Staying Calm

Perhaps the most trivial problem associated with the sub-prime mortgage meltdown is that it's given renewed prominence to a series of issues about which I know nothing. That said, The Nation's view on this seems wildly overblown:

The dismantling of financial regulation, likewise, did not begin with Bush I or II or even Ronald Reagan. It began in the late 1970s, when Democrats were in power. Are the Dems prepared to address their big mistakes and begin the hard task of re-regulating the banking and financial systems to protect the people from the familiar spectacles of outrageous gouging and unpunished crimes of fraud?

Something much, much, much worse than what's happened over the past couple of weeks would need to happen before I found it plausible that comprehensively rolling back three decades of financial deregulation is the appropriate policy response here. Tweak something or other? Sure. It seems to me, though, that the main thing is to try to ensure that whatever bailing out and whatnot happens is designed to minimize losses for middle class and working people rather than to minimize loss for millionaire investors and traders. It's not clear to me that there's any regulatory fix at all for the fact that asset bubbles happen sometimes.

Comments

Robert Borosage of Campaign for America's Future on Political Buzz Radio today at 5 PM

http://blogtalkradio.com/hostpage.aspx?show_id=44691

Posted by mp | August 10, 2007 2:43 PM

Well Matt, like you say you don't really know anything about this - and I think the Nation's take on this is a little silly* - but there is no question that removing or loosening the wide variety of financial regulations that were put in place during the New Deal has (among other things) increased both the number and the size of asset price bubbles we've experienced since the mid-1970's. This more or less amounts to saying that deregulation has made financial markets much more volatile than they were in the past. Moreover, a number of other policy changes (including the decline of traditional pensions and the rise of 401ks) makes working class people much more exposed to financial volatility than in the now distant past. Check out the Levy Institute's web site for more along these lines, along with Steve Keen's site Debunking Economics.

*silly, because important aspects of financial deregulation (including the elimination of capital controls and the depegging of the dollar) occurred much earlier, while many others (the end of Glass Stegal) came much later. What happened in 1980 was the deregulation of S&L's, and that particular chicken came home to roost a long time ago.

Posted by Rich C | August 10, 2007 2:44 PM

It's not clear to me that there's any regulatory fix at all for the fact that asset bubbles happen sometimes.

You really think that's all that happened here? That the industry got "caught" in some little bubble? That's a very naive way of looking at this.

Posted by Freddie | August 10, 2007 2:51 PM

Re: "It seems to me, though, that the main thing is to try to ensure that whatever bailing out and whatnot happens is designed to minimize losses for middle class and working people..."

Why should anyone be bailed out? If people made poor investment decisions, why should the government now come in and protect them?

You can make a case that this should be done if the macro effects of what's going on are extremely serious to the economy as a whole, but I haven't heard that justification yet.

Posted by Jim W | August 10, 2007 2:52 PM

...and this is why no one really every talks about or links to the Nation

Posted by MR. X | August 10, 2007 2:53 PM

I hate to agree with NRO about anything, even if it is only partially, but there is no question that the Dems, when they controlled Congress, allowed the huge amount of campaign donations from financial/banking interests to make most of them acquiesce to loosening regulations.

What you won't have NRO say is that this is a huge argument in favor of public financing. The impact in the 1980s was the S&L collapse (which ended up in a cost of billions of dollars of taxpayers' money) could have been avoided in the Dems had stood up for principle rather than their donors.

Posted by hopeless pedant | August 10, 2007 3:00 PM

hopeless pedant:
Won't happen as long as you have guys like Schumer and Biden in the Senate.

Posted by Joe Klein's conscience | August 10, 2007 3:16 PM

There is nothing to see here.

Some wealthy folks made a bundle selling worthless securities...then the U.S. government used $35,000,000,000 worth of your and your children's money to buy them up today.

Call it Scooter Libby finance.

Watch out, Tom Friedman...Yglesias is gunnin' for your slot.

Posted by alphie | August 10, 2007 3:24 PM

I surmised some time ago that MY didn't know much about financial/economic matters. Which is too bad, because the ongoing deterioration of America's financial situation will prove to be THE story of the next few decades.

The sub-prime mortgage meltdown is a sympton of the wreckless use of credit at all levels in the U.S., which has been aided and abetted by the Federal Reserve's easy money policies.

Bailing anyone out only increases the moral hazard that is an integral part of the problem.

Posted by kafka | August 10, 2007 3:26 PM

Matt, deregulation also lead to the S&L crisis. It also had alot to do with LTM. So this hardly the first case.

Posted by Rob | August 10, 2007 3:31 PM

Mr. X:

...and this is why no one really ever talks about or links to the Nation

Well, better to express it as "no one (who matters) really ever talks about or links to the Nation." Just as no one (who matters) really though Iraq had no WMD, or that invading Iraq was a terrible idea.

Of course, the Nation does have a circulation perhaps twice that of the Weekly Standard and 3-4 times that of the New Republic, but those Nation subscribers are no one (who matters).

Posted by grh | August 10, 2007 3:33 PM

both alphie and kafka get at aspects of this that matthew does need to understand better.

for a few years, we had perfect conditions for a housing price bubble to develop, but over the last couple of years, it has been perfectly clear for a while now that nothing less than fraud has taken place in many of the mortgage approvals that have been granted (Tanta, a senior mortgage banker on medical leave, has done excellent work on this over at Calculated Risk if you really want to learn more).

The incentive for the fraud was the securitization of mortgages, since the traditional link between mortgage issuer and customer was severed; indeed, part of the problem right now is that there is no easy "workout" scenario, since the originating mortgage bank likely doesn't even own the paper anymore.

