Columbia and who knows what other countries. Oh, I forgot Afghanistan and the opium trade. And yet drugs are still easily available almost everywhere and use of them hasn't been curbed at all.

At November 30, 2008 7:58 PM, Anonymous Anonymous said...

Some people believe the "credit crisis" b.s. Read the following paragraph a couple of times.

"There is, so far, only a lower but still substantially positive growth rate of loans. Commercial and industrial loans at all commercial banks was $1.60 trillion on 10/1/2008 compared with $1.39 trillion on 10/1/2007. Consumer loans over the same period have risen from $788.5 billion to $869.3 billion. Real estate loans have risen from $3.54 trillion to $3.79 trillion."

The whole article is here:

At December 3, 2008 1:42 PM, Anonymous Anonymous said...

The Bet That Blew Up Wall Street
Steve Kroft On Credit Default Swaps And Their Central Role In The Unfolding Economic Crisis


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