93% of 2006 AAA-rated subprime mortgage-backed securities now rated junk(nytimes.com)
nytimes.com
93% of 2006 AAA-rated subprime mortgage-backed securities now rated junk
http://www.nytimes.com/2010/04/26/opinion/26krugman.html
13 comments
which would mean that they wouldn't be paying out absurd bonuses
No it wouldn't. Investment banks are huge and diverse businesses. If you're an FX trader, nothing whatsoever to do with mortgage-backed securities, and you've done your job well this year and made excellent profits (which for the bank as a whole offset their losses) then why shouldn't you get a bonus as usual?
Of course the loss-making traders shouldn't get bonuses (that is after all the point of the bonus system) but lumping everyone in with them is both inaccurate and counter-productive.
No it wouldn't. Investment banks are huge and diverse businesses. If you're an FX trader, nothing whatsoever to do with mortgage-backed securities, and you've done your job well this year and made excellent profits (which for the bank as a whole offset their losses) then why shouldn't you get a bonus as usual?
Of course the loss-making traders shouldn't get bonuses (that is after all the point of the bonus system) but lumping everyone in with them is both inaccurate and counter-productive.
I'm sure the head chef on the Titanic wasn't too happy when it started sinking either.
Big powerful organizations attract skilled employees by offering status, pay and economic security. And at the individual level, diligent and honest performance should indeed be rewarded. But the whole reason most of us obey the law and pay our taxes is founded on the idea of mutuality: our interdependence is essential to freedom economic success.
Commercial losses are ultimately a shareholders' problem. But when the public become shareholders or creditors by necessity, it's facile to say that individually successful employees are economic free agents who should earn the full reward of their productivity. Nothing prevents them from leaving to join a more stable competitor, or establishing their own funds: if they choose to stay with an organization that benefits from public expenditure, they've made a choice of financial security over financial liberty.
Besides, limiting the bonus payments of the productive employees when other staff rack up huge losses is a fabulous economic incentive to improve risk management and governance within the organization. Those who consider such matters above their pay grade or outside their job description are obviously not ready to leave the kiddie pool.
Big powerful organizations attract skilled employees by offering status, pay and economic security. And at the individual level, diligent and honest performance should indeed be rewarded. But the whole reason most of us obey the law and pay our taxes is founded on the idea of mutuality: our interdependence is essential to freedom economic success.
Commercial losses are ultimately a shareholders' problem. But when the public become shareholders or creditors by necessity, it's facile to say that individually successful employees are economic free agents who should earn the full reward of their productivity. Nothing prevents them from leaving to join a more stable competitor, or establishing their own funds: if they choose to stay with an organization that benefits from public expenditure, they've made a choice of financial security over financial liberty.
Besides, limiting the bonus payments of the productive employees when other staff rack up huge losses is a fabulous economic incentive to improve risk management and governance within the organization. Those who consider such matters above their pay grade or outside their job description are obviously not ready to leave the kiddie pool.
I've wondered this too. As an employee of a small company, I really wish I could use the same argument (and trust me, I've tried). "Hey boss, I'm doing the work of two people, at about a 40% discount to market rates for the average embedded engineer. You don't seem to think I'm average, and there's no question that you're more than happy with my performance. I realize business is off right now and sales suck, but why shouldn't I get a bonus/raise?" "Cause we don't have any more money, and the government won't give us any."
I really like my job, but sometimes it's tough not to be jealous of the world of big money and government.
I guess my answer to your question might be: "because Joe two floors down blew up, and we wouldn't exist as a company anymore if not for the government bailouts".
I really like my job, but sometimes it's tough not to be jealous of the world of big money and government.
I guess my answer to your question might be: "because Joe two floors down blew up, and we wouldn't exist as a company anymore if not for the government bailouts".
Try asking for the bonus Wall St style: "Hey boss, you know I am worth a lot. Pay me more or I quit. "
Your boss may find the money, or your new job will pay more.
Your boss may find the money, or your new job will pay more.
The better way to do this is to find the other job, get that offer, then go to your current employer and say, "Another company is gave me an offer for more salary elsewhere, but I don't want to go there for reasons X, Y and Z. However (name financial reason - spouses are convenient) is pushing me to take the money. Can you help me?"
The fact that you went to your employer first, and you made it clear that you didn't want to leave, both go a long way to mitigate the possibility of bad emotional reactions. (They don't eliminate it, but they mitigate it.) And they put you in a position to renegotiate your salary. Furthermore if it doesn't work, your fallback is a new job at higher pay.
Be warned, though, that this is a bullet you can only fire once. Having done it, you've burned some social capital. If you keep going back to that well, your employer is going to eventually cut you loose.
Also be warned that if you have actually accepted a job elsewhere, you should never accept a counter-offer. In that situation your employer will be willing to offer a lot because they are desperate, but they know that it is just a question of time until they lose unhappy people. So they will work to replace you, and it is just a question of time until you are fired with no job offer in hand.
That's why if you try this it is critically important to go to your employer with the message that you want to stay, but (financial situation X) is a problem for you. (It helps, a lot, if the financial situation is both real and known to your employer.)
The fact that you went to your employer first, and you made it clear that you didn't want to leave, both go a long way to mitigate the possibility of bad emotional reactions. (They don't eliminate it, but they mitigate it.) And they put you in a position to renegotiate your salary. Furthermore if it doesn't work, your fallback is a new job at higher pay.
