The true story behind the financial crisis.

[gator996]

Uhhh, I respectfully disagree with you...

But let me ask you a quick question and then I'll explain why I think you're wrong.



When you say if the market acted "normally" what market are you referring to?

The home loan market?
The securitization market?

What market do you mean needed to act normally?



While I wait for your answer....


You regulate markets so that they operate "normally" & efficently...


Its kinda like contracts...you don't write them for "normal" operation, you write them to resolve conflicts when "normal" doesn't occur.

[CHFG8R]

Originally Posted by Matthanuf06

The private market can only play the game by the rules set by the government. That right there is a distortion. There is a laundry list of distortions here.

Yet we all know how much power these banks have over policy, especially financial policy. So I'll ask again, did they lobby for these types of things or against? If the former, then the Private Sector vs. Government argument is moot.

[Matthanuf06]

Originally Posted by 108

lets just pretend Matthanuf06 is correct and this lays at the feet of Government relaxing standards.....how does this make the case for less regulation?

It's not just relaxing standards. It's distortion of the market at all levels. Even something such as the mortgage interest deduction comes into play. The government is so involved here, at all levels, that they really have to sleep in the bed they made.

[Matthanuf06]

Originally Posted by gator996

Not only do you not understand what I'm saying but I highly doubt you understand macro side of the business all that well...

Should I take a guess that you worked on the retail side of the business?

This is like the guy who worked on the assembly line at GM saying he knows the auto industry like management.

And I'm not saying that in a condescending manner ...seriously.

The start of the financial crisis & the mortgage meltdown was the inability for Soc Gen to value the MBS securities in two specific funds.

They announced they couldn't value them (not good, very public)
There were liqudity rumours circling (by that afternoon)
There was a run on those funds by investors (the next morning)

And quickly Soc Gen stopped redemptions... (how could they they couldn't value them)

Investor confidence was shaken and the rest is history...

If you think this has been caused by crap going on at the retail level then GM went under because "Rosie the Riveter" didn't bolt the door on well enough...

The individual loan collateral was a problem but that alone didn't cause this....

The amplification through securitization multiplied the positive & negative effect well beyond anything that could be contained...

The amount of times that crappy individual loan was sliced diced resold & repackaged caused this meltdown...

...not some appraiser or loan officer in Orange county.

Its a very complex issue that had sources all over the "business"...retail, financial markets, government, rating agencies, investors...

Trying to assign all of the blame to one entity is kinda futile but if I had to say who was repsonsible for magnitude of the problem I would start with Wall St.

I'm in portfolio management in something like a fund of fund structure. So while I don't analyze securitized products directly, I interview and hire the best in the world that can. I'm also a CFA charterholder and a certified FRM, so yeah this isn't something I just read about in the newspaper with my talking points fed from my favorite biased commentator.

And I never said it was caused by loans to risky borrowers. Those loans have an investment purpose and serve an important role in our markets. Packaging them and reselling them also played a minimal at most role, which is my point.

Securitized products are not that complex. They really aren't. For your sake its just a bunch of loans packaged into one. By definition they are less risky than a single loan if the correlation isn't one, hence the higher quality. The failure from a risk management standpoint is vastly underestimated the correlation amongst loans. So it's just a package of loans instead of owning a single loan, like owning 30 stocks instead of 1. What's wrong with that? Now of course it gets more specific and marginally more complex depending on risk tolerances (and return expectations) leading to tranching, liability type matching needs, and generally other desires when it comes to what you want out of the product. It's still just a package of loans. Customization to suit someone's needs is a good thing.

Now the complexity is more on the modeling side, aka how it should perform, once your slice and diced the package of loans to suit various needs. And that really comes down to the correlation failure.

But even still, NONE OF THAT MATTERS, if we don't have a major standard deviation event that crushed the market. Those loans would have NEVER defaulted at that rate with those correlations. Hence the problem was the market decline. I never pinned the failure solely on the government. I said they set up the rules, the distortions to the market, the incentives, the moral hazards, etc. We played their game. But can we improve? Damn straight we can. Our analysis was tremendously shallow then as it is now from a risk standpoint.