What appears to be binding up markets is that - after being perfectly happy to pretend that what everyone knew was happening wasn't happening - buyers and sellers of mortgage-backed securities can't figure out realistic pricing, and probably won't be able to for a while until we really sort out how many under-performing/problem mortgages there are and how much leverage has been employed.

but as alphie notes, meanwhile, a pile of money was made.

(I don't know the regulatory solution to this, btw, because i don't really know the field well enough, but it's hard to believe there isn't a regulatory solution sufficient at least to reduce fraud if nothing else.)

but as kafka gets at, part of the perfect storm that initially supported the jump in housing prices was the exceptionally accomdating position that the fed took, which encouraged the ladling on of debt (most irresponsibly, of course, at the federal level, and masked by the theft of the social security surplus) at all levels.

because there's a lot of capital in the world, and because the US is a huge market, it's been possible for all that debt to have relatively modest carrying costs, but the big question is whether that will continue to be true.

my own estimation is that the logical outgrowth of bush league economics is stagflation lite, that we already have experienced that in various ways, and that the fed is between a rock (the economy, and in particular the consumer, is now reliant upon cheap debt) and a hard place (easy credit in conjunction with our net indebtedness leading to a weaker dollar and imported inflation to which the long market responds by jumping a couple hundred basis points and really squeezing).

Posted by howard | August 10, 2007 3:39 PM

The sub-prime bust isn't the result of too few regulations; it is the inevitable deflation of a credit bubble. The seeds of this were first planted by the Fed when it opened the liquidity spigot in 1999 ahead of the dreaded Y2K, and again in 2001 after 9/11. That led to a mortgage boom which fed the real estate boom.

Bailing out sub-prime borrowers, lenders, or buyers of the lenders' sub-prime-backed debt securities (CDOs) would just increase moral hazard among all parties and lead to bigger problems down the road. So far, Bush has wisely (yes) resisted the temptation to do anything stupid about this. A largely hands-off approach is best here. The market is sorting this out.

Some people with bad credit who borrowed more than they could afford to buy houses bigger than they needed will lose them, and more prudent people will get to buy their houses at a discount. Mortgage companies that lent to much to bad credit risks are already going out of business; their remaining assets (if any) will be purchased by more prudently-run mortgage companies. Some hedge funds that borrowed to load up on sub-prime-backed CDOs will be forced to liquidate them for dimes on the dollar; better run hedge funds and other investment firms will buy these assets at deep discounts and profit from them. Other buyers of debt securities will do more due diligence in the future.

One bit of house-cleaning that does need to happen -- and hopefully there is a market solution for this, because I don't see a government one -- is the creation of better debt rating groups. Moody's, S&P, and Fitch may have dropped the ball here.

Posted by Fred | August 10, 2007 3:57 PM

Not precisely what’s being talked about here, but I’d like to see some regulations on short term loans and credit card interest rates. I’ve seen cards that when you add in fees and services like “Credit Protection” and “Extended Repayment” are effectively charging 40% interest.

Posted by DJ | August 10, 2007 4:04 PM

Our banking and financial industries aren't regulated? When did that happen? I should vote for whoever did that.

Posted by too many steves | August 10, 2007 4:07 PM

Just looking at the Nation quote, two things come to mind:

1. I'd put removal of the Glass-Stegall 'firewall' pretty far ahead of the rest of deregulations, in the recent past, as a potentially compounding risk-factor.

2. I'm not 100% sure that the advent of deregulation has increased the ability of Wall Street to manufacturer junk debt(s). (There was plenty going on in the 'olden days', too.)

The first time around, however, it created a market for it among "professionals", arguably (those who bought the junk were S&L's who had no business doing so).

We're finding out now jut who bought "sub-prime" junk this time (and at what price). I don't think too many pension funds allow themselves to dip that low in the barrel (it'll be an outrage is any one does), but some banks may do, despite risk-based capital guidelines designed to keep them solvent if they do (we'll find out if those guidelines were enough).

The real "dupes" this time around appear not so much to be the professionals that we'd worry about, but those who got lured into floating-rate mortgages, NOT of the sub-prime variety. I just read a comment by someone on a blog that their interest rate on their mortgage is going up over 10% next year.

I'm not sure we can blame deregulation for the phenomenon of people sucking equity out of their home with multiple refinancings over the past seven years to boost current consumption. Would you?

Posted by Amicus | August 10, 2007 4:10 PM

The bottom line is that the mortgage and banking industries were willing to get a mortgage for my gerbil and there was no one in the food chain to tell them this was a bad idea.

Posted by magisterluti | August 10, 2007 4:15 PM

A tip for those of you who would like to profit from this, btw: I recently bought Fortress Investment Group (FIG) $18.10 per share (it traded as high as $37 after its IPO). Remember when I wrote in my last comment that some well-run hedge funds would profit from this? I think that some of Fortress's hedge funds are among those that will. We'll have a better idea of that soon, since Fortress announces earnings next Tuesday.

Do your own due diligence, of course.

Posted by Fred | August 10, 2007 4:17 PM

Fred, as i understand it, the "ratings agencies made me do it" is a cop-out answer. as i've read about it (and i don't claim to have exhaustive knowledge), the ratings agencies aren't detective agencies: it's not their job to go in and inspect the goods.

if mortgage brokers are handing out mortgages wrongly, again as i understand it, all the ratings agencies can do is wait for the market imperfections to appear.

now, the buyers of these securities who thought that due diligence consisted of looking at moody's, there we have a systemic failure! and then leveraging up, to boot!

Posted by howard | August 10, 2007 4:56 PM

Hope Matt is right, but I also strongly doubt it, like a number of the commenters. And it's not just about liquidity and asset bubbles. We've long been conditioned to think the stock market is relatively safe because of all the reforms and regulations implemented since 1929. Sure, the market might go up or down hundreds of points in a day -- but off a 13,000-plus Dow that's nothing. Most people think a 1929 style crash couldn't possibly happen now.