Be warned, though, that this is a bullet you can only fire once. Having done it, you've burned some social capital. If you keep going back to that well, your employer is going to eventually cut you loose.
Also be warned that if you have actually accepted a job elsewhere, you should never accept a counter-offer. In that situation your employer will be willing to offer a lot because they are desperate, but they know that it is just a question of time until they lose unhappy people. So they will work to replace you, and it is just a question of time until you are fired with no job offer in hand.
That's why if you try this it is critically important to go to your employer with the message that you want to stay, but (financial situation X) is a problem for you. (It helps, a lot, if the financial situation is both real and known to your employer.)
Effective regulations are those regulations that change the balance of incentives to remove moral hazards and internalize externalities.
That is true. But the organizations that have been forced to internalize externalities have a strong desire to externalize them again. And will try to change the regulations to allow them to do so. Success is generally a question of when, not if.
As an example we averaged one credit crisis per decade for over a hundred years. Then Depression era regulations such as Glass-Steagall put an end to that for several decades. The regulations were eroded then finally removed, and a decade later we had a credit crisis. The Depression era regulations succeeded. But a later generation came to believe that the threat they were blocking was hollow, and the regulations changed.
As an example we averaged one credit crisis per decade for over a hundred years. Then Depression era regulations such as Glass-Steagall put an end to that for several decades. The regulations were eroded then finally removed, and a decade later we had a credit crisis. The Depression era regulations succeeded. But a later generation came to believe that the threat they were blocking was hollow, and the regulations changed.
And unicorns are magic horses.
The properties of ideal entities aren't much use in a universe where nothing approximating such entities actually exists.
Note that Fannie and Freddie actually lied about the mortgages pools that they constructed (said mortgages contained more subprime than they admitted). This not only defrauded the folks who bought those pools, it also made the entire mortgage market look safer than it actually was.
Note that it was regulators who pushed subprime mortgages and insurance for such securities (so they could justify "encouraging" banks to hold them as regulated assets). Said regulators also gave ratings monopoly AND told banks that they had to hold Fannie and Freddie stock, which put many of them into technical default when Fannie and Freddie went down.
At best, regulation is systemic risk. Often, it's corruption backed by a threat of violence.
The properties of ideal entities aren't much use in a universe where nothing approximating such entities actually exists.
Note that Fannie and Freddie actually lied about the mortgages pools that they constructed (said mortgages contained more subprime than they admitted). This not only defrauded the folks who bought those pools, it also made the entire mortgage market look safer than it actually was.
Note that it was regulators who pushed subprime mortgages and insurance for such securities (so they could justify "encouraging" banks to hold them as regulated assets). Said regulators also gave ratings monopoly AND told banks that they had to hold Fannie and Freddie stock, which put many of them into technical default when Fannie and Freddie went down.
At best, regulation is systemic risk. Often, it's corruption backed by a threat of violence.
Whats that economics law that says something like "Once pressure is put upon an observed regularity in the markets for control purposes it tends to disappear"? When buyers only cared about the truth of a rating they had a pretty good reason to want the ratings to be as accurate as possible (counteracting the seller's incentives). But as soon as reserve requirements are dependent on how what the credit rating says suddenly both the buyer and the seller have an incentive for things to be rated as highly as possible.
Lucas Critique
http://en.wikipedia.org/wiki/Lucas_critique
http://en.wikipedia.org/wiki/Lucas_critique
Headline is inaccurate, it's 93% of subprime-backed mortgage securities.
Exactly - the majority of AAA bonds would be US/Euro/Sterling government bonds, which are still AAA rated.
Greek bonds aren't doing so hot right now:
"The ratings agency, Standard & Poor’s, downgraded Greece’s long-term and short-term debt to noninvestment-grade status and cautioned that investors who bought Greek bonds faced dwindling chances of getting their money back if Greece defaulted or went through a debt restructuring. Earlier, S.& P. reduced Portugal’s credit rating and warned that more downgrades were possible."
http://www.nytimes.com/2010/04/28/business/28markets.html?sr...
There was an NPR Planet Money podcast recently that said if Greece failed, others were likely to follow:
http://en.wikipedia.org/wiki/PIIGS
http://www.npr.org/blogs/money/2010/02/podcast_yes_greece_co...
"The ratings agency, Standard & Poor’s, downgraded Greece’s long-term and short-term debt to noninvestment-grade status and cautioned that investors who bought Greek bonds faced dwindling chances of getting their money back if Greece defaulted or went through a debt restructuring. Earlier, S.& P. reduced Portugal’s credit rating and warned that more downgrades were possible."
http://www.nytimes.com/2010/04/28/business/28markets.html?sr...
There was an NPR Planet Money podcast recently that said if Greece failed, others were likely to follow:
http://en.wikipedia.org/wiki/PIIGS
http://www.npr.org/blogs/money/2010/02/podcast_yes_greece_co...
Especially ironic/inaccurate given the full context of the quote: And no, that’s not hyperbole: of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent - 93 percent! - have now been downgraded to junk status.
I would highly recommend the book, The big short by Michael Lewis. It really exposes how subprime-backed mortgage securities were developed and the credit default swaps that insured them. The story of Michael Burry, silicon valley founder of Scion Capital, who shorted the subprime market was very interesting.