[Row6]

Originally Posted by Matthanuf06

I don't dispute this. Although that doesn't answer why the speculation was occurring. Others were blaming the collapse on securitization, which I was pointing out is completely false.

I think it does explain why speculation was happening. I am small potatoes and so are my friends, but I knew several who started buying rental properties and decided on a beach condo as a good investment, and it was because they got burned on the stock market. Big money was doing the same thing and it resulted in a real estate bubble that largely carried the economy after 9/11. If you had taken real estate and building out of the stats economic growth was non-existent in the first half of the last decade. Did the tax cuts, which handed high earners a windfall, exacerbate the speculation? I don't have hard data, and it might be difficult to know, but wealthy people generally look to invest "extra" capital, as opposed to buying groceries and a new car, as the lower and middle earners do. Maybe a new beach house! Hey, how could you lose on that?

[Matthanuf06]

Originally Posted by gator996

Uhhh, I respectfully disagree with you...

But let me ask you a quick question and then I'll explain why I think you're wrong.

When you say if the market acted "normally" what market are you referring to?

The home loan market?
The securitization market?

What market do you mean needed to act normally?

While I wait for your answer....

You regulate markets so that they operate "normally" & efficently...

Its kinda like contracts...you don't write them for "normal" operation, you write them to resolve conflicts when "normal" doesn't occur.

I'm talking in statistical lingo for the real estate market. The home price decline caused default rates to increase, loans to correlate, and individual and packaged loans to perform much worse than expected.

The market decline was so extreme that it was a major outlier in any type of housing market analysis done. To model the loans you need default rates which is somewhat based on market values. Now the distribution isn't normal, but for these purposes that works. Long story short default rates were modeled off of a distribution assumption of home values, and the decline was such an extreme outlier that it tossed the analysis out the window. In my previous post I mentioned how we've come a long way, and much of it is how we treat extreme events.

[Matthanuf06]

It's also important to note the correlation spike wasn't isolated across just mortgage performance, but all assets. Most of us heard how equities had a correlation spike, but lets just talk paper.

The housing decline also caused the quality of credit card debt, auto loan debt, student loan debt, etc all to decline. So the entire book got worse, at the same time, due to a unmodelable event. This is where the complexity is, not at that securitization level.

[reformedgator]

Matt, thanks for taking the time to explain the issue to the rest of us who had to live with it, but don't understand how we got into this mess.

[108]

Originally Posted by Matthanuf06

Correct. Free market proponents are not anarchists. Protecting property rights and contracts are essential roles of government.

but not protecting its citizens from harm by the way of business right

you're living in a fantasy

[108]

Originally Posted by Matthanuf06

It's not just relaxing standards. It's distortion of the market at all levels. Even something such as the mortgage interest deduction comes into play. The government is so involved here, at all levels, that they really have to sleep in the bed they made.

you're saying stuff that needs to be shown how it specifically relates to the crash

please be more detailed

[Minister_of_Information]

So what caused the bubble.

[Row6]

Originally Posted by Minister_of_Information

So what caused the bubble.

http://www.gatorcountry.com/swampgas...9&postcount=61

[Matthanuf06]

Originally Posted by 108

you're saying stuff that needs to be shown how it specifically relates to the crash

please be more detailed

Isn't it all obvious? I don't mean that in a condescending manner. You quoted me when I mentioned the mtg interest deduction. That increases demand for home ownership vs. renting, which in turns raises the price of homes. The moral hazard is a huge one. That exists across the board (not with just companies, but individuals as well), entities behave differently when they know Uncle Sam will bail them out. Again, not just firms, can apply that to individuals and entitlements.

[Matthanuf06]

Originally Posted by Minister_of_Information

So what caused the bubble.

The short answer is a lot of things, which can be traced to increased demand.

