B.Y.: Did I suggest that headwinds are unfair? But on the financial meltdown in particular, if you're suggesting that that is a Republican creation, or even more specifically a McCain creation, I think you're on pretty shaky ground.
M.T.: You don't think the unregulated CDS market was a major factor in the current crisis? Were you watching when AIG almost went under? Were you watching the Lehman collapse?
B.Y.: I think that Fannie Mae and Freddie Mac were also major factors. And I believe that many of the problems in the mortgage area can be attributed to the confluence of Democratic and Republican priorities: the Democrats' desire to give mortgages to people, particularly minorities, who could not afford them, and the Republicans' desire to achieve an "ownership society," in part by giving mortgages to people who could not afford them. Again, I believe that if you are suggesting that the financial crisis is a Republican creation, or even more specifically a McCain creation, I think you're on pretty shaky ground.
M.T.: Oh, come on. Tell me you're not ashamed to put this gigantic international financial Krakatoa at the feet of a bunch of poor black people who missed their mortgage payments. The CDS market, this market for credit default swaps that was created in 2000 by Phil Gramm's Commodities Future Modernization Act, this is now a $62 trillion market, up from $900 billion in 2000. That's like five times the size of the holdings in the NYSE. And it's all speculation by Wall Street traders. It's a classic bubble/Ponzi scheme. The effort of people like you to pin this whole thing on minorities, when in fact this whole thing has been caused by greedy traders dealing in unregulated markets, is despicable.
B.Y.: I was struck by the recent Senate testimony of James Lockhart, who is head of the Federal Housing Finance Agency, about the sheer recklessness of Fannie in recent years. Despite "repeated warnings about credit risk," Lockhart testified, Fannie became more reckless in 2006 and 2007 than they had been in the scandal-ridden tenure of Franklin Raines (who departed in 2004). In 2005, Lockhart said, 14 percent of Fannie's new business was in risky loans. In the first half of 2007, it was 33 percent. So something terribly wrong was going on there, and it became a significant part of the present problem.
M.T.: What a surprise that you mention Franklin Raines. Do you even know how a CDS works? Can you explain your conception of how these derivatives work? Because I get the feeling you don't understand. Or do you actually think that it was a few tiny homeowner defaults that sank gigantic companies like AIG and Lehman and Bear Stearns? Explain to me how these default swaps work, I'm interested to hear.
Because what we're talking about here is the difference between one homeowner defaulting and forty, four hundred, four thousand traders betting back and forth on the viability of his loan. Which do you think has a bigger effect on the economy?
B.Y.: Are you suggesting that critics of Fannie and Freddie are talking about the default of a single homeowner?
M.T.: No. That is what you call a figure of speech. I'm saying that you're talking about individual homeowners defaulting. But these massive companies aren't going under because of individual homeowner defaults. They're going under because of the myriad derivatives trades that go on in connection with each piece of debt, whether it be a homeowner loan or a corporate bond. I'm still waiting to hear what your idea is of how these trades work. I'm guessing you've never even heard of them.
I mean really. You honestly think a company like AIG tanks because a bunch of minorities couldn't pay off their mortgages?
B.Y.: When you refer to "Phil Gramm's Commodities Future Modernization Act," are you referring to S.3283, co-sponsored by Gramm, along with Senators Tom Harkin and Tim Johnson?
M.T.: In point of fact I'm talking about the 262-page amendment Gramm tacked on to that bill that deregulated the trade of credit default swaps.
Tick tick tick. Hilarious sitting here while you frantically search the Internet to learn about the cause of the financial crisis -- in the middle of a live chat interview.
B.Y.: Look, you can keep trying to make this a specifically partisan and specifically Gramm-McCain thing, but it simply isn't. We've gone on for fifteen minutes longer than scheduled, and that's enough. Thanks.
M.T.: Thanks. Note, folks, that the esteemed representative of the New Republic has no idea what the hell a credit default swap is. But he sure knows what a minority homeowner looks like.
B.Y.: It's National Review.
I love Matt Taibbi's work. I just wish that when he has no idea what he is talking about, he would shut the hell up, rather than making an awkward public. Of course, in this exchange he looks good to people who have no knowledge of matters financial or economic. But sounding plausible to the ignorant is a rather low hurdle for a journalist to set himself.
In point of fact, Byron York is much more correct than Taibbi. CDS's (credit default swaps) are not the main cause of the crisis, and it seems more than possible that Taibbi has confused them with CDOs (collateralized debt obligations), the slice-and-dice securities that have done so much to destroy transparency in the mortgage securities market. Professional traders do not claim to understand all that is going on with securities, which makes me skeptical that Taibbi could provide the clear and concise explanation he is demanding from York. The only reason to fixate on CDS's in particular is that their deregulation can be attributed to a convenient Republican demon.
This brings me to a pet peeve that has been increasingly irritating me as the crisis wears on: people with little or no understanding of markets confidently opining on the causes of the crisis. Funnily enough, the cause of the crisis is always exactly what they happened to be against before the crisis happened, and the solution is for the people they disagree with to be banned from polite society and exiled from the political process.
What is most infuriating is that the people who know the least are the most confident about their appraisals. Anyone with any sort of expertise in the field knows that no one understands this crisis very well. Economists all over the ideological spectrum are rethinking the lessons we thought we had learned from the Great Depression and the Japanese experience. As it unfolds, we will no doubt be seriously rethinking our model of the relationship between the financial markets and the real economy.
The problem is, ignorant people who have somehow gotten hold of one or two precious facts, and brandish those facts like a mighty Sword of Truth, are superficially convincing. They are convincing because they misunderstand the situation in, well, the way that ignorant people misunderstand it. The stories they concoct are therefore very convincing to the ignorant, except those who have an ideological predisposition to doubt their story. Those ignorant people are busy listening to some other huckster peddling financial snake oil.
No one who did not know what a CDO was before the crisis should be opining as to the causes or the possible solutions. And anyone who tells you that they understand exactly why this happened, why we got this crisis instead of the dollar crisis we were expecting, and what kind of regulations will unquestionably fix it, is definitionally too ignorant to be opening their mouth.
Just for reference, how many times are you going to make the exact same post about how nobody knew what was going to happen, we certainly can't point fingers, nobody has suggested anything that would fix or prevent the crisis and everyone affected by the collapse who isn't in the financial industry should just stop worrying our pretty little heads about it?