It seems to me that rating agencies should be paid by the institutional investors that buy the bonds, not the banks trying to sell them. That might help the incentives line up better.
Am I crazy? Nobody suggests this, and I think I'm missing something crucial here.
Am I crazy? Nobody suggests this, and I think I'm missing something crucial here.
Rating agencies seem like an absurd idea altogether. Have they never heard of the perils of having a single point of failure? Much less a single point of failure that's a government-created oligopoly? Yikes.
It seems that businesses are just running on an outdated model developed when information sharing was a lot harder, so only condensed forms like quarterly reports and press releases were feasible. But now that information sharing is a lot easier, shareholders should be demanding more openness from businesses -- yes, today a lot of that information is considered to be a trade secret, but at the same time shareholders need to stop allowing businesses to get away with what's equivalent to deceit through "creative" accounting (e.g. apportioning profits/debts amongst subsidiaries). That's just a textbook example of exploiting information asymmetry. Shareholders should expect more information about the business' books and transactions. There must be some natural equilibrium between being open about transactions and protecting strategic advantages, but right now we have the functional equivalent to price fixing, er, information fixing -- companies don't release relevant information because "no other company does" and shareholders don't expect real operating information either because that's not part of the status quo.
Wouldn't an investment bank that was so confident in the principles behind its analysis that it was willing to list all its transactions in a continuously-updated XML file, despite the risk of copy-cats, seem like a pretty damn good investment? They wouldn't have to divulge their proprietary methods of analysis, just make their holdings public. This would greatly improve the efficiency of markets as investors could use their own proprietary methods to estimate the risk of an entity's portfolio management strategy when deciding whether to invest in it.
And there's definitely historical precedent for this -- the fabled value investor Benjamin Graham didn't go to great lengths to hide his trades, instead he'd use them as examples in his classes, and yeah, people copied him. And he still made boatloads of money.
It seems that businesses are just running on an outdated model developed when information sharing was a lot harder, so only condensed forms like quarterly reports and press releases were feasible. But now that information sharing is a lot easier, shareholders should be demanding more openness from businesses -- yes, today a lot of that information is considered to be a trade secret, but at the same time shareholders need to stop allowing businesses to get away with what's equivalent to deceit through "creative" accounting (e.g. apportioning profits/debts amongst subsidiaries). That's just a textbook example of exploiting information asymmetry. Shareholders should expect more information about the business' books and transactions. There must be some natural equilibrium between being open about transactions and protecting strategic advantages, but right now we have the functional equivalent to price fixing, er, information fixing -- companies don't release relevant information because "no other company does" and shareholders don't expect real operating information either because that's not part of the status quo.
Wouldn't an investment bank that was so confident in the principles behind its analysis that it was willing to list all its transactions in a continuously-updated XML file, despite the risk of copy-cats, seem like a pretty damn good investment? They wouldn't have to divulge their proprietary methods of analysis, just make their holdings public. This would greatly improve the efficiency of markets as investors could use their own proprietary methods to estimate the risk of an entity's portfolio management strategy when deciding whether to invest in it.
And there's definitely historical precedent for this -- the fabled value investor Benjamin Graham didn't go to great lengths to hide his trades, instead he'd use them as examples in his classes, and yeah, people copied him. And he still made boatloads of money.
Well, it's more subtle than that. The big ratings agencies are Fitch, S&P and Moody's. They are competitors for the business of issuers. So each one is incentivized to rate higher than the others, without blatantly being seen to take the piss.
The problem with complete openness is that it encourages short-termism. You see this even with quarterly results, companies that have recently gone public (and thus have minimal reputation) manage from quarter to quarter to quarter and are hugely volatile. Imagine working for a manager who only cares about the share price tomorrow.
The risk of your XML file is not copycats, it's front-running.
The problem with complete openness is that it encourages short-termism. You see this even with quarterly results, companies that have recently gone public (and thus have minimal reputation) manage from quarter to quarter to quarter and are hugely volatile. Imagine working for a manager who only cares about the share price tomorrow.
The risk of your XML file is not copycats, it's front-running.
The short-term price motivation is a great point. I'll think about that some more.
But how does this scheme encourage front-running?
But how does this scheme encourage front-running?
The problem is that the institutional investors buying the bonds are much smaller, and there is no way to keep the information from leaking. Therefore most of those investors won't be willing to pay for the bonds, and the ones that can pay will be paying less money.
That doesn't mean that this model is not viable. But it isn't viable at the kind of margins that the rating agencies would like to remain accustomed to.
That doesn't mean that this model is not viable. But it isn't viable at the kind of margins that the rating agencies would like to remain accustomed to.
Maybe investors could pool resources to start their own rating agency that would be answerable to them, and publish ratings for everyone to use? There has to be a better system.
The problem with that is that the ratings are a public good. Public goods have some counter-intuitive properties. Investors would have every incentive to individually contribute as little to the pool as possible as long as action happened. Economic theory says that one of four things is likely to happen. Those are:
1. The knowledge is worthwhile to a small group (often just one) of investors, who fund it. The memorable phrase for this is "the exploitation of the large by the small." (A practical example of this is OPEC and high oil prices. The complicated negotiations OPEC engages in illustrate the desire of members of the group to contribute as little as possible to provisioning the public good.)