Think again: Much of our securities trading now takes place under the totally unregulated umbrella of the hedge funds, which have been operating irresponsibly for a long time now. They should have learned -- and been regulated -- after LTCM in 1989, but that didn't happen.

Now, nobody knows what's going on behind their walls. There's no way to know, with their very limited reporting requirements. The bottom could fall out tomorrow (well, on a trading day) and the damage would be done before anything could be done about it.

Posted by Madison Guy | August 10, 2007 5:22 PM

then the U.S. government used $35,000,000,000 worth of your and your children's money to buy them up today

That's incorrect. The Fed lent $35B and took the mortgage backed securities as collateral. The move was meant to provide liquidity, not to get the Fed into the mortgage backed security business.

Posted by Al | August 10, 2007 5:44 PM

Exactly who are you refering to when you say "Bailing anyone out only increases the moral hazard..."? Are you referring to the people who made the money on the predatory lending, or the people who were conned into the sub-prime loans and then lost their homes. If it's the later, then that's a pretty crass euphemism for kicking people out on the street. If it's the former, then yes, I agree, they need to learn their lesson. As to whether it's a big issue or not, I don't think you have to be an econmist to understand that this crises will only exacerbate the economic problems everyone is facing (or at least most everyone). If someone does not consider this to be an important issue, I'd suggest their out of touch reality and should probably learn a bit more about it before poo-pooing the Nation article.

Posted by rihilism | August 10, 2007 5:50 PM

Howard,

Everyone should do his own do diligence, but it's not unreasonable for an institutional investor such as a municipal pension fund to assume that a AAA-rated debt security is of the high quality and low risk that that rating denotes. It may yet turn out that the AAA-rated tranches of sub-prime backed CDOs deserved that rating -- that the risk of default is low and the current paucity of buyers for them is causing a temporary, not permanent, loss in value for owners of those tranches. Time will tell. My point was that the major ratings agencies have had a profitable oligopoly for years while the value they have added to investors has been questionable. It might be worthwhile for a consortium of large institutional investors to pool its resources to create a new, better rating agency.

Also, you are misunderstanding how top tranches of CDOs got triple-A rating -- it wasn't because ratings agencies were unaware that this debt was backed by sub-prime mortgages.

Madison Guy,

The sky isn't falling. Stocks, on average, are trading at reasonable valuations -- nothing like the earnings multiples common in 1929 or 1999. Also, LTCM didn't collapse in 1989. It blew up in 1998.

Posted by Fred | August 10, 2007 5:52 PM

The Fed lent $35B and took the mortgage backed securities as collateral.
========
Al, I haven't been watching closely. That seems unprecedented to me. Has the Fed ever used Agencies in a liquidity operation that size before, do you know?

Posted by Amicus | August 10, 2007 6:07 PM

"That's incorrect. The Fed lent $35B and took the mortgage backed securities as collateral. The move was meant to provide liquidity, not to get the Fed into the mortgage backed security business."

Al,

Not to nitpick, but technically the Fed did buy $35 billion securities -- that's how those open market operations work. You are correct that the Fed did so to provide liquidity to the banking system and not to enter the mortgage backed security business. The Fed will leave the bulk of that to that source of sinecures for well-connected Dems, Fannie Mae, and of course Freddie Mac.

Posted by Fred | August 10, 2007 6:37 PM

rihilism: "If it's [sub-prime borrowers], then that's a pretty crass euphemism for kicking people out on the street."

If you are talking about the predatory lending practices involving people who had owned their homes free and clear, there are already state and local efforts popping up to help these people. Federal intervention is not necessary and would likely be counter-productive.

If you are talking about the bulk of the now-defaulting sub-prime borrowers who were at least complicit in exagerating their incomes and buying houses that they could not afford, or were essentially speculating on the value of the house they "bought", then you're way off base. Those people, whether or not they end up "kick[ed] . . . out on the street" aren't entitled to anything other than a potential cause of action against the lender, their counsel (if any) and possibly the real estate agents and/or builder involved with their acquisition of a house. Anything more essentially rewards them for participation in an ill-advised and unsustainable financial transaction. I for one, having purchased a house that I can afford and having re-financed into a fixed rate mortgage (twice!), do not want to bail out people who overspent so they can continue to live in nicer houses than mine for less money. Among other problems, it will just defer the pain of the real estate market adjustment.

Re: Federal Loans on MBS--Everyone has to remember that a significant portion of the (residential) MBS market is made up of loans that are ultimately guaranteed by the Federal Gov't. Making loans now to prevent a complete meltdown of the market is wise as a pretective measure. If the whole lot goes up in smoke, Uncle Sam will be paying out a bunch of $$ eventually, anyway.

Posted by zaleriana | August 10, 2007 6:54 PM

fred, two points: i didn't mean to suggest (if i managed to) that the ratings agencies were unaware there were subprime mortgages.

the question is the extent to which they were aware (in a way that they could formally "know" in terms of how they work) that there were subprime mortgages being issued under conditions that almost certainly justify the term "fraudulent" being wrapped up into some of these lovely tranches.

that clarification said, listen, i hold no brief for the ratings folk (or agin' im; i don't know enough) but i'm certainly willing to believe they are oligopolists and deserve to be ground into the competitive dust by a new entity, but that's not a regulatory solution (nor, recall, am i averse to as-yet-undescribed regulatory schema, including some better way to keep fraud from occurring!). and it doesn't mean that it's they who were at fault.

btw, as i noted earlier, i agree that there is more than zero value out there in many of the holdings for which there is no market to mark to right now, but i suspect it's going to take a few months before the market gets a handle on what that value might actually be, and things could stay bound up for a while....