Low interest rates (FED), Govt incentives and loans and certain policies, irrational exuberance (everyone wants on a rocket ship), poor financial modeling (correlation and tail risk analysis mainly), moral hazards, simple speculative buying, etc.

Lots of those things fall into the chicken or the egg type of problem. So the key is what started it? I'd say really owning vs renting. The price to rent ratio was low, essentially saying you are better off to buy than rent. This increased demand, which set off the irrational exuberance even when it was technically better to rent than buy because everyone thought home prices were a rocket ship, so even if you couldn't "afford it" you'd gain equity via appreciation.

[dangolegators]

Originally Posted by Matthanuf06

Isn't it all obvious? I don't mean that in a condescending manner. You quoted me when I mentioned the mtg interest deduction. That increases demand for home ownership vs. renting, which in turns raises the price of homes. The moral hazard is a huge one. That exists across the board (not with just companies, but individuals as well), entities behave differently when they know Uncle Sam will bail them out. Again, not just firms, can apply that to individuals and entitlements.

With regards to the recent housing bubble, the mortgage interest deduction had been around for decades prior to that. It wasn't a factor.

[Matthanuf06]

Originally Posted by dangolegators

With regards to the recent housing bubble, the mortgage interest deduction had been around for decades prior to that. It wasn't a factor.

It artificially increases demand for housing. Considering that was what caused the bubble it certainly was a factor, albeit a small one. And even still it's simply a market distortion. It's an incentive for people to buy vs rent.

[dangolegators]

Originally Posted by Matthanuf06

It artificially increases demand for housing. Considering that was what caused the bubble it certainly was a factor, albeit a small one. And even still it's simply a market distortion. It's an incentive for people to buy vs rent.

If the mortgage deduction had changed to make home ownership more favorable in the years preceding the bubble, you could certainly make a case for it, but the deduction has been around for decades. It is a factor in only the tiniest of ways.

[Matthanuf06]

Originally Posted by dangolegators

If the mortgage deduction had changed to make home ownership more favorable in the years preceding the bubble, you could certainly make a case for it, but the deduction has been around for decades. It is a factor in only the tiniest of ways.

You could say that about every non-emotional factor. The housing boom was due to a multitude of factors as I listed, eliminating any single one wouldn't have solved it.

Either way I'm not sure how you don't see how it played a role. It increased demand ever since implementation. So over the years it caused more homes to be built than what is optimal. That increased demand (over optimal) continued to exist during the boom. Therefore more people bought homes than would have if that incentive did not exist. And one the downswing it added to the supply of homes on the market and vacant given the decades of increased supply it caused. I'm not claiming it was the only factor, or even a large one, this incentive was a small contributing factor.

Consequences are a pesky thing.

[dangolegators]

Originally Posted by Matthanuf06

You could say that about every non-emotional factor. The housing boom was due to a multitude of factors as I listed, eliminating any single one wouldn't have solved it.

Either way I'm not sure how you don't see how it played a role. It increased demand ever since implementation. So over the years it caused more homes to be built than what is optimal. That increased demand (over optimal) continued to exist during the boom. Therefore more people bought homes than would have if that incentive did not exist. And one the downswing it added to the supply of homes on the market and vacant given the decades of increased supply it caused. I'm not claiming it was the only factor, or even a large one, this incentive was a small contributing factor.

Consequences are a pesky thing.

It played a role in the same way an extra in movie crowd scene of 1000 extras plays a role. Interest deduction on mortgages, which began 100 years ago, isn't worth discussing as a cause of the housing bubble.

If you want to go back far enough, you can say it's Christopher Columbus' fault. If he hadn't discovered America, there never would have been a housing bubble. Maybe there would have been a teepee bubble instead. That's similar to the logic you are using here. It's silly to include every possible factor, no matter how small, when trying to determine the cause of something. In statistics, too many input variables just ruins the usefulness of the model.

[wgbgator]

Man, not only did Columbus commit genocide, he made the housing bubble possible. And we still have Columbus Day why?