I'm well aware that in the real world things are complicated and we don't actually have all the facts yet, but for god's sake if all you are willing to do is criticize anyone for having an opinion one way or the other and opine about how Paulson or Bernanke have a rilly rilly tough job what are you bringing to the table?
This is the quintessential libertarian pundit problem; because no actual actors in any real-world areas of interest operate from your first principles the primary impulse you have is to lay back and grouse about anybody who says or does anything. What's your plan?
Slightly off topic: But does anyone else notice Megan's propensity to rail against and dismiss as an ignoramus anyone who doesn't meet her knowledge threshold (the irony is, of course, that she subtlety shifts the goalposts so that she is never wrong), while at the same time decrying this tactic from her commenters?
I'm not offended by her flippant self-satisfaction; I think it's kind of funny, particularly since most of the economists I know think this blog is an absolute joke.
Taibbi repeats a lefty straw man, that mortgage defaults by minority borrowers were a primary cause of the credit crisis. No one has argued that; what they have argued is that standards that were lowered in part to increase minority home ownership rates were a proximate cause of this crisis; in other words, the bar may have been lowered to get more blacks and Latinos into houses, but plenty of marginal white borrowers took advantage of these lowered standards too and defaulted as well.
Now, if CDOs were structured more transparently, and if Fannie and Freddie had been run without political interference (admittedly, tough to imagine, since they were political creations) than there wouldn't have been much of a secondary market for crap no-money-down mortgages, to marginal minority or non-minority borrowers. Without an active secondary market, mortgage originators wouldn't have been writing all of that crap paper, because no one would have paid them for it.
The bipartisan drive to turn unqualified minorities into home owners led to a drop in standards across the board. That turned otherwise reliable structured finance products into houses of cards.
America is a diverse country, and non-Asian minorities don't have the same level of human capital, on average, that whites and Asians do. The 'ownership society' was an attempt to live like an 90% white country when we are only a 60% white country today. It was never sustainable. We're going to have accept a standard of living more inline with our diverse population.
Just for reference, how many times are you going to make the exact same post about how nobody knew what was going to happen, we certainly can't point fingers, nobody has suggested anything that would fix or prevent the crisis and everyone affected by the collapse who isn't in the financial industry should just stop worrying our pretty little heads about it?
"Until it finally sticks" might be a good time, although I think that last line about pretty little heads might be something you just made up. There are plenty of things to be worried about -- thing is, those who are best positioned to analyze and explain what those are, are presently still engaged in collecting and analyzing evidence.
Meanwhile, those who are certain they know what the problem is and are busy harping on one or two pet peeves, are drowning out the reasoned debate and will almost certainly get us more reactionary legislation of the Fox in S-Ox variety.
> This brings me to a pet peeve that has been increasingly irritating me as the crisis wears on: people with little or no understanding of markets confidently opining on the causes of the crisis.
This is a pet peeve of mine in general. It's frustrating when people confidently assert a solution and, since they did so in such an authoritative manner, other people fall in line behind the confident assertor. And what's really infuriating is that when the facts come out and it's clear that the confident assertor was wrong the whole time, the person that was right the whole time is assumed to be some sort of holder of grudges when he/she tries to set the record straight.
I guess I shouldn't try to include links. Whatever...
For his most notable contributions to mankind, the review of "The World is Flat" and the perfect description of David Brooks in two words, Mr. Taibbi deserves the designation of National Treasure.
Destroying weak-minded fools of Byron York's ilk is shooting fish in a barrel for Taibbi, 'cause that's what he does.
An edition of Bloggingheads with Jane Galt and Mr. Taibbi would have the potential for high, high comedy in an Iron Mike Tyson vs. Marvis Frazier kind of way.
Taibbi is a moron. But anyone who's ever read anything by him would already know that.
His attempt to pin the cause of the crisis on credit default swaps is particularly moronic. We've just had the largest bankruptcy in history. And all of the credit default swaps were settled yesterday for a total of $5 billion, on $400 billion notional amount of swaps. That's not a loss of $5 billion by AIG or any other particular seller. It's the total loss by all sellers of swaps.
Excellent analysis.
I can say with certainty that certain factors contributed to this crisis. And I can say with nearly equal certainty that specific regulatory changes would mitigate those factors. (Though perhaps creating other problems that are even worse.)
But you are right to say that the story is more complex than any single explanation. The crisis represents the collective actions of hundreds if millions of people, their perceptions of trillions of dollars in wealth, and the actions that they took as a result. These actions caused market movements, which changed perceptions, and so on... For many months now.
It'll be interesting to watch. Hopefully, I'll stay employed as it unfolds.
If CDS weren't the culprit, then why don't you actually make an argument that CDS' weren't the culprit, rather than snidely assert that they weren't the problem.
In short, someone tell me why two of the smartest journalist outlets around, 60 Minutes and This American Life, have experts that argued the exact same thing as Taibbi.
Just compare this to the world of the physical sciences. If you can prove a theory is wrong, that's pretty valuable, even if you aren't whiz enough solve the problem yourself. And I don't see how anyone could expect Megan to solve the current crisis herself.
Informing us that other people like MT who think they've identified a cause actually haven't is a pretty valuable service from where I'm sitting.
So I read this MT-BY exchange last week and am now glad to see it explained...
The is a great time to be an economist or studying to be one. A lot of doctoral candidates in economics are going to make their reputations writing about this crisis. Twenty years from now, one or two will get Nobels for their work on it.
Without getting into what caused the crisis, let me posit a contributing factor at least to the ongoing decline of the stock market. The stock market's collapse started right after Lehman filed for ch. 11. At that time, Obama and McCain were tied, or maybe McCain was up a point or two. The stock market collapse and credit crisis tilted the scales to Obama as lots of undecided voters said, throw the bums out, the new guys can't be any worse.
My thesis is that the ongoing decline of the stock market from that point on reflects in part the markets' anticipation that Obama will be elected. He is poised to be the most anti-business, anti-economic growth, anti-wealth formation president in memory, and once he became the likely winner, the markets started pricing in the costs of his victory. The further decline in the stock market, in turn, drove more voters into his camp, which made his victory more likely, and drove the market down even more - a kind of negative feedback loop, if you will.
Note I'm offering this as a hypothesis. Not being an economist, I don't have the tools to prove or disprove it. But maybe somebody will.