2. An organization exists that investors belong to for some other reason which funds the ratings. (A practical example of this how people belong to AAA for membership benefits, but then AAA lobbies for road improvements.)
3. A coercive organization intervenes and forces the matter. (Virtually all government regulations fall into this category.)
4. The public good is not provisioned. (What happened to investors who wanted trustworthy ratings.)
Read The Logic of Collective Action for the classic introduction to this topic.
1. The knowledge is worthwhile to a small group (often just one) of investors, who fund it. The memorable phrase for this is "the exploitation of the large by the small." (A practical example of this is OPEC and high oil prices. The complicated negotiations OPEC engages in illustrate the desire of members of the group to contribute as little as possible to provisioning the public good.)
2. An organization exists that investors belong to for some other reason which funds the ratings. (A practical example of this how people belong to AAA for membership benefits, but then AAA lobbies for road improvements.)
3. A coercive organization intervenes and forces the matter. (Virtually all government regulations fall into this category.)
4. The public good is not provisioned. (What happened to investors who wanted trustworthy ratings.)
Read The Logic of Collective Action for the classic introduction to this topic.
This seems somewhat similar to open source software, where there is also a free rider risk. This has not stopped large corporations from contributing to open source software, because there are often strategic advantages stemming from the software's existence and wide distribution.
I'm not sure how this applies to an investor funded rating agency. I don't know that there is any strategic advantage to large firms having accurate bond ratings publicly available, but it would be interesting to hear business models where there would be.
I'm not sure how this applies to an investor funded rating agency. I don't know that there is any strategic advantage to large firms having accurate bond ratings publicly available, but it would be interesting to hear business models where there would be.
Open source is an interesting example.
Normally there are transaction barriers that inhibit cooperation in providing public goods. However software has far fewer of those barriers. And so you get a situation where a network of loosely connected people each pursuing individual goals can collectively provision a public good.
I remember running across a footnote in The Logic of Collective Action saying that this was a theoretical possibility, but no example was known of it. (The book was written back in the 1960s.) In any case it is an extremely unusual example.
Normally there are transaction barriers that inhibit cooperation in providing public goods. However software has far fewer of those barriers. And so you get a situation where a network of loosely connected people each pursuing individual goals can collectively provision a public good.
I remember running across a footnote in The Logic of Collective Action saying that this was a theoretical possibility, but no example was known of it. (The book was written back in the 1960s.) In any case it is an extremely unusual example.
http://www.cepr.net/index.php/beat-the-press/krugman-nails-t...
Dean Baker has been suggesting that either the exchange or the SEC take over selection of the rating agency for over a year now.
Dean Baker has been suggesting that either the exchange or the SEC take over selection of the rating agency for over a year now.
If anyone is interested in a very clear example of the story behind the stat, I highly recommend this podcast/radio episode: http://www.thisamericanlife.org/radio-archives/episode/405/i...
Krugman fails to mention that this is the corrupt fallout from his cheerleading in 2002 for low interest rates in order to create a housing bubble to fill the void of the .com bubble !
"Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble." - Krugman 2002
http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip...
"Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble." - Krugman 2002
http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip...
Now I don't understand what your motive is - but your quote is taken waaay out of context...
Original quote: "The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."
Here Krugman basically quotes another source. The way I interpret this quote (and article) is not cheerleading for lower interest rates. The message to me is that whole system is unsustainable and that only move that will be able to perpetuate the lie is to replace one bubble with the next.
In this context Krugman's vision has proven prophetic.
The whole notion, nothing personal - I have noticed it more than once, that Krugman somehow argued that replacing one bubble with another is good for economy somehow is ridiculous.
Original quote: "The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."
Here Krugman basically quotes another source. The way I interpret this quote (and article) is not cheerleading for lower interest rates. The message to me is that whole system is unsustainable and that only move that will be able to perpetuate the lie is to replace one bubble with the next.
In this context Krugman's vision has proven prophetic.
The whole notion, nothing personal - I have noticed it more than once, that Krugman somehow argued that replacing one bubble with another is good for economy somehow is ridiculous.
The point of that editorial is that business investment won't end the recession, so the only hope is housing.
"To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. "
Krugman is just repeating the same "insufficient demand" theory of recessions that Keynesian economists are using today.
"To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. "
Krugman is just repeating the same "insufficient demand" theory of recessions that Keynesian economists are using today.
Yes, but once the economy was humming again he expressed worries about government spending, debt financing, and inflation too, but lots of libertarians told him to stop being such an old lady: we were spending because there was a war on, China buying US debt was proof that market economics the key to growth, and inflation of property prices didn't matter because they're not building more land.
I appreciate that Austrian economists dislike the idea of stimulating demand through looser monetary or fiscal policy, but they're not exactly famous for demanding greater restraint during good times, are they? I don't recall any of them screaming in horror when the Dow was at 14k.
I appreciate that Austrian economists dislike the idea of stimulating demand through looser monetary or fiscal policy, but they're not exactly famous for demanding greater restraint during good times, are they? I don't recall any of them screaming in horror when the Dow was at 14k.
And he was right. 7 years from 2001 to 2008 he was saying this and everyone dismissed his concerns by calling him a partisan bush-hater. Maybe so, but he was still right.
