The Minds Behind the Meltdown(online.wsj.com)
online.wsj.com
The Minds Behind the Meltdown
http://online.wsj.com/article/SB10001424052748704509704575019032416477138.html
3 comments
A better book is "The Big Short" (http://en.wikipedia.org/wiki/The_Big_Short) its got some incredible stories regarding the market for CDOs and the GFC. A few people in the know actually saw it happening, bet against the whole system, and won.
Lewis' sequel, "Travels in the New Third World", is also good, and especially relevant given the current gyrations in Europe over Greece.
> A few people in the know actually saw it happening...
IMO you didn't need inside information to understand that the American real estate market was a bubble as it was operating in plain sight. Sure if you want to bet against credit default swaps, it helps if you have a hedge fund behind you, but anecdotally I knew a number of people who didn't buy into the property bubble on the way up, but saved their cash and bought a house at a reasonable price after the bubble popped.
The Australian real estate is in a similar bubble, but it's remarkable to me how few people recognize that here.
> A few people in the know actually saw it happening...
IMO you didn't need inside information to understand that the American real estate market was a bubble as it was operating in plain sight. Sure if you want to bet against credit default swaps, it helps if you have a hedge fund behind you, but anecdotally I knew a number of people who didn't buy into the property bubble on the way up, but saved their cash and bought a house at a reasonable price after the bubble popped.
The Australian real estate is in a similar bubble, but it's remarkable to me how few people recognize that here.
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The housing meltdown happened because there was a housing bubble, and the housing bubble was mostly created by the Government trying to artificially and aggressively influence the market so "everyone can have a home". That's the source. That the banks got involved in it later on and wanted to make easy money is just a symptom and an effect of the initial cause.
As someone actively involved in valuing and trading structured products, since their first (below the radar) crisis in 2001-3, I really don't understand where this idea about the roots of the problem being the government came from : Except that it was manufactured by politicians for their own ends.
The housing bubble (IMHO) had much more to do with the rating agencies getting overconfident in the validity of historical default data, and being lead by the nose (by investment banks) into areas where the models were bound to fail. One of the core modelling assumptions was that house prices could never decline across the USA as a whole. Everyone in the food chain was happy to let the rating agencies use this idea as a foundational assumption in the modelling of RMBS - because everyone creating new structures (and providing enormous numbers of mortgages) made money as long as the game didn't stop.
Also at fault were the regulators, who entrusted the Rating Agencies with determining the leverage in the financial system, by using their ratings ('AAA', 'AA', 'BBB', etc) as the basis on which bank's capital was used. Simply achieving a AAA rating (which was always possible : the Rating Agencies published their models, leading quants at investment banks to optimize against them) meant that banks could buy enormous quantities of the assets (since they were basically risk-free for capital purposes). Oh - I could go on and on, but most people will only read my first paragraph anyway...
Long story short : I'm frustrated that the financial crisis story is being told and retold by politicians with an agenda, most of whom should have said something at the time... And didn't.
The housing bubble (IMHO) had much more to do with the rating agencies getting overconfident in the validity of historical default data, and being lead by the nose (by investment banks) into areas where the models were bound to fail. One of the core modelling assumptions was that house prices could never decline across the USA as a whole. Everyone in the food chain was happy to let the rating agencies use this idea as a foundational assumption in the modelling of RMBS - because everyone creating new structures (and providing enormous numbers of mortgages) made money as long as the game didn't stop.
Also at fault were the regulators, who entrusted the Rating Agencies with determining the leverage in the financial system, by using their ratings ('AAA', 'AA', 'BBB', etc) as the basis on which bank's capital was used. Simply achieving a AAA rating (which was always possible : the Rating Agencies published their models, leading quants at investment banks to optimize against them) meant that banks could buy enormous quantities of the assets (since they were basically risk-free for capital purposes). Oh - I could go on and on, but most people will only read my first paragraph anyway...
Long story short : I'm frustrated that the financial crisis story is being told and retold by politicians with an agenda, most of whom should have said something at the time... And didn't.
I'll keep an open mind - who should have said what, when?
Of course, the US government magically controlled the housing markets in Britain, Spain, Ireland, and a number of other countries which experiencec similar housing bubbles and crashes. How'd that work?
Banks borrow from overseas markets. The largest such market by a wide margin is the USA. Cheap US dollars make their way around the world, variously driving up currencies and driving down interest rates offered by banks.
Here in Australia, there's been a great deal of consternation that the "Big 4" banks no longer closely follow the movements in the cash rate set by the Reserve Bank (our central bank). This is because central bank funds have fallen to less than half of the cost of funding for our banks -- they mostly get their cash from the US and relend it Australians.
When the crisis first broke, Australian bank rates rose even while central bank rates fell. And that's because international finance became much more expensive.
Here in Australia, there's been a great deal of consternation that the "Big 4" banks no longer closely follow the movements in the cash rate set by the Reserve Bank (our central bank). This is because central bank funds have fallen to less than half of the cost of funding for our banks -- they mostly get their cash from the US and relend it Australians.
When the crisis first broke, Australian bank rates rose even while central bank rates fell. And that's because international finance became much more expensive.
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Was the government the one giving negative-amortizing option ARMs to buyers without any documented income, then selling the (tranched) loans to investors as "risk-free"?
>just a symptom and an effect of the initial cause.
The major problem was that the banks had all that bad debt, not Fannie and Freddie. The government caused Fannie and Freddie to take on a lot of bad debt, but that in no way sank the economy. The stampede for the mortgage securities was all private sector and voluntary.
Saying that Bear Stearns' collapse was a 'symptom' of government policy is the conservative party line, and it's maliciously untrue.
The major problem was that the banks had all that bad debt, not Fannie and Freddie. The government caused Fannie and Freddie to take on a lot of bad debt, but that in no way sank the economy. The stampede for the mortgage securities was all private sector and voluntary.
Saying that Bear Stearns' collapse was a 'symptom' of government policy is the conservative party line, and it's maliciously untrue.
"The meltdown also revealed dangerous links in the financial system few had previously realized—that losses in the U.S. housing market could trigger losses in huge stock portfolios that had nothing to do with housing. It was utter chaos driven by pure fear. Nothing like it had ever been seen before. This wasn't supposed to happen!"
The author admits the link here. Then lists all sorts of erratic behavior in the stock market. And ultimately fails to connect how quants caused an unsustainable housing bubble.
The author admits the link here. Then lists all sorts of erratic behavior in the stock market. And ultimately fails to connect how quants caused an unsustainable housing bubble.
I believe that the quants actually warned against believing their equations were infallible, but were ignored.
> And ultimately fails to connect how quants caused an unsustainable housing bubble.
I don't think that the NAFC has a single cause, or even that the graph of causes is directed and acyclic.
I don't think that the NAFC has a single cause, or even that the graph of causes is directed and acyclic.