Consider this thought experiment: suppose that all the subprime housing loans were made, and to some extent supported by government guarantees; then, that housing prices fell as they have. What would have been the result? Some trouble for banks, some issues for Fannie and Freddie. Absolutely no impact on the global financial market beyond that, zero, zip, nada, none.
Taibbi's point is that the people who invented MBS's and their derivatives, the CDOs and CDSs and the like, were people who were generating phony wealth for themselves without producing any tangible product or benefit for anyone. They had ZERO regulation because that was forcefully opposed, in the main by Republicans but also by some Democrats. Their aim was to produce profit for themselves and their companies via transaction fees and showing 'growth' where in fact there was nothing at all being produced. The value of these instruments, which could not be objectively evaluated in any way, was always essentially zero, and it was in effect a Ponzi scheme. There was, indeed, one Democratic official who tried to get them regulated and was squelched.
The contrast here would be between the actual value of ALL the subprime mortgages that went into default (at most a trillion dollars, probably very much less) and the sum total value of all those securities... which was many times greater. That's the point Taibbi was trying to make and it's a valid one.
When we do take Ms. McArdle's approach and silence everyone who doesn't understand this, it will by definition shut down Mr. York and every right winger who takes the Blame Fannie and Freddie and the Poor People line.
What would be even better would be to apply this rule of silence for the ignorant to foreign policy. No one, on the right or left, who doesn't understand the culture, religion, history, and military tactical and strategic issues in Iraq, Iran, Afghanistan and the like would be allowed to write about them. That would shut down the entire neocon war party noise bath in an instant. A consummation most devoutly to be wish'd.
Uhm... Why aren't CDSs a major part of the scandal. In my, granted ill informed, opinion, they are the primary cause of the credit freeze. The over the counter nature of the CDSs means that they are unregulated and unreported. Because they are not regulated they don't have a capitalization requirement, so companies have written far more in CDS obligations than they could reasonably cover. That they are not reported means that no one knows who is liable to whom. This is dangerous because if I loan you money I want to know that you can pay me back, or alternatively I want to buy insurance in the form of a CDS in case you don't. Unfortunately, many of the people writing CDSs are seriously overleveraged, and whats worse - I have no way of knowing which ones are and which aren't. Which means I can't rely on getting a CDS to cover your debt. Also, since everyone in the commercial paper market is both debtor and loaner, I am worried that the CDSs you have covering your debt are worthless as well (e.g. if called in the CDS writer will have to go bankrupt), and so on down the line. The widespread nature of these CDSs meant that the bad news in the housing sector infects the entire economy. Regulation might actually fix this in that it would have better leveraging requirements and require more transparency in who owed what.
Now, CDOs are certainly problematic as well. And you are right that I don't think anyone was pushing to regulate them.
However, I think you are really wrong in suggesting that York has a point at all. The attempt to shift blame onto FM & FM seems really mistaken. It is certainly a problem that we had an implicit guarantee on FM & FM without actually bothering to own and regulate them. But that only accounts for our bailout of them specifically, and York doesn't present any reason why that would have spread to the rest of the housing sector that actually bought subprime loans and led the housing bubble.
The cause of the problem is really simple- too easy credit extended to too many people. Credit was extended to people who shouldn't have been loaned money in the first place (your subprime borrowers), and more credit than was wise was extended to people who were credit-worthy, but only up to a certain point. In addition, what looked like completely secured loans weren't completely secured, and only if the collateral didn't fall in value- something that not only couldn't be guaranteed, but was almost certainly not going to turn out to be true unless credit could be inflated endlessly in this particular market- which it cannot.
Our monetary system is based completely on debt, and when debt goes bad on a scale like this, defaults, bankruptcies, and deflation are the inevitable results. On a big enough scale, and this one might be, a debt crisis can destroy the monetary regime completely, leading to governmental collapse. Watching our leaders trying to paper over the bad debt with more debt is disheartening, but not particularly surprising.
Yes, York is correct, lending standards were relaxed to loan credit-unworthy people money for homes, and it should come as no surprise to anyone that these lendings turned into losses for the lenders, but the relaxed standards go all the way up the borrowing chain- everyone becomes credit-unworthy if you lend them enough money.
Tabbibi is simply incoherent, and I think Megan may be right that he has confused two similar terms. However, I still don't believe most CDS was sold/bought by speculators, but were brought into being through legitimate desires to hedge out default risk by both lenders and the writers of the insurance. I think the fundamental flaw of the CDS market is that credit risk can only be spread out so far before the risk comes back to you in some other form. I don't think the market participants knew the limits to risk spreading. As the financial system contracts through defaults and mergers, we are going to increasingly see that this risk was largely unhedged because of this.
"Tabbibi [sic] is simply incoherent, and I think Megan may be right that he has confused two similar terms."
Why have other experts echoed the exact same thing Taibbi said?
One other note - Taibbi doesn't even *attempt* to explain why he thinks that credit default swaps caused the crisis. It's as if he can say the magic words "Phil Gramm" and everyone therefore knows that credit default swaps caused the crisis.
So then you have people like TomO, confidently asserting that "Because they are not regulated they don't have a capitalization requirement, so companies have written far more in CDS obligations than they could reasonably cover". Actually, sellers of credit default swaps have to mark them to market every day AND post cash collateral for them. As noted above, the entire market for Lehman credit default swaps settled for a mere $5 billion - that's not a payment by any particular institution, but the total payments by all sellers of Lehman credit default swaps ($400 billion notional amount, in total).
So, I'm wondering how any person with any understanding of credit default swaps at all could believe, even for a second, that credit default swaps were even a minor cause of the crisis.
M.M. said last week that "Nassim Taleb and Benoit Mandelbrot... nailed what to me is the core issue: bankers pricing security risk as if it were distributed along a normal curve with thin tails" and also offhandedly mentions NNT and BM's work is about "faulty probability models being used by financial wizards, who assumed that they could quantify risk along normal distributions".
Isn't "the mispricing of risk" and "the use of faulty probability models" basically a more vague way of saying that the CDOs and CDSs that blew up were dogshit?
Also, in the blame game, if the goal of govt is to "enforce transparency, solve collective action problems, and analyze the system for systemic rather than local risk", then the Bush-led govt (e.g. EC chairs are appointed by President) is highly to blame for not carrying out the 3 above MM-stated duties from AD2001 - AD2008.