Posted by howard | August 10, 2007 7:05 PM

Don't be too guilty about not knowing about finance Matt, neither does Ben Bernanke. He apparently actually believed Mondays rally showed that things were just fine. Over the last five months the Fed has added virtually nothing to their System Open Market Account. (The Feds method of adding permanent liquidity to the system is to buy Treasury and agency paper, called open market operations) For the five previous years the SOMA has been growing at a 5% rate. Since spring however the growth has been absent.

Now I am ideologically neutral on Fed open market operations and believe that the Fed is actually now a small time player in the credit and monetary worlds but the fact they have sat on their hands as Rome started to burn is simply CRAZY.

Why were they so stingy as the so called sub prime problem (sub prime is the tip of the iceberg of crappy debt paper) developed. One can only conclude that they didn't have a freakin clue what was going on. That all was well, the best economy of all time as the WSJ said in an editorial this week. I don't think Ben took the blue pill. I don't think he will have to. The Matrix will collapse on it's own.

Posted by rapier | August 10, 2007 7:07 PM

No doubt the lack of regulation and the enforcement of regulation has played a part in the Credit Bubble. However the biggest factor has been with the financial world itself. Willing to make bigger and bigger and bigger bets with, and this is crucial, Other Peoples. Money, OPM

For years and years Greenspan et. al have told us how the modern financial world has thrived on the ability, through the use of new financial insturments, to spread risk to those who can afford it. Then he went about bailing out the markets after the 87 crash, the Russian Crisis, LTCM, etc. etc. etc. This made people think that in fact risk had been eliminated. In finance when people think risk is being backstopped by the Goverment or some other entity they start acting recklessly and it's called Moral Hazard.

The entire economy post 2000 has been one big experiment in Moral Hazard. It has been thought that all risk had been sent into outer space. In fact most if it is sitting there quietly on the books of banks insurance companies, hedge funds etc, etc etc. Some has found it's way to the terrestrial equivalent of outer space, the Cayman Islands. Well not so quietly anymore.

Posted by rapier | August 10, 2007 7:23 PM

Democrats will be unable to make any gains from the financial and then economic problems ahead because they were equal partners with the GOP in fostering the Credit Bubble.

Everyone may recall that the so called sub prime problem emerged into the markets and the publics consciousness in late Feb. They will also recall the universal declaration by every manner of Wall Street shill and politician and regulator and crackpot pundit declared that the problem was "contained". This was a lie. So remember that everything you hear going forward from the very serious financial community will be a lie as well.

The lack of understanding about finance will be especially sad going forward as revisionist history will be a minute by minute occupation and the overwhelming majority of people won't have a clue about what is and what isn't true.

Liberals and Progressives take it as almost a point of honor in not knowing about finance. Thus seeding the entire landscape of law , regulation and chatter about all matters financial, monetary and debt related to the players.

Few understand that the revisionist history of the Great Depression was written by Milt Freidman and codified into the conventional wisdom. The basic premise is that the Fed was a fault for not providing enough 'liquidity' for the banking system. Ben Bernanke is the embodiment of this crap. The better truth is that too much bad credit accumulated in the system, especially the financial system. There was a bubble. It is possible I suppose that the Fed could have reliquified the bubble but only by fostering new bubbles. Which by the way is the story of the 2000's so far as the Fed and the system desperately inflated one bubble after another.

A fundamental tenet of Standard Economic Theory is that markets must 'clear' on their own. When too much supply comes online prices must fall and players taken out. When the credit market becomes overheated and risk is forgotten as prices for assets spiral ever higher there always comes a point where the last buyer, ie. sucker, is in and prices start to fall. While ever serious economist subscribes to this on the deepest principal in practice they ignore it. Look at this weeks panicked calls for the Fed or the goverment, or somebody, anybody, to do something.

It's all well and good to have an ideology, until you or your friends start losing money, or God forbid, power. Then you can take your free market and shove it. All for the common good of course.

Posted by rapier | August 10, 2007 8:36 PM

Re: the U.S. government used $35,000,000,000 worth of your and your children's money to buy them up today.

The US did not "buy" any securities today. It acepted those securities as collateral for temporary (two weeks I think) bridge loans. The money will be repaid in a couple weeks and the securities returned where they came from.

Posted by Jonf | August 10, 2007 9:10 PM

Howard,

There may not have been anything fraudulent about the way sub-primes were packaged into CDOs -- I haven't heard of any institutional buyer of CDO debt yet claiming they didn't know what was under the hood. You should resist the facile temptation to try to sort market participants into villains and victims; chances are, most in this case were neither.

Posted by Fred | August 10, 2007 9:10 PM

Look, Fred,

Here's a simple fact:

Mortgage-backed securities composed of mortgages held by people with good credit would pay a return about equal to U.S. government bonds (say 5% a year)...because people with good credit can get a mortgage for a little over 6% a year interest...and the securities can't pay a higher return than the people who are holding the actual mortgages are paying.

If you bought a Mortgage-backed security that was paying 7% or more a year...you would have to know the underlying mortgages were held by people with very bad credit.

The government should not have bailed anyone out.

Jonf,

The government ain't getting their money back if the companies they "bought" them from go under.

Did the strategic petroleum reserve every get refilled by the oil companies that got to tap into it after Katrina by the way?

Posted by alphie | August 10, 2007 9:25 PM

Alphie,

"If you bought a Mortgage-backed security that was paying 7% or more a year...you would have to know the underlying mortgages were held by people with very bad credit."

The AAA-rated tranches of sub-prime backed CDOs were paying the lowest rates of any in the CDO; yields varied inversely with credit ratings, as they typically do. You may want to do a little homework on this so you get a better sense of what's going on.

