Banks are getting back into the business of building mortgage bonds
wsj.com
wsj.com
Maybe we can blind the rating system? If Standard & Poor can't tell whether this instrument they're rating was created by HSBC or me in my basement, they may take a few seconds more to consider whether the scent of shit is because it is in fact just shit in a thin paper shell.
And if you blind them but they still don't give true ratings you can trivially exploit that to fill the market with highly rated shit, destroying the market but leaving the real economy largely untouched. Rinse and repeat until all the dumb money is sucked into your pocket.
We also cannot downplay the significance of speculation systems themselves. There needs to be more burdens put on such financial mechanisms to prevent them from getting out of hand like in 2008.
Plus these are securities, and all market participants should have access to the same public information. It is a problem to have half the investors in the dark about the transaction if they couldn't pay for a private rating (which in turn would negatively affect pricing).
The borrowers were different so there was really no precedent, but just a cursory review of historical data would make what we experienced highly unlikely.
[0] https://en.wikipedia.org/wiki/Subprime_mortgage_crisis#/medi...
on the other hand, it is easy to predict that: when the average joe holds "home ownership" up as the sterling example of "making it"; then the average politician will determine that the best way to make voters happy is to increase home ownership by lowering barriers, and exempting home ownership from risk, taxes, estates, bankruptcy, medical expenses, etc. all in the name of "obvious" fairness;
then [it's easy to predict that]: mortgages and mortgage backed institutions will become unsound.
TL;DR a crisis like this is going to happen again, and it happened before, see previous "savings and loan" crisis.
bonus lesson in finance/accounting: if the problem is framed and worded properly, it's easy to see that money paid for rent is not actually "wasted money down the drain", and that it is a fallacy that it is better to put the money toward a mortgage.
Let's say out of college you live in your old room at mom's while you save money to get your own place. Your job turns out well and you're making good money, but instead of renting your own apt, you stay at mom's to save for a down payment on a first house. You save up, and you buy a place. OK so far?
Now owning your own place, do you move into it? Well, think about it, you could stay at mom's and rent this new place you own out to somebody else and let them "waste the rent" while you collect all this fingerquotes "free money". Id est, i.e., if you move into your new place, you are essentially depriving yourself of the rent that you are entitled to earn from it; you effectively pay rent to live in your owned home. You are the one "wasting the rent money".
And the extra details actually work against you: mortgage interest expense is tax deductible, right? Well, if you rent the place out, ALL expenses are tax deductible, that's more deductions than if you live in a place.
As an additional point, is rent "such a waste of money to the tenant" that wealthy people (let's use Bill Gates as an example) buy lots and lots of houses and apartments to rent out to the rental suckers? no, they don't.
TL;DR purely financially, owning is not better than renting; rent is not wasted money, at least not more than the fingerquotes rent you spend when you live in your own place.
Also, leverage: if you're borrowing money to make an unsecured investment in a scheme, disaster awaits.
The United States allows 'microfinancing' via kickstarter, where poor people are allowed to give money to new ventures without any expectation of return on the given capital. Meanwhile, the rich get the opportunity to invest for actual returns on capital. Do you think an accredited investor is going to give money on kickstarter when they could offer cash as an investment?
So why is giving money allowed, but spending the same money on acquiring shares not? The answer that 'some people got scammed' does not excuse the fact that people are still allowed to spend the same money today, without consumer protections, while not receiving any benefit. In other words, we have created yet another way to privatize the benefits of new ventures (by only allowing rich people to profit off of them) while socializing the costs (the people asked to contribute to new ventures without any ownership interests via microfinancing platforms). The response that this is for consumer protection is crap, and anyone not blinded by legal confirmation bias can see that
Maximal investment limits based on income are perhaps appropriate, but wholesale banning is morally reprehensible, and a direct contributor to income inequality.
and all the bankruptcies and home foreclosures in an economic downturn shows the cost of high leveraged investing. A better way to achieve leverage is high beta stocks. Beta behaves just like leverage, except it automatically rebalances debt/equity on the way up and down. And the base rate of growth of the stock market is substantially higher, so you are leveraging a higher rate, even though you can't lever as much as a home.
and don't forget, owning a home and living in it as real estate prices rise means that you are "throwing away" higher and higher virtual rents that you would be entitled to collect and which factor into the value of your home.
Only if you're having no kids which you plan to leave some wealth to inherit. Owning a home is the way for the lower/ middle class to build up trans-generational wealth. Let's just take the following example:
1. I buy a home today and pay it off in 30 years (standard schedule).
2. I get a kid in three years.
3. The kid is ~30 when I become a pensioner and move off to Croatia to smoke pot all day and night... meaning the kid can either move with his family into my fully paid off home, rent it out or sell it off at 4-5x the "original" value. Either way, my kid can keep a vast proportion of his paycheck and either save it up or investing it, thus creating wealth.