"Taibbi's point is that the people who invented MBS's and their derivatives, the CDOs and CDSs and the like, were people who were generating phony wealth for themselves without producing any tangible product or benefit for anyone."
What you mean like people who bought homes they couldn't afford for the sole purpose of selling them for a profit as soon as possible?
Megan is right in that people don't fully understand all that happened here. Anyone who offers a cut dried explanation is lying, a fool or both. Somewhere at the root of all this though lurks the idea, pushed by both parties, that home ownership and appreciation in home values was the key to wealth for large numbers of people. Absent a change and the supply and demand structure of the housing industry, there is no reason why homes should appreciate in value much above inflation. Yes, you should see some bubbles in places where space or government regulation artificially restricts supply, but absent a population explosion housing prices ought to stay pretty stable. Owning a home should not be a key to wealth beyond the equity you build up in it by paying off the loan. Once we decided that housing prices were somehow immune to the laws of supply and demand, we were in a lot of trouble.
At least we're looking for answers and learning. What are you doing?
One needn't have known was a CDO and CDS was prior to the crisis to learn what they are now.
I'm surprised this post is subtitled "Matt Taibbi shreds Byron York into little tiny pieces" when ever the you, Megan, know that York has the better part of this argument. Taibbi is simply doing what Taibbi always does--spew a lot of crap and make the other guy to all the research to prove him wrong.
It's particularly craven here where it's live so Taibbi can make fun of the other guy while he does the work Taibbi is too lazy or dishonest to do himself.
Megan,
Small point - I'm one of those pedants that thinks openings (and titles) should explain what an article is about. You can still be clever (really!) but just imagine you were searching through your archives trying to find this ONE article... "Peanut gallery" does not really help.
So. Pedantry aside -
Good article! I wonder how many people are more hypnotized by the confidence than by the content though? This is a really scary thought for me...
This is the greatest single problem with democracy, when you get right down to it. Most people simply can't make sense of complex economics, but it's test day, and they have to guess on every question on the test. And since there are so many more non-economists than economists, actual intelligence gets drowned out in the noise of randomness. It's a very scary thought.
@ Al sellers of credit default swaps have to mark them to market every day AND post cash collateral for them
Michael Greenberger on 60Minutes a couple weeks ago said "The problem was that if [CDSs] were insurance, or called what it really is, the person who sold the policy would have to have capital reserves to be able to pay in the case the insurance was called upon or triggered. But because it was a swap, and not insurance, there was no requirement that adequate capital reserves be put to the side."
Frank Partnoy on 60Minutes said, "[CDSs] were the centerpiece, really. That's why the banks lost all the money. They lost all the money based on those side bets, based on the mortgages."
Please explain, Al, with references, how these guys are wrong? The ignorant await.
The bill in question received strong bipartisan support. Larry Summers supported it as Treasury Secretary, and, I believe, 95 senators voted for it. So Byron York has a point that making this all about Gramm and McCain is a little disingenuous.
On the other hand, Megan is doing the same thing to Matt Taibbi that he pulled on Byron York. Taibbi does seem to be talking about credit default swaps, and he does seem to know what they are. Otherwise, he does sound like a grandstanding jerk.
"The only reason to fixate on CDS's in particular is that their deregulation can be attributed to a convenient Republican demon."
I'm not sure this is true. Lots of people are worried about the ramifications of the huge market in credit default swaps for reasons that are not political.
Ms. Mcardle is perfectly correct about the 'causes' of the current difficulty. Stuff like this doesn't happen unless a large number of seemingly unconnected people screw up royally at the same time, and in this case it's necessary that all of them screw up. If Congress (and all electioneering aside, the Dems are at fault on this far more than the GOP), didn't screw up Fannie and Freddie, this wouldn't be happening, if Wall Street assessed risk properly, the SEC didn't bipartisanly lower Ibank capital ratios, this wouldn't be happening, if the ratings agencies were doing their jobs, if people weren't buying houses they couldn't afford...
The problem is that if you wanted to hang them all, you'd have to hang an extremely large number of people, including the whole (Dems and Reps, but the process should be more painful for the Dems) Washington political class, in addition to some less than 100% portion of Wall Street and Main Street bankers.
Taibbi, if he's sincere rather than doing some freelance electioneering, is rather classic here. He clearly has no idea what he is talking about, but the amusing part, is the deep well of self confidence he has while he has no idea of what he is talking about. I guess if one knows how to run one's mouth, one knows about everything.
rickm,
The other experts may be equally incoherent, but I can't know for sure. All I do know is that what Taibbi is saying in the above interview makes little sense, and actually has no substance as one other commenter above has noted.
And, in any case, the focus on CDS is missing the point- there is a mountain of unpayable debts that must eventually be declared to be losses for someone. All we are seeing from the bankers and the politicians are attempts to hide this fundamental fact under more debt. Right now, the total losses are limited to the bad debts- CDS doesn't change this number. All CDS does is change who the losers are (some initial losers will recover on insurance payoffs, and some will find their insurers can't pay, so they end up having to eat the losses). However, the longer we attempt to hide the bad debt with more debt, the larger the number grows. Insolvent institutions need to be put down as soon as possible- this is the only way to restore confidence.
Posted by rickm | October 23, 2008 2:15 PM :
"In short, someone tell me why two of the smartest journalist outlets around, 60 Minutes and This American Life, have experts that argued the exact same thing as Taibbi."
Is that satire? I hope it is :) Because if it is - it's brilliant.
@rickm
I believe that people (including experts) who claim to fail to understand this are being deliberately obtuse. They have a vested interest - either philosophical, political, or monetary - for acting in this manner.
If you have a 750 beacon and you have a house worth $500K that you owe $250K on, you're a pretty good risk for a $150K equity line of credit, right? Yes, until the rug is pulled out from under an inflated home values market and sends the value of your house spiraling back to $250K. Now you're not just a risk, you're a threat. You owe $150K MORE than your home is worth.
The home values were inflated because government turned loose millions of buyers who were previously unable to get a house. It doesn't matter if those buyers defaulted or the guy above defaulted. In any case, the original bubble was *caused* by government intervention.
Everything that followed was a result of that bubble and the government's attempts to disguise it and keep it moving.
Pssittakos is right--the bill was bipartisan, and signed by Clinton.
Now will anyone engage Ron O'Neal's points??