Keynesian economics brought us out of the great depression and the lack of their application led to deflation and the lost decade for Japan.
Supply-side economics, on the other hand, have been tried twice in the last 30 years and both times they ended with massive government deficit and collapsed asset bubbles.
Before casting aspersions on someone by virtue of their -isms, I'd check the record of the -isms in question.
Keynesian economics brought us out of the great depression and the lack of their application led to deflation and the lost decade for Japan.
Supply-side economics, on the other hand, have been tried twice in the last 30 years and both times they ended with massive government deficit and collapsed asset bubbles.
Before casting aspersions on someone by virtue of their -isms, I'd check the record of the -isms in question.
I didn't cast aspersions on anyone. I simply summarized Krugmans column: to increase consumer demand, the fed should create a housing bubble, but even that is unlikely to work.
I don't think that's what he was intending to say. I remember a whole bunch of cautionary columns of his from that time period, some of which were very partisan and accused Greenspan of keeping interest rates low for political reasons.
The way I read it is that Krugman is quoting someone to support his argument for ultra low interest rates.
Krugman like all Keynesians thinks bubble booms are good and recessions are bad. He fails to mention the artificial carry trade in gold that central banks set up in the 90s to push gold prices down and stock prices up. Central banks at this time also promoted derivatives to create the illusion of low inflation by soaking up the price rises due to commodity speculation.
He also does not mention the FED money printing in the 30s to artificially support the pound and stop the draw on gold from London. Could this have had something to do with the boom then ???
The moral of the story is don't let the government and central bank 'run' your economy. All they can do is make bad guesses and try and cover up reality.
Panama has done without a central bank for a hundred years and look at the state it is in: http://www.costaricapages.com/panama/blog/wp-content/uploads... Who 'runs' their economy ??? Who prints their money ???
Krugman like all Keynesians thinks bubble booms are good and recessions are bad. He fails to mention the artificial carry trade in gold that central banks set up in the 90s to push gold prices down and stock prices up. Central banks at this time also promoted derivatives to create the illusion of low inflation by soaking up the price rises due to commodity speculation.
He also does not mention the FED money printing in the 30s to artificially support the pound and stop the draw on gold from London. Could this have had something to do with the boom then ???
The moral of the story is don't let the government and central bank 'run' your economy. All they can do is make bad guesses and try and cover up reality.
Panama has done without a central bank for a hundred years and look at the state it is in: http://www.costaricapages.com/panama/blog/wp-content/uploads... Who 'runs' their economy ??? Who prints their money ???
Who prints their money? The US Treasury, literally. Panama has pegged its currency 1:1 to the US dollar since independence and doesn't even bother printing its own paper money, using US notes instead.
Unlike the US dollars/balboas in Panama are not printed out of thin air. Panama has to do productive work in order to earn dollars and thus the money supply can not race ahead of the productive capacity of the economy. This is why Panama has never had an inflation problem (unlike the rest of Latin America) and has short periods of deflation.
Now if I understand you right. You're saying that US and worldwide financial markets have been ran by Keynesians for the last 30 years, leading to massive explosion and refutation of all Keynesian theories?
Let me guess - you also believe that Fascism and Nazism are right-wing ideologies?
EDIT: I'm no economist (barely an amateur wiki-economist): but as far as I know (read, heard) Keynes actually argued that money supply management should be "mechanically" managed - without central banks and officials who are corruptible and fallible.
Let me guess - you also believe that Fascism and Nazism are right-wing ideologies?
EDIT: I'm no economist (barely an amateur wiki-economist): but as far as I know (read, heard) Keynes actually argued that money supply management should be "mechanically" managed - without central banks and officials who are corruptible and fallible.
WRT to whatever Keynes argued, the idea that any system of mechanical management would avoid capture by the political system is fatuous. Which he should have known.
93% isn't bad luck. 93% is fraud.
Not that I think everything was above-board, but to be fair, these are hugely correlated instruments: it's not reporting 93% of all AAA debt tanked, but 93% of all AAA-rated derivatives of subprime mortgages. Given the subprime-mortgage crash, it's not surprising that everything tied to subprime mortgages uniformly tanked too.
The way an AAA-rated derivative of a subprime mortgage could exist to begin with was via "tranching", where debt was sliced up into different buckets of repayment priority, which heightened the correlation. In a minor crash, the AAA securities would do okay, because they'd get the payments from the non-defaulting loans, and the lower-rated tranches would take the losses. But once you go over the threshhold where there isn't enough money to even repay the top tranches, then everything tanks all together. So really, near-0% and near-100% default rates were the likely outcomes.
The way an AAA-rated derivative of a subprime mortgage could exist to begin with was via "tranching", where debt was sliced up into different buckets of repayment priority, which heightened the correlation. In a minor crash, the AAA securities would do okay, because they'd get the payments from the non-defaulting loans, and the lower-rated tranches would take the losses. But once you go over the threshhold where there isn't enough money to even repay the top tranches, then everything tanks all together. So really, near-0% and near-100% default rates were the likely outcomes.
but to be fair, these are hugely correlated instruments
That makes them more risky, not so? How did they get the AAA rating then?
That makes them more risky, not so? How did they get the AAA rating then?
By recursion.
