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Comment by adaml_623 | Hacker News Reader

It would be a good intermediate step to define 'the right thing'.

And then to pay them for doing the right thing.

There is a strong possibility that nobody actually knows what the right thing is. There is a story that says the mortgage mess was done largely for reasons of "for the social good" and that people believed that.

There may be somebody, but they aren't known, don't get listened to or otherwise don't exist for purposes of this sentence. The existence of a Micheal Burry* does not keep a bubble from forming.

*A "The Big Short" person of interest.

But yeah - I'd expect a drop in stock prices once interest rates hike a bit. We have in effect a generation (perhaps two) that has known nothing but very low rates.

Defining the "right thing" to do is the crux of the issue. If it was easy, we wouldn't need the stock market, banks, VC funds, or any of these things because we could just have our committee of experts make the optimal investments. As people on this site should know, sometimes the best long term decisions seem like wild long-shots at the time (like investing in a start-up).

It might be easier to define the "wrong thing" to do, but even that is usually short for the "wrong thing to do yesterday". Most people don't go and make the exact same mistake again unless they believe there is a convincing reason why This Time Is Different™.

Common sense "wrong things" also bring tradeoffs or don't have clear policy mechanisms. Even if we all agreed the stock market was overinflated, how can we deflate it without restricting valid investment and hurting the broader economy?

Or perhaps put a framework into place that prevents them from doing anything other than the right thing?

But what is the right thing?

Fannie and Freddie shoved mortgages through the pipeline to both increase their profits and fulfill their stated goal of increasing American home ownership. The latter is what most considered to be "the right thing" including their regulators.

But then the law of unintended consequences reared its ugly head, housing prices started to fall and we all realized how tied together that securitization pipeline had become. Investors bought credit swaps on their mortgage bonds to protect their downside and move the assets off their balance sheets in order to buy more mortgage bonds—also allowing retail banks to create more mortgages, further increasing home ownership. The companies who sold those swaps (AIG) assumed that housing prices would never fall and default rates would never rise.

They were wrong.

As soon as that black swan event happened and Bear, Lehman et al had to start marking losses on those MBS products, the market pounced. Then AIG had to start paying those swaps but couldn't (hence the nationalization).

While there were definitely bad actors (those handing out liar loans and so forth), at any individual stage in that massive, trillion-dollar pipeline, most actors were behaving in a way that rationally made sense. Banks sought to hedge their downside by buying CDSs against their MBS products. Insurers trusted the ratings agencies. The ratings agencies were too weak to do anything despite internal misgivings about those MBS products (and of course the incentive structure there is all sorts of stupid). The investment banks definitely twisted arms at the ratings agencies to get investment-grade ratings on what were truly junk bonds and that was bad on their part and arguably fraud, so yes, someone should probably be liable for that.

But what could've been done differently at the macro level to ensure that every actor in that pipeline acted in the interest of the "greater good" when we can't even define what that is? Yes, we could have tighter controls on mortgage underwriting standards but will that prevent the next crash? How do we hold someone liable for not avoiding a crash? We can't even tell when a crash is coming, are we honestly going to blame someone for not being able to do the impossible?

I've bookmarked this to come back and respond. My father was a mortgage underwriter who attempted to blow the whistle at a major lender (to no avail). I'm very familiar with the various complications faced in properly regulating the MBS marketplace.

Plenty of people tried to blow the whistle. The SEC and Fed were warned but were unable to comprehend the overarching microeconomic problems brewing within each firm.

And that doesn't change the overarching problem of defining the right thing at every level. Was AIG acting unethically by failing to properly assess the risk of their CDSs? Or were they just incompetent?

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