I don't see how CDSs weren't/aren't a major problem when they are now being settled for pennies on the dollar. The bets on Lehman were settled for 5 billion, but their actual value was over 70 billion. Purchasers of CDSs aren't realizing upwards of 90% of what they are owed, presumably to avoid inducing any further implosion of the economy. I agree with Fred 2:11 on CDSs not being the sole cause of the current crisis, but to flat out deny that a trillion dollar market of insurance policies isn't somehow complicit seems egregious at best.
Nick,
That only explains that people defaulted on their mortages. The real question is, why did banks that survived the Great Depression and World War II no survive people defaulting on their mortages? Defaulting on mortgates isn't supposed to bring down the financial industry, and I think the argument is from 60 minutes, Taibbi, et al that the CDS greatly exacerbated the loss from a defaulted mortgage.
I don't know if shreds is right, I think they both look like fucking idiots.
"there was no requirement that adequate capital reserves be put to the side"
Explain to me why capital reserves should be "put to the side" when there is already cash collateral posted for loss.
Fred at 2:11 said:
I respectfully disagree. If you look at some of the trends and the "conventional wisdom" -- financial institutions were acquiring and growing, many were buying the loan portfolios of community banks and treating them as little more than marketing agents or mortgage brokers, the general (ahistorical) sense was that real estate values would only go up -- someone would have decided that by using MBS/CBOs to spread the risk and insuring them with CDSs was an absolutely safe bet because (a) the default percentage had gotten quite low and (b) the appreciation of the homes would always cover any spread. This was not a matter of FM & FM, or lower loan standards. This was (1) a hubristic belief that CBOs covered by CDSs had so diffused risk as to render it immaterial; (2) an ahistorical bet that for the relevant future housing prices would only go up; and (3) an inability to look at what appeared to be easy money and turn it down out of an understanding that if it looks to good to be true it likely is. Under those assumptions, someone would have bought the "crap paper," FM & FM or no.
As anecdotal support for my theory, I give you the home equity line of credit and credit card markets. If the FM & FM triggered housing market collapse hadn't started this contagion, the crisis likely would have happened anyway as other economic factors turned credit card and home equity debt into drivers of the collapse. The short version of the story is that as a society we have lost the discipline to live within our means and some institution is always willing to take the gamble on our undisciplined ways for the hope of making easy money. This has a lot less to do with FM & FM than some broader societal trends.
To engage in absolute heresy, let me suggest one of the main drivers of that societal lack of fiscal discipline was Ronald Reagan charmingly telling the American People that they could have - nay, they should demand - it all: more defense spending, no significant cuts in social programs or entitlements, and lower taxes, and their faith in God and the Flag would make the math workout (and if not, hey, he'd be out of office before H.W. Bush had to clean it up anyway).
Taibbi is just bullshiting. He might as well be Joe Biden. He is someone who knows nothing but confidently says a bunch of crap and appears smart doing it. The last "the NR has no idea what CDS are" is particularly gauling. You can't talk to people like that. They think snark and BS are a subsitute for thought.
Whoa John... methinks you have a pretty bad case of projection.
Except that MT has the better factual argument. True, we don't understand the complex causes of the crisis, but we do know that gambling in CDSs is a major contributing factor in the freezing of the credit markets, and bringing down AIG. York is repeating the new meme that efforts to encourage lending to minorities is a major contributing factor to the crisis--sure, in a way it is, but it seems more accurate to say that the over-levered financial products created from those loans, poor risk assesment etc are bigger factors--if I borrow a bunch of money and place a huge bet that some poor people are going to repay their mortgages because their house values will continue to rise, it seems a bit silly to blame poor homeowners if I bankrupt myself on that bet. Based on the above exchange, it appears that York doesn't really know what derivatives are or how they fit into the mess.
Rick,
If you can't see through Taibbi and realize he doesn't know anything, then you are dumber than he is. At least Taibbi can BS. Just because someone agrees with you doesn't mean they know anything.
"I borrow a bunch of money and place a huge bet that some poor people are going to repay their mortgages because their house values will continue to rise, it seems a bit silly to blame poor homeowners if I bankrupt myself on that bet. "
That is an idiotic straw man. No one is blamming poor people for anything. Two things happened here; lending standards were lowered accross the board in the name of universal home ownership, and banks made very foolish financial decisions buying CDS. Eliminate either one and the crisis doesn't happen. The fact that the banks were foolish doesn't make the efforts to increase minority home ownership by lowering credit standards any less foolish.
Purchasers of CDSs aren't realizing upwards of 90% of what they are owed, presumably to avoid inducing any further implosion of the economy.
I guess Scott hasn't heard of this odd financial concept called "netting".
Al:
Mark to market is completely different than a regulation capitalization requirement, and does not provide the type of protection I am suggesting would help.
All MtM means is that I have to list on my books what the market price of my liability would be today. So, in terms of a CDS it would be how much I would have to pay someone to take the CDS off my hands, which given current market estimate of how likely it is to be called is substantially less than the amount that would need to be paid if it was called.
Regulation, like the insurance industry, would likely require companies to demonstrate they can cover a substantial percentage of the total value of the CDS if called. And thus would provide greater protection.
Other people think this to0, for example href="http://www.time.com/time/business/article/0,8599,1723152,00.html">Time . Newsweek has a slightly different take on it, but still thinks CDSs are a large part of the problem.
I will grant you that Tabai doesn't really develop this argument in that piece. But only because its clear that York doesn't have a clue what he is talking about, so why bother.
Please explain how the bad loans in the housing sector spread to freeze the commercial paper market absent the CDS problem?
I don't understand what it means "people bought houses they couldn't afford." There was a bubble. Of course this happened. Both the buyers and the lenders were betting on the fact that they could afford the houses and it was the lenders who had the power. The lenders had more power because they could sell off their loans and get more money to lend. The leverage was in the financial markets and it was a result of overconfidence in bad risk models.
@rickm
No, it explains the bubble - the place where all this debt came from.
If it weren't for the bubble, none of this would have happened. There would have been no need for mortgage-backed securities bought and sold on the open market and backed by CDS instruments of questionable lineage.
The bubble is there because government decided that everyone should be a homeowner. They demanded the banks make it so, endorsed the help of non-governmental organizations like ACORN, offered Fannie and Freddie as a "wink, wink, nudge, nudge" and away we went.
MBS, CDS, money, money, money, spend, spend, spend...
