This is probably good as we do not need someone that is overly connected with the street, if you know what I mean.
>Summers oversaw passage of the Gramm-Leach-Bliley Act, which repealed Glass-Steagall ... He then oversaw passage of the Commodity Futures Modernization Act, which banned all regulation of derivatives
An overwhelming majority of all the banks that failed during the crisis had zero OTC derivatives on their books, but plenty of average vanilla home mortgage loans.
Internal documents from the banks that did deal in more sophisticated financial products show that they had a good understanding of how these products exposed them to risks in the home mortgage market, they just didn't think that housing prices would fall that much.
Despite all this, people like to blame OTC derivatives for the crisis rather than overconfidence in the housing market.
Why is this?
There is no way that the markets would have fallen that far and that fast if most participants, and the rating agencies, had the capacity to accurately and directly determine how much risk they and their counterparties had.
I imagine that the complicitness of the rating agencies in the whole thing never would have even gotten so egregious if most institutions had vanilla instruments on their books that were straight forward to value. OTC derivatives made it very easy to hide finagling and create an environment where rating agencies feel comfortable playing the tit-for-tat game with banks because they thought no one would notice ethical transgressions among all the indirection of derivatives.
This is simply incorrect. The cash flows involved in an OTC derivative are explicitly stated in the contract itself.
I imagine that the complicitness of the rating agencies in the whole thing never would have even gotten so egregious if most institutions had vanilla instruments on their books that were straight forward to value. OTC derivatives made it very easy to hide finagling...
You imagine incorrectly. Pricing most of these contracts is 8'th grade math given a specific scenario - fancy math comes into play only in estimating the probabilities of each scenario. In principle, the pricing formula is this:
price = P(housing goes down) x BIG LOSS + P(housing goes up) x MODERATE GAIN
Other than that, I agree. It was the lack of a central clearing house for the derivatives -which would have allowed issuers to determine counter party risks and price it properly -that was the failing. But that's a human error. There's no need whatsoever to blame the securities themselves.
I'm not trying to bait you or argue, but do you have any links? I'd be interested in some supporting documentation for your claim.
My (weak) take on the crisis TL;DR:
Prolonged, low interest rates set by the Fed in the aftermath of the dotcom bubble led to investors looking for better returns outside of AAA bonds. With the introduction of CDOs, investors were given the option of purchasing AAA rated tranches that paid better rates than bonds. The interest in CDOs exploded, leading to weakening of lending standards allowing the housing boom to really take off. From there it gets much more complex, but ultimately the maths on CDOs didn't work out and everything came crashing down.
No offense, but it starts with having an understanding of what a derivative is and how they are used. There is nothing sinister about them in any fashion, nor were they the "cause" of anything. The mainstream, as usual, has it wrong.
At the base level, excessive risk was the problem, and because derivatives employ leverage, that risk is amplified.
Let's assume I know what a derivative is. We can go from there. The specific accusation made in the mainstream press was that by the time the instruments were sliced and diced a dozen times, risk was not made clearly visible to derivative purchasers, and that the buying and selling of derivatives got way ahead of the banks' ability to track the risk inside of them. At high leverages, it became such that being wrong by just a few percentage points could mean financial disaster. The guarantee that Freddie and Fannie made contributed to a general feeling that the market was mostly protected from huge systemic risks, when that wasn't the case at all.
Now consider the least risky tranch of a CDO. Payoff = min(homeowner_payments.sum(), 0.7 x MAX_HOMEOWNER_PAYMENT).
Is it unclear that if homeowner_payments.sum() goes way down, you lose money? Of course not. For every derivative on the market, computing your gains/losses given a specific scenario is straightforward.
The only difficulty is computing the probability of each scenario, but derivatives don't change that calculation at all.