Posted by Fred | August 10, 2007 9:44 PM

yeah, Fred,

That's what I'm saying.

Only credit criminals pay 7%+ for a mortgage.

If your CDO is paying 7%+ return a year...it's backed by people in way over their heads.

And anyone in the business know that.

Posted by alphie | August 10, 2007 9:50 PM

Even if MBS buyers were pure as snow and innocent as lambs in regard to the quality of the mortgages being made in the late stages of the boom the root of the problem lies much deeper. That was the assumption that the MBS pools and all the other flavors of structured finance really deserved their AAA rating.

They didn't and they don't.

"I have often addressed the notion of the “Moneyness of Credit” – in particular, the vital role played by what had been the prevailing Credit market perception that myriad debt instruments are both a store of nominal value (“safe”) and readily marketable (“liquid”). In general, a market’s belief that Credit is as attractive as “money” plays a decisive role in fostering Credit expansion. Over time, as the perception of moneyness is applied to expanding types and quantities of Credit instruments, a full-fledged Credit Bubble will take hold. And, as we’ve witnessed, the longer Credit excesses inflate asset prices, corporate earnings, and household incomes - the more seductive the Myth that the underlying Credit instruments are increasingly safe and liquid.

It takes years (decades?) and, importantly, the successful perseverance through at least a few close calls, for the perception of Moneyness to become fully embedded in the structure of the Credit system. Emboldened market participants eventually come to believe that that nothing can interrupt the boom. Each near crisis surmounted leads to only greater confidence in the underlying Credit system and the capacity for the authorities to sustain the boom - each period of greater excess layering more dangerous layers of risk on top of risk. "

http://www.prudentbear.com/articles/show/2086

Posted by rapier | August 10, 2007 11:00 PM

Fred, you seem to be having a little reading comprhension problem. this is the second time you're responding to something i didn't say.

what i said is this: the original subprime mortgages sold in the past couple of years that were securitized were fraudulently sold. buyers were not properly informed of the risks, and due diligence was not carried out by the mortgage brokers.

i then noted that lots of other people realized this (hell, i realized this) and yet continued to package and sell those securitized mortgages on the grounds that you yourself have already tried to use: the rating agencies let us down. (indeed, you're now more or less contradicting yourself since it was you that tried the "it's the rating agencies fault but obviously there's nothing more than can be done" rationalization).

there is nothing "facile" about this explanation: these are the simple facts of the matter. if you're not happy with the facts, that's quite clearly your problem, not my misunderstanding of reality.

Posted by howard | August 10, 2007 11:23 PM

To rapier: The best posts I've ever seen here.

Posted by kafka | August 10, 2007 11:35 PM

Zalriana:"If you are talking about the predatory lending practices involving people who had owned their homes free and clear, there are already state and local efforts popping..."

Well that's certainly re-asurring that there's a piecemeal approach to an institutional problem. You say Federal intervention may be counterproductive. Why? I'm not an expert on this issue, but it's seems to be the first response, after twenty seven years of conditioning, is that 'the Federal government can't solve anything and regulation and assistance will only exacerbate the problem'. Well it doesn't appear to me that the states or the business and financial communities have done a fantastic job given this current debacle,... and the S& L debacle, and the "new economy", etc., ad nausium. It's as if Federal involvement in anything is tragic, unlike the magic powers of the states and private sector. History is replete with examples of Federal involvement that has been effective, kept people honest, and help standardize the rules and act as a safety net to those who actually need it (whether they used to be rich or not). The founders themselves saw the importance of "promoting the general welfare". That's why they entered into this social contract. The Fed isn't perfect, but that's our own fault because we don't always pay close enough attention.

People have participated "...in an ill-advised and unsustainable financial transaction..." every single day since the dawn of time (btw, "Anything more essentially rewards them...", what are they, lab rats?, Pavlov's dogs perhaps). I don't assume that everyone will act rationally when money is involved (human history has proven otherwise). I don't think we should reward bad behavior either, but I'm sure we could probably come up up with a list of whose been naughty and nice (or just plain ignorant) and sort out who might actually need some help from losing their job and their shirt and their roof. You're free to think everyone with the nicer houses got what they deserved, but you and I and everyone else is paying for it whether we like it or not in higher interest, tighter credit, lowered property values, and yes even higher crime and welfare payments, ad infinitum. You've made good financial decisions, good for you. But you may want to consider that we're all in this together whether we like it or not. We may not have much choice of economic systems (socialism is dead isn't it?, darnit), but pure unadulterated capitalism ain't all what's it's cracked up to be and sometimes, yes, sometimes, people are stupid we need the Feds (i.e., us, what Uncle Sam embodies) to help propmote the general welfare before and after the fact to mitigate the harsh side of capitalism for everyone ('cept the really greedy bastards and the totally selfish, who got their's and screw everyone else cause I'm going home..., and of course, and we all know who those bastards are and exactly what circumstances led them to make poor financial decisions, don't we? ;)). If we actually did that and paid attention (instead of building a cult to deregulation and 'bad Federal Government, bad') maybe we wouldn't have to pay for it as often as we do.

Posted by rihilism | August 10, 2007 11:46 PM

Is it true that someone slapped a AAA rating on a tranche backed by sub-prime junk? What, did they pretend that there was sufficient geographic diversification or something? LOL!

I firmly believe in a market for junk, but alphie is right, you don't need a PhD to know that you cannot turn fool's gold into real gold ...

BTW, you gotta love the internet. The actions today are available online, for inquiring minds like Matt's.

3-days, $38 billion, single largest ever operation on mortgages (and the only one in electronic history devoted solely to MBS). Even then, they took up just half of what was bid and went as low as 3.5 at the end of the day to do it! Bet on a manic Monday?