Soon everyone was spending money they didn't have while economists jerked their arms out of joint patting themselves on the back for creating the economic equivalent of the perpetual motion machine. An economy that just grows! Novel concept.
In the end, it didn't take much for it to come crashing down - The defaults - and it doesn't matter if they were black, white, red, or green - high, medium, or low income - The defaults came rolling in faster and faster.
They spread like a virus through the MBS network because many loans were pooled not in single instruments, but across several. How do you sort it all out?
In addition, there was the question in at least one courtroom over whether or not the holder of an MBS is even entitled to foreclose on the property. A US District Court judge said "no" and threw out fourteen foreclosure suits brought by Deutsche Bank.
Confusion in the market, confusion in the courts, confusion in the halls of government - and everyone just sat on their hands and acted like nothing was wrong.
I only marvel at the fact that it took so long for it to finally make itself public. Funny, it took Lehman Brothers to fail for everyone to finally see that there was a real problem.
Now everyone seems to think the solution is to keep throwing money at it.
Typical.
Megan, you didn't highlight the most ignorant part:
"The CDS market, this market for credit default swaps that was created in 2000 by Phil Gramm's Commodities Future Modernization Act, this is now a $62 trillion market, up from $900 billion in 2000. That's like five times the size of the holdings in the NYSE. And it's all speculation by Wall Street traders. It's a classic bubble/Ponzi scheme."
A bubble! A CDS bubble! Because the notional amount was so big!
There's a reason people don't look to RS for financial markets coverage.
The CP problem has nothing to do with the CDS market, which per the current nastiness, is like most everything else in that it has nothing to do with the CDS market. The CP problem started when Lehman went down, and defaulted on their CP, causing a big MM fund to 'break the buck' causing a run on MM funds that has all of them wanting to hold cash or Treasuries rather than CP. Lehman went down because of 'bad loans in the housing sector' in addition to alot of other bad loans in the LBO sector, not because of the CDS market.
Per Taibbi again, he's a pretty good chattering class member in that he expresses himself rather well, and if one doesn't know anything about the topic he's writing or talking about, he comes across as knowledgable and leaves his reader with the erroneous thought that he has learned something.
One isn't going to learn much about all this stuff in the MSM though. If it's more complicated than sex and/or bribery, regurgitating poll numbers, or commenting on a candidate's style, 98% of the press (including Taibbi or 60 minutes) isn't smart enough to comment on whatever the issue at hand is (Our hostess, at least in economics stuff is part of the 2%). The press's job is to sound intelligent on all these issues which they often succeed at, since most of their readers/viewers don't understand the topic of their articles/shows, in which case they'll come away with the thought that they've learned something even if in fact the article made them more clueless, which, if said topic is not on the above list, is usually the case. Taibbi isn't any different than the usual run of the mill.
Ok, reading the comments I think people can't keep CDO's and CDS's strait.
M.T. said, "It's a classic bubble/Ponzi scheme."
Please make a note of that comment, MM......you'll probably want that when the Dems refuse to fix Social Security, and then try to lay it at the foot of whichever Republican candidate is handy.....
j mct,
You are exactly right. When Taibbi goes into the gotcha on how York doesn't know what a CDS is. Of course Taibbi doesn't explain anything about what they are either and it is unclear if he knows anything about them other than he has heard the term somewhere. But York didn't explain the whole thing in detail so he is an idiot.
The whole thing reminds me of the "Bush Doctrine" question that Palin couldn't answer. I have spend most of the last 9 years doing some kind of international law and law of war. I can tell you I have never once heard the term "Bush doctrine". Pre emptive self defense yes but not Bush Doctrine. My guess is that Charles Gibson or 95% of the media couldn't give a cogent explanation of it. But, Palin was stupid because she couldn't play stump the chump with Gibson.
"I have spend most of the last 9 years doing some kind of international law and law of war. I can tell you I have never once heard the term "Bush doctrine"."
That's evidence that you, not Sarah Palin's critics, are a moron.
No Rick, you don't know anything. There is no such thing as the "Bush Doctrine". It is an invention of the media. No one who is in the field would ever use the term. In fact, if there is anything called the "Bush Doctrine" it would be the idea that we have to deal with failed states in order to stop terrorism. When I first heard Gibson's question that is what I thought he was talking about.
John, fi Palin were as well read as she claimed she was, and the Bush doctrine were a creation of the media, than shouldn't she have been able to at least ask a follow up question to clarify?
Megan is a brainless non-entity who can't shine Matt Taibbi's shoes.
Her blog is a super sized, steaming pile of excrement.
I think a lot of peopel are missing the point Taibbi was perhaps trying to make.
As Megan said, the crisis is very confusing, and no one knows how it started. But Tiabbi WASNT saying it was all created by Republicans, or by the unregulated CDS market. He was saying that the attempt by McCain and many conservatives to focus all the blame on fanny, freddie, and brown people is silly, exactly BECAUSE they display ignorance about things like the CDS market and other security-packaging related reasons why everything got very complicated.
The liberal point here is that it is exactly the case that it is a complicated, unpredicable issue. Blaming it on something simple like poor minorities is retarded. Lack of government regulation is equally not the cause of the problem, that's also retarded. That's like saying lack of an umbrella caused a rainstorm.
But the next line is obvious. The umbrella can keep you from getting soaked. Liberals who respect the role that government can play in minimizing downside risk recognize that in any complicated situation like this these new security markets, there will eventually be a bubble, or fraud, or monopoly, or something; you need regulation to keep things running smoothly. That doesn't mean you regulate the hell out of everything! But it does mean that you never, ever, take a hardline libertarian position that regulation should always be a measure of last resort, after we've suffered a depression.
TomO references a Time article entitled "Credit Default Swaps: The Next Crisis?". It states: "Banks and insurance companies are regulated; the credit swaps market is not. As a result, contracts can be traded — or swapped — from investor to investor without anyone overseeing the trades to ensure the buyer has the resources to cover the losses if the security defaults."
As I've already pointed out, this is just wrong - the terms of credit default swaps generally require the posting of cash collateral, which provides the insurance that the loss will be covered if the underlying security defaults. It's not surprising that a general interest publication like Time puts out information that is completely misinformed, but you shouldn't rely on it.
Meanwhile, I'm still waiting for the credit default "crisis". We've already settled the credit default swaps for Lehman, Fannie, Freddie. No CDS selling institution defaulted on its obligation. And no buyer of such CDS didn't get paid. So counterparty risk was negligible. So where's the crisis?