The initial iteration is that they pool a bunch of loans together to aggregate the risk. They know from history (short term history - a vulnerability that turned into a failure mode) that mortgage defaults are quite unlikely to happen in the first, say 5, years, so they can sell paper that matures in 5 years and be confident that it has a low failure rate from the (flawed) historical perspective. The longer term paper on the loans will historically have a higher probability of failure, so the longer term paper has lower ratings.
Then the recursion occurs.
1) Homeowners kept refinancing their houses (encouraged by the insatiable appetite for new mortgages to slice and dice into AAA-rated paper), so their loans never aged, they just kept getting reset.
2) The bankers took the remaining less-than-AAA-rated aggregated debt and used to create a new debt vehicle and then claimed all over again that the "new" debt (which was really old debt reheated) could be re-sliced into AAA-rated debt plus residual lower rated debt.
This quickly turns into a house of cards which inevitably failed when short term history (low failure rates based on long held mortgages and "perpetually" increasing house values) failed to model reality.
The initial iteration is that they pool a bunch of loans together to aggregate the risk. They know from history (short term history - a vulnerability that turned into a failure mode) that mortgage defaults are quite unlikely to happen in the first, say 5, years, so they can sell paper that matures in 5 years and be confident that it has a low failure rate from the (flawed) historical perspective. The longer term paper on the loans will historically have a higher probability of failure, so the longer term paper has lower ratings.
Then the recursion occurs.
1) Homeowners kept refinancing their houses (encouraged by the insatiable appetite for new mortgages to slice and dice into AAA-rated paper), so their loans never aged, they just kept getting reset.
2) The bankers took the remaining less-than-AAA-rated aggregated debt and used to create a new debt vehicle and then claimed all over again that the "new" debt (which was really old debt reheated) could be re-sliced into AAA-rated debt plus residual lower rated debt.
This quickly turns into a house of cards which inevitably failed when short term history (low failure rates based on long held mortgages and "perpetually" increasing house values) failed to model reality.
Trick is, the ratings agencies knew 1 and 2 were happening; questions about the practice were raised.
That no-one did anything when questions were raised is what brings us back to fraud. The ratings agencies were allowing a known-flawed system to apply known-incorrect ratings because it served their own financial interests.
That no-one did anything when questions were raised is what brings us back to fraud. The ratings agencies were allowing a known-flawed system to apply known-incorrect ratings because it served their own financial interests.
Excellent explanation. Also, I think it's relevant that the models that undergirded the ratings also had to assume some probability distribution of mortgage market price volatility... which was generally perceived as being far more stable than it turned out to be...
Yes, all (ex) AAA-rated derivatives of subprime mortgages are highly correlated. No, that (in itself) does not make them more risky. You just do not want to invest %100 of your portfolio in them.
E.g. U.S. Government debt is currently AAA rated. But all bonds and treasuries are highly correlated: in five years either 0% or 100% of US Gov debt will still be AAA.
E.g. U.S. Government debt is currently AAA rated. But all bonds and treasuries are highly correlated: in five years either 0% or 100% of US Gov debt will still be AAA.
Yeah, it's somewhat similar to weather predictions for nearby areas. If the weather forecast predicts 10% chance of rain for Palo Alto, and the same for East Palo Alto, Mountain View, Atherton, etc., the expected outcome is not that it will rain in exactly 10% of those places. It will probably rain in close to 0% or close to 100% of them.
The bonds would typically be a composite of loans from all over the US. So the argument was made that even if (say) California's housing bubble crashed then only a small fraction of your bond would suffer losses as the loans made in other states would be ok. Thus the banks claimed that these were uncorrelated safe investments and the rating agencies agreed to rate them highly.
There is some argument to be made that an awful lot of sophisticated investors didn't recognise before the crash that there was such a high level of correlation, so to some extent we're talking with the benefit of hindsight at this point. With hindsight it seems obvious that these bonds were doomed, but without the benefit of what we now know, how much should the ratings agencies be blamed for not recognising the risks?
There is some argument to be made that an awful lot of sophisticated investors didn't recognise before the crash that there was such a high level of correlation, so to some extent we're talking with the benefit of hindsight at this point. With hindsight it seems obvious that these bonds were doomed, but without the benefit of what we now know, how much should the ratings agencies be blamed for not recognising the risks?
I wonder if anyone from these rating companies ever bothered to talk to the people actually buying these mortgages - i.e. the people the whole crumbly edifice was based upon. Or indeed how they were being sold.
I would have expected someone to do some due diligence and find out what all of this business was actually based on.
Some guys from Lehman Brothers did some actual research (i.e. they went and talked to the sales guys selling these mortgages) and concluded that it was all going to end in tears. At according to:
http://www.amazon.com/Colossal-Failure-Common-Sense-Collapse...
I would have expected someone to do some due diligence and find out what all of this business was actually based on.
Some guys from Lehman Brothers did some actual research (i.e. they went and talked to the sales guys selling these mortgages) and concluded that it was all going to end in tears. At according to:
http://www.amazon.com/Colossal-Failure-Common-Sense-Collapse...
Akadien has recommended "The Big Short" already, and I'd second that. It goes into a lot of detail about this situation. The problem with trying to price these CDOs was that an individual CDO might be made up of 100 pieces of other CDOs which each might be made up of parts of another 100 CDOs, which each might be made up of parts of a bond containing thousands of individual loans. So you could go and look at the individual loans but the effort to try and price the whole thing accurately would have been phenomenal.