If I will spend the rest of my time renting, however, I will leave nothing for my kid to inherit and use as leverage to build their own wealth.
Now you understand why my generation is so truly fucked.
>And if you can save money for a downpayment then you have to compare the opportunity cost of investing those savings versus using them to buy a house.
The house will always win if you are in any metropolitan area. In 20 years property prices in Munich, for example, have tripled or quadrupled, if not more. If you're not in a metro area you don't have the rent problem anyway.
No. I find it incredibly difficult to understand why my generation seems to be so truly 'fucked'. Especially, the type of people who are on HN should be able to save money and make a down payment.
Put another way, as a landlord you are the best tenent you will ever have.
How does it work out when your mom is renting herself and when you went to university she started renting a smaller place without extra room, to save some money?
rent vs own comparison may look a little different when you actually need a place to live
It's the rating on the debt which makes it clear exactly how risky it is, and allows people to make a decision about it.
What? No. Its a statistical decision. Its a question of how good your data on your risk profile and the risk the creditee represents is.
The Dodd-Frank bill passed in 2010 removed this immunity, making them liable for bad faith ratings that did not represent the real risk. As some people may recall, this created a temporary problem in the market as many debt instruments were suddenly re-rated to eliminate this legal liability. This is also related to the downgrade of US Treasury debt from AAA status in 2011.
Remember Arthur Anderson. They're gone, but the US Supreme Court concluded that they weren't guilty! They make O J Simpson look like the picture of innocence, and yet somehow the Supreme Court felt the need to grant certiorari and then decide actually people who do crimes aren't necessarily guilty of those crimes if they're rich old white men...
I don't think that's enough, David Duncan in particular should have gone to jail, but it's not as if there were no consequences and to be fair to the US government they went after AA hard.
> They were indicted for shredding documents. These documents were drafts and other items that do not support the final product. All accounting firms establish policies for routinely shredding such documents.
See - all routine. Sure, your routine might not include being "reminded" to arrange for piles of documents to be urgently shredded once you hear investigators are coming but that's why you might some day be found guilty of crimes, whereas Arthur Anderson were "not guilty" after all the evidence was destroyed and their chums in the US Supreme Court reached in and overturned verdicts against them for destroying the evidence.
Now, one of the nice things in overseeing the Web PKI is that I don't care whether the auditors are incompetent or crooked, it's the same either way to me. I don't expect even their own bosses to do as much as slap them on the wrist for enabling fraud. If I'm relying on audit then I know I might as well toss a coin, I'm always going to be digging deeper than that to understand what was actually going on regardless of whether the auditors "forgot" or deliberately chose not to look.
Previously, if they rated junk debt as AAA, and you bought that debt based on that rating, you would have no recourse for their misrepresentation of risk as they were granted immunity from such things. To make matters worse, for some regulatory purposes companies were required to buy instruments rated by these organizations and take these ratings at face value.
With the change in law, if someone sells me junk debt rated as AAA by one of these NRSROs, I can now sue the NRSRO in court for damages for misrepresenting risk. For any particular rating, there are thousands of companies, often with deep pockets, who have standing to recover losses from the rating companies for misrepresentation of risk. Even if they avoid criminal liability, there is the very real prospect that the civil liability would destroy them.
The models the rating agencies were using were not secret. They defined to a great extent what was allowed to go into a pool, and how much support and credit enhancement would be necessary for the senior tranche to get a AAA rating. So as a pension fund manager, if I see to pieces of AAA paper of similar maturity trading at radically different yields, I have to consider am I getting a deal, or does the smart money know something about one of these deals? And honestly if I just buy in bulk, relying on the rating alone without due diligence on the deals, shouldn't I bear some responsibility?
Beyond that, it's not clear that you could prove civil liability. The ratings were based on models, and the models were based on historical experience (and some wishful thinking.) But when push comes to shove in the context of billion dollar lawsuits, you can imagine they'll tease the wishful thinking out of the models and show that their rating models, though flawed, were based on a reasonable interpretation of historical experience and that ratings are not an endorsement or a guarantee of suitability.
As someone who witnessed the crisis up close, the ultimate cause of the crisis was a bunch of ordinary people, both on Main street and on Wall Street, making good faith decisions that seemed rational at the time, but in retrospect proved to be idiotic.
https://www.cnbc.com/2018/05/24/trump-signs-bank-bill-rollin...
Broader point here: grading systems aren't all that resilient. It only takes one bad actor to threaten the whole system, if we assume ratings (in aggregate) are always believable. Dodd-Frank may have been re-worked but I wouldn't, for a second, assume there isn't a loophole in there that will allow the bad guys to resume.