AIG, after all, didn't default on its obligations with respect to the credit default swaps it sold. And it didn't have to turn to the Fed bailout because some gignatic bankruptcy meant it had to pay out a ton of money on CDSs it sold. As far as we can tell, to the extent that AIG's CDS were responsible for its troubles, it was a result of the counterparties requiring AIG to post more collateral, mostly due to the downgrade of AIG itself.
The issue with CDSs isn't that these institutions are at risk of having to pay off on all of the CDSs they sold - after all, how likely is it that *every single debtor in the world would default on their debt at exactly the same time*? Not bloody likely. Instead, the biggest problem is that the mechanism that requires posting of collateral makes sellers of CDSs vulnerable to their own downgrades. If you want to require additional sellers to have capital to protect against THAT risk, then I'm with you. But capital with respect to the CDS instruments themselves is not really necessary.
I am someone w/ next to no economics background, but when things are explained to me at a reasonably intelligent level, I think I get it. Put another way, I think I could acquire an economics background if I desperately wanted to/ had time/ etc.- but I'm not going to, and I still think I should be able to form an opinion on economic stuff. I'm a biologist, and I think it's good that people hold forth about ecology, evolution, and stem cell research, even if most people have a rudimentary understanding (and are often wrong).
So I've been increasingly annoyed at 1) trying, and failing, to make partial sense of what's happening economically, and 2) posts like this one that say I'm too inexperienced to try and should never voice an opinion. As mentioned before, I'm not an authority on these matters. However, I think we can all agree that how this plays out is of great importance to everybody, and insofar as I can participate (voting, calling my senators and representative, spending my apparently forthcoming stimulus check) I'd like to do so in a way that is as informed as possible. To me that means that I should understand the situation enough that I can integrate new information into my model and arrive at a sound conclusion, instead of wailing like a babe in the woods until you explain it for me. So if you with expertise can help me out (as you are only partially doing currently), I'd appreciate it. I'm really annoyed with the idea that although the economy is the most important thing on people's minds, none of us plebeians can possibly have a valid opinion. Is the idea that more people should be conversant in economic matters, or blissfully ignorant and trusting of the technocrats in our political parties and the media?
The way it works in biology is that you change the delivery of your message to fit your public. I realize blogs have a different audience than newspapers, but cut me some slack here. Generally, this means that you assume that the people you're talking to aren't idiots, but you explain things in terms that they can get. And lastly, maybe most importantly, you provide a model accounting for as much of the current info as possible, and point out its shortcomings. So even if you don't understand everything (in biology, you never, ever do), you still try to make a model that is rapidly comprehensible, internally consistent, and at least relatively intuitive given the evidence you cite.
This tends to happen w/ columnists and op-eds in newspapers, but only occasionally w/ blogs. So if you find people who get a lot of their economic info from NPR or Paul Krugman (among other sources) particularly contemptuous, maybe you can get in the business of making your (supposedly more correct) view of the economic situation a little more bite size.
One other thing I'd ask- if you want to make a completely counter-intuitive point about the way markets work you need to defend that position more than if it were more obvious. Same goes for trashing someone else's view. You should be able to articulate why an intelligent person might come to this incorrect understanding besides pure wrongheadedness, and then say why. These things should make sense. It annoys me that what I consider your (partial) failure to explain, you consider my failure to understand. It works two ways, and I'm trying to meet you halfway.
ps- As far as picking out soluble problems from the morass of incomprehensibility, I think you've done a good job (deciding in favor of some kind of bailout instead of reflexively against one). And on more limited points, I think I get you. I appreciate your take on the Taibbi thing, which on its face I found persuasive initially. And generally speaking, I enjoy reading your blog- especially because you take viewpoints that I wouldn't even consider, necessarily.
And not every post needs to be dumbed down- you can and should write at the highest level of your expertise, and the people who are right there with you can hang and debate at that glorious zenith of economic experience. I'll try to get what I can from it. But I'd appreciate an occasional breadcrumb to my level. Or if you could refer me somewhere, I'd appreciate it.
I don't think Taibbi is confusing CDO's with CDS's. I think he's doing what I've seen several bloggers do (in particular Emily Bazelon on the Slate political gabfest). They listened to two one hour episodes of This American Life explaining the crisis then started parroting exactly what they heard with the tenor of authority.
After the first TAL financial crisis episode suddenly I started reading a lot of non-economic bloggers getting excited about exotic derivatives and Fannie Mae and Frannie Mac. I hadn't heard of a CDS before the second episode but now tons of bloggers are dropping them casually in political posts.
What I'm guessing Taibbi can't do is explain why CDS's are bad; mostly because TAL didn't explain why. They gave some lame explanation about it being like multiple people insuring the same house, when only one person owned the house but stopped there. They didn't talk about the consequences of shared shock across multiple investments.
I love these TAL episodes but they should be taken as one hour of observations on an aspect of the crisis and not as an instant degree in economics to every listener.
I do claim to know what caused the financial crisis, and have no expertise, but it's not anything political. My stat prof said, most issues with stat-related papers come down to assuming variables are independent when they are not. If anyone asks me why this happened, I say that it is because the payoffs of various mortgages were considered as independent random variables, when really they are correlated (since the macroeconomic conditions affect them all in the + or - direction).
I'm not saying that people shouldn't form an opinion--obviously, shutting up and leaving it all to the experts wasn't a great strategy. What I'm saying is, if your opinion is recently formed and sketchy, be humble about it--don't loudly inform everyone that you've found The Answer.
The more commentators actually know about finance, the more humble they are likely to be about diagnosing the problem, and suggesting solutions. Even a genius like Luigi Zingales merely says that he is offering his opinion; he makes no guarantee that he knows exactly how it could have been prevented, or that his solution will make everything hunky-dory. If you aren't Luigi Zingales, you should downgrade your certainty appropriately.
I have a broad opinion about how things are going in Iraq. But I also recognize that I do not know enough about matters military or middle eastern to know how things might have gone better, or what we should do now.
I don't know why anyone tries to discuss any of this with Megan McArdle, who is barely literate and is the biggest embarrassment to the Atlantic Monthly in a very long time.
CDS's (credit default swaps) are not the main cause of the crisis, and it seems more than possible that Taibbi has confused them with CDOs (collateralized debt obligations), the slice-and-dice securities that have done so much to destroy transparency in the mortgage securities market.