The most honest thing the agencies could have done was refuse to rate them. But that probably wouldn't have gone down very well with their clients.
The most honest thing the agencies could have done was refuse to rate them. But that probably wouldn't have gone down very well with their clients.
It's more likely underpaid raters at Moody's and S&P being intimidated by overpaid traders at Goldman Sachs and Deutsche Bank. I'm reading "The Big Short" (highly recommended), and it puts all of this and the current GS hearings in the right perspective.
Quant's at rating agencies get the same pay as any back office quant.
Not from what I saw. I worked at a very large Manhattan-based investment bank and we paid the research quants way more than the rating agencies. There was a brain drain from rating agencies to the bulge bracket firms. There's a lot more money in making the right trades (for yourself or for clients) than in writing reports.
The quants who figure out the right trades are front office quants. Back office quants (risk management, finance, operations) are not paid nearly as well, even in investment banks.
Ratings is back office work, and is paid commensurately.
Ratings is back office work, and is paid commensurately.
If anyone listened to the hearings, they quoted a part from the book, "The Big Short: Inside the Doomsday Machine" which discusses some of what the author thinks were the inner workings. I've been reading through it now and cannot recommend it enough.
http://www.amazon.com/Big-Short-Inside-Doomsday-Machine/dp/0...
http://www.amazon.com/Big-Short-Inside-Doomsday-Machine/dp/0...
Let's not forget that Krugman was one of the chief advocates of the housing bubble (before it popped) and that his "berating of the raters" should begin with an apology.
http://blog.mises.org/10153/krugman-did-cause-the-housing-bu...
http://blog.mises.org/10153/krugman-did-cause-the-housing-bu...
I'm not a big fan of Krugman, but let's also not forget that we were in a recession at the time of those remarks; when Krugman was saying the Fed should raise interest rates a few years later, and taht the US was addicted to Chinese treasury purchases, libertarians scoffed and called him an alarmist.
This 2005 example of libertarian economic thought is particularly ironic, arguing that measures of inflation like CPI give too much weight to housing and car prices while an adjacent advert promotes a book explaining how the crisis was caused by too much easy money: http://www.cato.org/pub_display.php?pub_id=3752
Other sparkling jewels of economic wisdom include his prediction at the beginning of 2008 that recession was a non-issue, or his comments from earlier in the decade (when the Fed had raised rates a bit) that the nation would achieve substantial long term benefits from the 'glorious housing boom' created by previously low rates, which had allowed many refinancers to invest and consume more.
Physician, heal thyself.
This 2005 example of libertarian economic thought is particularly ironic, arguing that measures of inflation like CPI give too much weight to housing and car prices while an adjacent advert promotes a book explaining how the crisis was caused by too much easy money: http://www.cato.org/pub_display.php?pub_id=3752
Other sparkling jewels of economic wisdom include his prediction at the beginning of 2008 that recession was a non-issue, or his comments from earlier in the decade (when the Fed had raised rates a bit) that the nation would achieve substantial long term benefits from the 'glorious housing boom' created by previously low rates, which had allowed many refinancers to invest and consume more.
Physician, heal thyself.
Point taken. However, Krugman's comments were a little stronger than what you suggest. He explicitly called for the creation of a housing bubble (see my other response below).
Please don't take the link as a blanket endorsement of libertarianism; it was just the first link that came up as a result of my google search. I remembered reading up on Krugman's predictive failures many months ago ...
Krugman stopped being an economist a long time ago and is now a political hack - regardless of whether or not he has a point in this particular instance. I imagine that you didn't need Krugman to tell you that the raters were issuing ridiculous ratings ...
Please don't take the link as a blanket endorsement of libertarianism; it was just the first link that came up as a result of my google search. I remembered reading up on Krugman's predictive failures many months ago ...
Krugman stopped being an economist a long time ago and is now a political hack - regardless of whether or not he has a point in this particular instance. I imagine that you didn't need Krugman to tell you that the raters were issuing ridiculous ratings ...
That is bunk. That blog article is pulling a few quotes from 2001. In 2001 we had a recession with high unemployment, and lowering interest rates was sound advice.
If you find some quotes from 2004 or beyond where Krugman actually advocates policies that would encourage a housing bubble, then you may have a case.
If you find some quotes from 2004 or beyond where Krugman actually advocates policies that would encourage a housing bubble, then you may have a case.
Please see my comment above. You are evidently confused about the history of the housing bubble: it was beginning just as Krugman was making these comments and writing the article I link to below.
The burden is, in fact, on you to find a link from circa 2004-6 by Krugman calling for restraint of the bubble whose inflation he advocated so fiercely. See above for a more detailed exposition of this point.
Anyways, here is another article from 2002. I don't know how you can get any more incriminating:
Quoting Krugman: To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.
http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip...
BTW, asking for a quote from 2004 calling for the creation of a housing bubble is a bit ridiculous: by then the housing bubble was in full bloom.
http://upload.wikimedia.org/wikipedia/en/c/c1/Median_and_Ave...
As you can see, late 2002 (when the above article was written) would have been just at the beginning of the disaster.
(sorry for the delayed reply; at work all day.)