Perhaps there really ought to have been stricter regulation of lending practices, especially if there is bogus-looking stress in the near-prime markets that is related to monetary variables rather than layoffs and such ...

Posted by Amicus | August 11, 2007 12:09 AM

I don't know, kafka.

The way I see it, the same crowd that recently got their pet politicians to pass a law that financially rapes ordinary people who file for bankruptcy just got a $38 billion government handout because...they got in over their heads wth credit.

And now their pet pundits are working overtime to hide the stain.

That's how pundits get in the club.

Posted by alphie | August 11, 2007 12:11 AM

Howard,

Instead of assuming my reading comprehension skills are poor, perhaps you should try to write more clearly and check the cogency of your points?

Amicus,

"Is it true that someone slapped a AAA rating on a tranche backed by sub-prime junk? What, did they pretend that there was sufficient geographic diversification or something?"

I haven't seen this clearly explained anywhere, but my guess as to how this worked is that the CDO issuers structured it so one tranche would have the first claim on payments in the event of any defaults, and thus it got the highest credit rating and paid the lowest yield; then the next tranche got a subordinate claim and got a slightly lower credit rating and paid a slightly higher yield, etc. It may be that the AAA-rated tranches end up deserving that rating, because of the stability of their interest payments. The issue now is that no one wants to buy any of it, so it has become illiquid. And that has led to certain chain reactions: e.g., margin calls on companies as their sub-prime-backed debt is marked to market, etc.

"3-days, $38 billion, single largest ever operation on mortgages..."

This sort of operation by the Fed is useful in providing temporary liquidity. Hopefully, the Fed will resist political and Wall Street pressure to lower the Fed funds rate at the next FOMC meeting though. Expectations that the Fed might lower interest rates when the credit bubble deflated increased the moral hazard which helped inflate the bubble in the first place. Expectations of a pending rate cut are probably dragging this out too.

Posted by Fred | August 11, 2007 12:45 AM

Just FTR, it's not a "handout". [Technically, the Federal Reserve cannot do a handout, just a reach-around].

Here's a brief sketch:

A number of people call up their broker and say, "Look, i've got this junky stuff. Buy it from me for cash."

Some of them do.

Suddenly, the brokers have a *LOT* of sh-t on hand, just for doing their job. Comes the end of the day, they need to give up the cash to their clients.

They go to the Fed and say, "Here, hold this sh-t for me overnight." For a limited amount, the Fed agrees to do so, charges interest, and gives cash to the broker.

The broker then gives the sh-t to the fed to hold and the money to their client. (They still own a lot of sh-t - the banks and brokers' stocks tanked today because of it, but they've kept the market running).

They go home and hope, like the rest of us, that tomorrow is a better day.

So, it's not a handout, it's sorta like grease, so everyone can do their job.

Posted by Amicus | August 11, 2007 12:55 AM

Fred, thanks for your reply. My point would be that maybe - maybe - through setting up of different tranches you could get to a BBB or BB rating, but never to a AAA, using totally crap credit for collateral.

If it was proclaimed to have been accomplished, I wouldn't be surprised, however!

Of course, sixty mortagage lenders dead later, we can safely say that the "model" was wrong ...

Check out Roubini:

http://www.rgemonitor.com/blog/roubini/

Posted by Amicus | August 11, 2007 12:59 AM

Amicus,

Why can't the financial geniuses of Wall Street raise quick cash just like everyone else does?

Pawn shops take Rolex watches and Park Ave condos.

I thought the financial folks in the government would bail out their cronies by bailing out the people who got the phony mortgages.

I never dreamed they were so corrupt they would just buy the worthless paper directly off their pals.

We truly live in a time of new levels of corruption.

Posted by alphie | August 11, 2007 1:12 AM

There are any number of questionable things that WStreet does, but the Fed's open-market facility is not one of them.

I have little doubt that there are people figuring out how best to raise some cash and pretty pissed off about it.

The Fed is just holding them over. They are pretty insulated / protected from major loss.

What's more, the situation is a little more complicated than I described. Remember that the FED is taking MBS as collateral, not any CDOs (or probably R-MBS), at least so far as I know. This is an extra layer of protection for the FED and more headache for the broker.

So far, the people losing money are (a) the client who probably sold it to the broker for real cheap and (b) the broker, if it turns out that cheap wasn't cheap enough, quite yet.

Things that we don't know, that are important: 1. How much of all this is related to sub-prime related credits and how much is related to people just worried, in general, about everything that has an "M" in it (and therefore, acting fast not to 'take any further chances') . 2. How much more there is of sub-prime related paper out there that hasn't been ... er, "marked down" yet.

Someone who knows junk mortgages may ultimately make a lot of money consolidating and cleaning up the mess.

I looked at Fortress (FIG), mentioned above. Their MBS/CMO guy (Howard Rubin) has been buying the stock ... but there is only public data through this February. It's possible that they might fire on all cylinders in the quarter, but it's almost impossible to predict, without knowing how they are positioned. (For all we know, Howard could have made a smallish fortune just lending out his collateral in the quarter ...).

Posted by Amicus | August 11, 2007 9:16 AM

Friday's Fed repos were simply weekend adds. In my opinion a strategic blunder. They should have been permanent adds (outright purchases for the Fed System Open Market Account). As long as your showing panic you just as well not hedge it by saying everything will be back to normal Monday. It was a sissy move.

Last week foreign central banks were net sellers of Treasury and agency securities. Last week the Treasury actually was a net buyer but that changes next week as they will be in the market for $30 billion or so and they will be in the market buying till the end of September when quarterly tax payments are due.

So where will the liquidity come from next week?