I’m in my early 30s and can recall the following in the US. All for different reasons which would lead me to believe that government regulation post crisis can be effective at avoiding the same crisis from repeating (while arguably could cause a new one):
- mortgage crisis 07 - dot com 00 - savings and loans late 80s - oil crisis late 70s
Yes, all of them for the same reason: FIAT currency instead of real money.
You realize even hard specie only has value because of government fiat declaring that it’s appropriate to use for public debts right?
Money based on value of some kind, as opposed to debt.
The only reason we ever decided on gold or silver as the store of value was because kings made it so.
The buyer. By paying the price.
[1] https://en.wikipedia.org/wiki/Methods_of_coin_debasement
Some of the major reasons why financial recessions happen are: abnormal leveraging, liquidity mismatches, wars, taxes, subsidies, governance.
[1] https://www.businessinsider.com/qe-in-the-financial-crisis-o...
This book by two economists seeks to answer that question:
This Time It’s Different: Eight Centuries of Financial Folly
http://www.reinhartandrogoff.com/
Hint: yes.
Yes, they all do. Fundamentally, they are the result of leverage (usually with a significant amount of maturity and liquidity mismatch) being used to bid up the price of capital assets. HIGHLY recommend reading Irving Fisher's "Booms and Depressions" and "The Debt Deflation Theory of Great Depressions" as well as pretty much everything Hyman Minsky wrote as a starting point. This is a subject that has fascinated me for decades.
Also, the submission was previously titled something like, "Banks are cozying up to the same types of mortgage bonds as the ones from 2008."
You can also find it on a podcast or two where someone reads it.
generally speaking, regulation slows but also stabilizes economic growth. Until the removal of the gold standard and stronger fiscal and economic policy in the 30's, we had a boom bust cycle almost yearly with inflation/deflation cycles often within 16 months and massive spikes and drops in the stock market. Since the New Deal era, the stock market has seen typically steady growth without constant swings in inflation and a longer trend or cycle to economic crashes usually dictated by the process in my first paragraph.
Inflation rates since 1914 (see the negative or deflation period in the early 20's): https://www.usinflationcalculator.com/inflation/historical-i...
Dow Jones average over the last 100 years (see the ups/downs leading into WWII and the not uniform but consistent growth since the New Deal era): https://www.macrotrends.net/1319/dow-jones-100-year-historic...
History of US recessions (very brief but note that regulation/government entities created to prevent the same issue from coming up again like the 1907 recession): https://www.macrotrends.net/1319/dow-jones-100-year-historic...
If we haven't made the disincentives stronger (we haven't) and if they were inadequate the first time (they were), why are we expecting bankers to make different choices?
This is the expected outcome.
Let's just clarify - American citizens lost $12.8Bn. [0] That money didn't evaporate, it got funneled back into many of the banks and auto manufacturers as a hand out. Some banks that took risk had little to no downside and we know that there were a continuation of bonus payouts to executives by banks that took bailout trailing the debacle. The US had a chance to wipe out some of the hogs of the market but instead chose to feed them.
[0] https://finance.yahoo.com/blogs/daily-ticker/2008-financial-...
With the 2008 setup, there is little incentive not to repeat it.
Also, the shareholders of such banks should be held accountable - the banks in question should be dissolved and the assets distributed to the public/the state. If shareholders do not have to fear total loss as a consequence of managerial misconduct they will not have any incentive to put actual controllers instead of yes-men to the boards.
do you believe them?
and even if you do, why are they allowed to remain that big? this is exactly what "too big to fail" means, and why it's a problem.
$12.8 Trillion is the actual loss.
In reality, MBSs are a truly beautiful idea that have a lot of potential to help a lot of people. The banks just needed to have better risk management and I think a lot of lessons have been learned. Despite what the public thinks, banks, especially Goldman, (one of the only institutions to not get hit very much by the collapse) take risk management very seriously. And the guys that didn’t have gone out of business (i.e Lehman).
And you’re right, this is the expected (good) outcome. Learn some lessons and start selling a useful product again gaining some wisdom. Nothing wrong with that.
The principle is simple and fine, chop up a bunch of mortgages from all over, with the same risk profile and pool them together.
That way local environmental factors don't cause the whole investment to go south. Basically raid for investment
What is a problem, and one that still hasn't fully been tackled is the industrial scale fraud that sold delinquent, or knowingly under par mortgages as high quality instruments.
Through all the use of fancy words, every seems to have got the impression that commoditized mortgages investments are complex, using words like "tranche", "proprietary instruments" and blended risk.
its really not, get a bunch of mortgages, shove them in a blender and make mortgage sausage.
So long as there isn't widespread and systematic fraud, then everything will be fine.
However considering that there haven't been large scale arrests, I don't hold out much hope.
If Bank X is sloppy about qualifying customers for mortgages but keeps the mortgages on their own books, the sloppy behaviour will bite them in the ass. Thus, they are incentivised to be careful with no external oversight needed.