The burden is, in fact, on you to find a link from circa 2004-6 by Krugman calling for restraint of the bubble whose inflation he advocated so fiercely. See above for a more detailed exposition of this point.
Anyways, here is another article from 2002. I don't know how you can get any more incriminating:
Quoting Krugman: To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.
http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip...
BTW, asking for a quote from 2004 calling for the creation of a housing bubble is a bit ridiculous: by then the housing bubble was in full bloom.
http://upload.wikimedia.org/wikipedia/en/c/c1/Median_and_Ave...
As you can see, late 2002 (when the above article was written) would have been just at the beginning of the disaster.
(sorry for the delayed reply; at work all day.)
those quotes are all from 2001. that's more than just a little "before it popped". this criticism is worthless.
No, your criticism is worthless. Insofar as you are correct in pointing out where I am correct, I give you some credit. But you fail to appreciate the full scope of my correctness and thus miss the whole point.
1. Consider: who would actually be so buffoonish as to call for the creation of a financial bubble at the peak moment before said bubble was about to burst - particularly when the bubble had reached an historical scale. Krugman is silly, but not that silly.
2. As it turns out, he was calling for the bubble at that crucial moment in history which we now recognize as the actual creation of the bubble. http://upload.wikimedia.org/wikipedia/en/c/c1/Median_and_Ave...
Let me spell it out for you: he got what he asked for, when he asked for it.
3. Given that he called for the creation of a bubble, I am willing to assume that perhaps he didn't mean for it to get so over-inflated. But that puts the burden on you to find an article circa 2004 for him saying: stop, I meant only inflate it a little ...
Of course he did not call for the creation of the bubble just before it popped. In fact, it is much worse: he called for the inflation of the bubble just as it was getting started.
We all know how that ended ...
1. Consider: who would actually be so buffoonish as to call for the creation of a financial bubble at the peak moment before said bubble was about to burst - particularly when the bubble had reached an historical scale. Krugman is silly, but not that silly.
2. As it turns out, he was calling for the bubble at that crucial moment in history which we now recognize as the actual creation of the bubble. http://upload.wikimedia.org/wikipedia/en/c/c1/Median_and_Ave...
Let me spell it out for you: he got what he asked for, when he asked for it.
3. Given that he called for the creation of a bubble, I am willing to assume that perhaps he didn't mean for it to get so over-inflated. But that puts the burden on you to find an article circa 2004 for him saying: stop, I meant only inflate it a little ...
Of course he did not call for the creation of the bubble just before it popped. In fact, it is much worse: he called for the inflation of the bubble just as it was getting started.
We all know how that ended ...
Your title is wrong and misleading
Can someone actually find the source for this 93% figure? I haven't been able to. I just keep seeing the link back to the NYT page. I'd be good to actually see real numbers - not just Krugman's opinion.
Thank god that we have government regulated credit ranking agencies to protect us from this mess and having to use our own judgment when investing. Oh wait... hmmm...
This rating agencies are making their money the same way the big business consultants does - by confirming client's illusions and narcissistic views. This is called corruption.
what does this have to do with news.yc ?
it's not even about startups!
From the FAQ:
"On-Topic: Anything that good hackers would find interesting. That includes more than hacking and startups. If you had to reduce it to a sentence, the answer might be: anything that gratifies one's intellectual curiosity.
Off-Topic: Most stories about politics, or crime, or sports, unless they're evidence of some interesting new phenomenon. Videos of pratfalls or disasters, or cute animal pictures. If they'd cover it on TV news, it's probably off-topic."
This one's a bit of a gray area, as it's heavily political in nature, but the mechanics of loan securities is of both intellectual and personal interest to what I'd imagine is a heck of a lot of HN readers.
"On-Topic: Anything that good hackers would find interesting. That includes more than hacking and startups. If you had to reduce it to a sentence, the answer might be: anything that gratifies one's intellectual curiosity.
Off-Topic: Most stories about politics, or crime, or sports, unless they're evidence of some interesting new phenomenon. Videos of pratfalls or disasters, or cute animal pictures. If they'd cover it on TV news, it's probably off-topic."
This one's a bit of a gray area, as it's heavily political in nature, but the mechanics of loan securities is of both intellectual and personal interest to what I'd imagine is a heck of a lot of HN readers.
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Appropriate regulation can help for a bit. But unfortunately the regulated party has incentives to provide incentives (such as contributions to political campaigns) to gain control of the regulations. This leads to regulatory capture that then renders the regulations ineffective.
In a perfect world we'd be forcing the banks right now to write down securities that took a hit, forcing them to declare losses, which would mean that they wouldn't be paying out absurd bonuses. This would absorb the money we gave them from the bailout. In a slightly less perfect world we'd be enacting useful regulations that would avoid this problem returning for a few decades (such as happened during the Great Depression).
In the real world we gave the banks a big bailout, have let them mark securities to models of their choice, and they paid themselves big bonuses on their "profits". Of course they are still sitting on lots of toxic securities (like bad CMBS and the junk bonds issued by private equity) that they have not marked down yet. When that blows up we have good odds that they'll ask for another bailout. And the behavior of both parties says that the leadership will try to get it for them. They nearly didn't manage to deliver it last time, and given the public outrage since, they may not be able to deliver it next time.
This could lead to interesting times. Interesting times.