It's very odd that there is panic in the air with stock averages near all time highs. With the down days well within the normal expected historic range. That said the last four years have seen a distinct shrinking of stock market volatility. While I am in the school that says this is due mostly to the management of the market by insiders with government and Fed acquiescence if not outright participation the important thing is the fact, not the cause.

So stocks are 5% off their highs, Yawn. Ten percent corrections are the norm on an historic basis. 3% down days a dime a dozen. The fact is playas have been conditioned to expect the downside to be shallow.

Of all the oddities of this eras free market theology is it's unwavering embrace of the Greenspan as Maestro and Fed as savior memes. Nothing is the antithesis of free markets more than the idea that one man or one institution is controlling the markets. The level of cognitive dissonance is staggering.

*Most opinions and so called facts given by me are the ideas of others.

http://wallstreetexaminer.com/

http://www.prudentbear.com/archive_home_com.asp?category=18

http://globaleconomicanalysis.blogspot.com/
(best to ignore the hard money strict Austrian School aspects of this one. It's an odd fact that the severest critics of the financial status quo are often of the right)

http://ml-implode.com/

Posted by rapier | August 11, 2007 10:59 AM

Fred, here's the sentence in question:

the question is the extent to which they were aware (in a way that they could formally "know" in terms of how they work) that there were subprime mortgages being issued under conditions that almost certainly justify the term "fraudulent" being wrapped up into some of these lovely tranches.

i have no idea how you drew your interpretation without a reading comprehension problem, the words "subprime mortgages being issued" being a dead giveaway to most people.

the cogency of my argument remains untouched: the market liquidity problem we are seeing now is rooted ultimately in mortgages that should never have been issued. lots of people knew that and ignored it because they were making money hand over fist.

Posted by howard | August 11, 2007 11:47 AM

I am shocked at any suggestion that there is fraud in the financial sphere.

August 2: It is important to note that the Company (Countrywide Financial Corp.)has experienced no disruption in financing its ongoing daily operations, including placement of commercial paper.

August 9: Countrywide Financial Corp. faces "unprecedented disruptions" in debt and mortgage-finance markets that could hurt earnings and the company's financial condition, the Calabasas, Calif., lender said in a regulatory filing.

The associated press is reporting Countrywide Financial Chief Executive Angelo R. Mozilo Exercises Options for 92,000 Shares.

The chairman and chief executive of mortgage lender Countrywide Financial Corp. exercised options for 92,000 shares of common stock under a prearranged trading plan, according to a Securities and Exchange Commission filing Wednesday

In a Form 4 filed with the SEC, Angelo R. Mozilo reported he exercised the options for shares on Wednesday for $14.69 apiece and then sold all of them the same day for $28.74 apiece.

Let's do the math. $14.05 * 92,000 = $1,292,600

Posted by rapier | August 11, 2007 3:30 PM

Amicus,

"I looked at Fortress (FIG), mentioned above. Their MBS/CMO guy (Howard Rubin) has been buying the stock ... but there is only public data through this February."

It's not that there isn't public data available since February, it's just that there have been no insider trades in Fortress since then. According to Edgar Online via Nasdaq.com, there were 11 insider buys of Fortress since its IPO and zero insider sales. Rubin's buys were at $28 per share, btw. Broadly speaking, here is why I like Fortress.

In addition to its real estate "castles" and private equity funds, Fortress runs hedge funds. Peter Briger, who runs Fortress's hybrid hedge funds group, used to be the co-head of the fixed income principal investments group at Goldman Sachs. If you consider that principal investments (i.e., the division at Goldman that trades the firm's own money) has been the most profitable part of Goldman Sachs for years, buying Fortress now is a little like buying the most profitable part of Goldman Sachs at pre-IPO prices. There is obviously some uncertainty, do to the current market situation, but the risk is ameliorated somewhat IMO, by Fortress's current ratio of 6.4 (i.e., it has 6.4 times as much current assets on hand as it does current liabilities; usually companies with current ratios of 2 or higher are considered to be in strong positions).

Howard,

"Fred, here's the sentence in question"

Here is what you seem to be missing:

1) It was no secret that the CDOs, including the AAA-rated tranches, were comprised solely of sub-prime mortgages.

2) There doesn't seem to be anything fraudulent about this.

3) The rating agencies knew what was in the CDO tranches that they rated. See my 12:45am post for an explanation of why I think these were rated triple-A.

4) It may be that the ratings agencies were correct in rating the top tranches AAA -- they rate credit quality (the likelihood of interest payments being paid) after all, and I haven't heard of any significant defaults of these AAA-rated securities. The worries now are about liquidity, since institutional demand has dropped for these securities.

Too clarify a previous point of mine:

Rating agencies, IMO, dropped the ball by not anticipating these liquidity issues, so they could better advise institutional investors. Ratings agencies in the past have done a poor job grading credit quality as well. I do think some new blood would be useful in this business. That said, I don't blame the rating agencies for the bubble and the bust. That's mainly the result of the Fed flooding the system with easy money in the run-up to Y2k and later after 9/11. On balance, the Fed probably did the right things then, given the circumstances. But the perception that the "Greenspan put" would transition to Bernanke increased moral hazard and helped inflate the credit bubble even more. This time the Fed should let the market sort itself out, instead of inflating another bubble.

Posted by Fred | August 11, 2007 4:16 PM

On further reflection and investigation , outright buying of agencies and MBS's would be a terrible thing. They have been doing repos of these for some time but never have they added them to their permanent account.

The thing to know is they do their open market operations only with their primary dealers. (Not ordinary banks by the way. Giving lie to the whole concept that they are somehow directly effecting the broad banking system with their open market operations) It's one thing to buy perfectly fungible Treasuries from their dealers but would be quite another to buy these damaged goods only from them. Such would be a direct bailout and profoundly unfair. The amounts until they reached the hundreds of billions would not be enough to bolster the market.