The moment it's possible to sell the mortgages on, that incentive is removed.
It's not. Investors in the secondary market don't want to buy shitty subprime loans. The only reason lenders originate these awful loans is because the government incentivizes them to do so by guaranteeing to buy them via Fannie and Freddie. Fannie and Freddie buy half of all US mortgages, and in doing so dramatically distort interest rates and the amount of liquidity in the housing market. They also guarantee these loans, something a lender would never do, which is why mortgage-backed securities were considered "safe" leading up to the crash in 2008.
If Fannie and Freddie didn't exist, subprime loans would either not exist or would have dramatically higher interest rates in order to properly protect against the risk of default.
I'm not sure where you got that idea. Fannie and Freddie exist for the explicit purpose of making mortgages more accessible to people who would otherwise be considered too risky to lend to (low down payments, low income, no assets, etc.). They do this by purchasing mortgages that are underwritten to lower standards and at lower interest rates than would be acceptable to private lenders, effectively shifting the risk from private lenders to the taxpayers.
Fannie and Freddie bought a tremendous amount of subprime loans. From page 454 of the Financial Crisis Inquiry Commission report[1]:
> "...on June 30, 2008, immediately prior to the onset of the financial crisis, [Fannie and Freddie] held or had guaranteed 12 million subprime and Alt-A loans. This was 37 percent of their total mortgage exposure of 32 million loans, which in turn was approximately 58 percent of the 55 million mortgages outstanding in the U.S. on that date. Fannie and Freddie, accordingly, were by far the dominant players in the U.S. mortgage market before the financial crisis and their underwriting standards largely set the standards for the rest of the mortgage financing industry."
[1] https://fcic-static.law.stanford.edu/cdn_media/fcic-reports/...
Whether or not you agree with the risk assessment of lending to low income borrowers, it is strictly not the same thing as subprime lending.
the reason why people did was because the instruments they were buying had a fraudulent A rating slapped on them.
As soon as word got out that these thing were dodgy, they were junked. Or sold on to some sucker and then junked.
the regulated market only work if illegality is minimised.
I'm really curious what this "alternative documentation" is. This was part of the problem leading up to 2008: banks did not verify people's information. Some people received mortgages after putting their pet's name on the paperwork.
We might not be there yet, but it's a slippery slope.
"Buying stocks for yield, bonds for capital gains".
I can't imagine they're going "remember that investment product that crashed? Please buy it again. "
If you had a VC behind you with trillions that would fund your every idea even after you burned many untold billions you wouldn't change your thought process either, it's no different here in my opinion. And that opinion might be jaded or unrealistic but I don't think I am that far off. I don't have much faith in the measures that have been taken to prevent another 2008 style crash.
Even pyramid schemes are profitable at the beginning!
I wonder if thousands of years from now people will look back on our economics like we did to the Romans- "how could they not understand inflation?"
When banks sell off their loans, which is what an MBS is, it fundamentally changes the ratio of money:debt originating from the banking system. In a non-MBS banking system, there is roughly the same amount of deposit money flowing around as there are loans. In an MBS using banking system, there are significantly more loans being created - unlike the initial creation of a loan by a bank, the sale of the MBS does not create any additional money.
So the underlying economy may or may not need the extra debt, but creating it this way is anything but side effect free. Granted neither is creating normal bank debt given the money supply side effects.
The evidence of history suggests that an economy can get away with small amounts of this, but at some point there is too big an imbalance of debt to money, and this causes solvency issues in paying back the debt. And that´s when everything all goes terribly wrong.
But it´s a $1 trillion a year industry in the USA, so perish the thought that minor issues like systemic stability should be allowed to interfere with that. On the plus side, China introduced them a few years ago as well, so it will be very interesting to see what happens there as things play out.
For a deeply depressing paper, considering when(2000) and where (US Federal Reserve) it was written, see:
https://www.sciencedirect.com/science/article/pii/S037842669...
Because when you take out a mortgage it gets deposited immediately in someone elses account. The mechanics are effectively the same as for non-intermediated (MBS) debt.
IANA finance expert, but I suppose you could bound the MBS market with some kind of maximum-degrees-removed-from-real-assets metric, and regulate based off of that. But that, to me, would seem unwise since that metric would likely be fairly abstract and therefore dis-preferred as a basis of regulation.
When a loan is securitzed (sold) by the bank, the DBE operations are:
[credit loan, debit deposit account of purchaser]
and the purchaser now owns loan. At this point strictly money has been removed from the banking system, but in practice the bank then recreates that money with a new loan (as above) because they are now within their regulatory lending requirements, and can issue a new loan. They can continue this indefinitely until the market for securitized loans dries up, which is effectively what happened in 2008.