Note: Countrywide is a primary dealer. To the extent the gang of 22 primary dealers are mortgage originators one might argue that purchases by the Fed is providing valuable liquidity to the mortgage market. Still, that does not change the fact that such an operation would be an unfair and unequal subsidy to those dealers.

Of course ..0001% of the population will have a clue what this is all about and only .0000001% will object.

Posted by rapier | August 11, 2007 5:40 PM

You don't need a Ph.D. in economics to recognize crony capitalism at work, rapier.

Posted by alphie | August 11, 2007 5:59 PM

The WSJ gets it right with this editorial today:

The Bernanke Call--II:
Wall Street wants the Fed to ease the pain of its lending mistakes.

Posted by Fred | August 11, 2007 8:42 PM

The only people profiting from this are going to be the rich hedge fund investors buying everything on sale. Ordinary mutual fund investors are going to be worse off.

Posted by Susie | August 11, 2007 10:46 PM

matt is, as he admits, ignorant on this, but so, unfortunately (and you may note the 'fortune' in 'unfortunately') are most posters here. i haven't seen it said here that greenspan created a housing bubble to bail the country out of the dot.com bubble's collapse (a bubble he might have prevented as well) by lowering interest rates to 1%--in the meantime giving notice that the fed would intervene (as it did with ltcm). now bernake will be obliged to lower rates in the face of the housing bubble collapse. when rates are lowered, after an initial relief rally, it will become clear that the dollar is toast, the economy will weaken drastically, and a great recession will follow, not only in the u.s. but around the world. greenspan's policies will be largely to blame. you could buy gold.

Posted by annie | August 12, 2007 2:09 AM

Annie,

Read the WSJ editorial I linked to above, or my earlier 4:16pm post which makes a similar point as the Journal's: Bernanke would be an idiot to lower rates now. I doubt he will.

As for buying gold: you could do that, I suppose. But given its massive run-up in the last few years, and the spread you'll pay to buy coins (assuming you're not buying bullion), you may be taking on more risk than you think. There are other ways to profit from a declining dollar, including investing in American companies that sell the bulk of their products overseas.

There are bargains to be had in the stock market now, if you know where to look (hint: most American blue chips get the bulk of their sales overseas). If you don't, you could do worse than investing in a first-rate fund such as The Fairholme Fund (FAIRX). Or, if you have a little more risk tolerance, take a look at a stock I mentioned earlier in this thread, Fortress Investment Group (FIG).

Posted by Fred | August 12, 2007 4:44 AM

Fortress's current ratio of 6.4 ...
------
How many analysts use CR as a good measure for financial companies?

They don't look like a super-duper capitalized operation to me ($120 Million in equity for $22 billion in assets).

Annie, when do you think the Fed will move first, how far and how fast for the rest?

rapier, it's not so easy to become a primary dealer, just for clarity of the record.

Posted by Amicus | August 12, 2007 10:34 PM

"How many analysts use CR as a good measure for financial companies?"

The current ratio is one of a few fairly common measures of balance sheet strength. I'm not sure how many analysts look at it when evaluating companies (financial or otherwise) -- probably not enough. S&P's analysts include it in their report on FIG. Most analysts looking at FIG though focus forecasting earnings going forward and then discounting them back to come up with a target price for the stock. Some use a discounted cash flow methodology.

If you're interested in how this works, and what assumptions are used, take a look at Lehman's analysis of Fortress by Roger Freeman, CFA (I'd link to it, but it's in the password-protected part of my Fidelity account. You may be able to find it elsewhere). The risk factors of interest to Lehman's analyst didn't involve Fortress's balance sheet, but potential sub-prime CDO exposure in its hybrid hedge funds (he considers this to be modest, with a possible short position) and the impact of tax changes on its private equity business.

"They don't look like a super-duper capitalized operation to me ($120 Million in equity for $22 billion in assets)."

AUM is actually closer to $35 billion, I think, including the $5 billion funds Fortress closed on last month. Asset management isn't a capital-intensive business though. The biggest expense is comp for employees, and the marginal cost of managing additional assets is negligible.

This time next year, my guess is that Fortress will be trading for at least $28 per share (Consensus estimates are higher, but I am more conservative). There are other, less speculative ways you can try to profit from the current credit crunch though if Fortress looks too exotic for you.

Posted by Fred | August 13, 2007 2:16 AM

rihilism: "[taking me as being anti-government]".

You misunderstood--I think that the propblem with federal intervention w/r/t individuals who were fraudulently induced to take out mortgages on homes they owned is that the facts are too local. Trying to apply a blanket federal regime when you have 50 sets of state real estate laws is a recipe for a good bill-signing photo-op and little else. Sure, some people will be helped, and some of the larger groups of fraudsters might wind up doing time in a federal pound-me-in-the-a$$ prison, but it's just not likely to be timely or focused on saving Great Aunt Mabel's house.

"but you and I and everyone else is paying for it whether we like it or not in higher interest, tighter credit, lowered property values, and yes even higher crime and welfare payments, ad infinitum"

Sure, I'm going to pay for it either through the effects on the real estate market and the broader economy or through higher taxes--given the choice, in these particular circumstances, I'll take the costs showing up through the market. If we support a federal bailout of (among others, admittedly) thousands of real estate speculators, professional and amatuer, then next time they'll do it again--there needs to be some individual pain when the risk-taking goes bad. Don't tell me the sob stories; the incidents of actual, naked fraud without complicity from the borrower are the outliers.

Posted by zaleriana | August 13, 2007 4:42 PM