I don't think Taibbi's error is all that you make it out to be. It's true that credit default swaps are not the "cause" of the economic crisis (bad mortgage backed securities are, obviously) but they most certainly are implicated in it. If you don't believe me, simply types "credit default swap" into a Google news search and see what comes up. I think Taibbi gets ahead of himself trying to say that this market is a much worse problem than just the market for mortgage backed securities, let alone the market for mortgage backed securities that involve only mortgages to minorities with bad credit from Freddie Mac and Fannie Mae. Where you have on one hand York trying to blame Fannie Mae and Freddie Mac (and by implication, minorities) for the meltdown, and Taibbi trying to get him to talk about a possibly worse crisis brewing in the financial markets without success, then I'll take Taibbi.
No one who did not know what a CDO was before the crisis should be opining as to the causes or the possible solutions.
Also, that seems like a very silly distinction to make as quite a few people who were quite familiar with what a CDO is before the crisis erupted, did not exactly do a very good job of predicting the crisis. And it is entirely possible to inform yourself well enough in the wake of the crisis to at least follow the news and make an educated guess about what's happening, which by the way, appears to be all that noted economists are doing as well.
What I'm guessing Taibbi can't do is explain why CDS's are bad; mostly because TAL didn't explain why. They gave some lame explanation about it being like multiple people insuring the same house, when only one person owned the house but stopped there. They didn't talk about the consequences of shared shock across multiple investments.
That's not the impression I got. Certainly they didn't provide more than a basic explanation, but that was the purpose of the show, to explain it in a manner most people could understand. And it's not only people who listened to that program who are talking about credit default swaps; those in the business were to a small extent before that show, and they are to a greater extent now, and I doubt that has anything to do with that program. If you don't believe me, see my above suggestion about doing a Google news search.
And incidentally, it wasn't the hosts of the show who arrived at the conclusions about credit default swaps. It was the economists they interviewed.
Anyway the shows are certainly not comprehensive, but they certainly do provide an excellent jumping off point for those who have no clue what's going on but intend to inform themselves as rapidly as possible (such as myself, for example.)
Taibbi is making the utterly ridiculous assertion that mortgage defaults were not an important component of this crisis. That is far, far more lunatic than anything Byron York is saying.
Dear McArdle,
I think the arguement Matt Taibbi is making is that, even though many people defaulted, that alone is not enough to bring down the house. I think he's saying that the defaults had such an effect because (a) the risk was way underappreciated/mispriced by financial models and (b) the risk was jacked up further due to incentives that made it very profitable to wilfully ignore the risk and passing along the risk to others.
If this is Taibbi's argument, is it more or less accurate?
Taibbi is making the utterly ridiculous assertion that mortgage defaults were not an important component of this crisis.
Taibbi is clearly responding to the ridiculous notion that Freddie Mac and Fannie Mae are to blame for the global financial downturn. Now York may want to soft-peddle it and just say those are "major factors", but clearly the right has been peddling the notion that loans to minorities are the real cause of the crisis and clearly, if you've been following that little meme at all, that's where York gets that point from. Honestly, you have to not understand the context at all to not get that that's what Taibbi is responding to.
So does the fact that only $5.2B had to change hands to settle the over $400B in outstanding CDS contracts written to cover Lehman begin to put to bed the notion that CDS's are simply instruments of speculation?
AIG only had to pay out $6.2M to settle its Lehman CDS's.
It seems, even to a layman like myself, that the CDS's reputation as a "financial weapon of mass destruction" may have been a bit overblown -- with all due respect to Mr. Buffet.
It just doesn't seem that there was much use of the CDS as a purely speculative way to make money -- at least in the Lehman case -- but rather as a hedge.
"I respectfully disagree. If you look at some of the trends and the "conventional wisdom" -- financial institutions were acquiring and growing, many were buying the loan portfolios of community banks and treating them as little more than marketing agents or mortgage brokers, the general (ahistorical) sense was that real estate values would only go up..."
You're missing the key difference between community banks and stand-alone mortgage brokers. Most community banks stuck to the traditional model of mortgage lending: they held the loans on their books, so of course they maintained logical underwriting standards and demanded down payments. As a result, most community banks are doing well, and we've had relatively few bank failures among them. Mortgage brokers, on the other hand, sold every loan they originated. Once a loan was sold, if it blew up later, it didn't matter, as far as they were concerned. These are the crooks who wrote the crap no-money-down loans. If it weren't for Fannie, Freddie, and, indirectly, the CDOs buying up this bad paper, they would have stopped originating it.
Yancey Ward beautifully explains why CDS aren't the main reason for the problems -
"And, in any case, the focus on CDS is missing the point- there is a mountain of unpayable debts that must eventually be declared to be losses for someone. ..... CDS doesn't change this number. All CDS does is change who the losers are"
There were problems with transparency in the CDS market - no one knew who owed what, so everyone got worried, especially after Lehman's declaring bankruptcy. That's something that should be fixed.
But Tabbi is wrong in claiming:
"The CDS market, this market for credit default swaps that was created in 2000 by Phil Gramm's Commodities Future Modernization Act, this is now a $62 trillion market, up from $900 billion in 2000. That's like five times the size of the holdings in the NYSE. And it's all speculation by Wall Street traders. It's a classic bubble/Ponzi scheme. "
The market clearly isn't all speculation. We saw with the Lehman settlement that out of $400 billion in CDS, all but $5.2 billion was hedged or netted out. As for that last $5 billion, yes someone on one side was speculating by selling insurance, but the other side can't hedge or buy insurance unless someone sells it. As Yancey pointed out, the CDS's didn't create the risk, they only allowed it to be shifted, and so far we have no evidence that any of it was shifted in an irresponsible way.
Last, it's garbage to say that blaming much of the problem on lower credit standards somehow means attacking minorities. Barney Frank, Chris Dodd, Bill Clinton, Franklin Raines and Jamie Gorelick aren't poverty-stricken minorities. One could far more easily argue that the poor people who were urged to take out home loans they couldn't afford are victims here - whatever payments they made on their home are now gone, along with their dreams. Politicians forced banks to lower their credit standards for political reasons and didn't do poor people any favors, in the end.
The banks and credit rating agencies and irresponsible borrowers (most of whom were not poor or minorities) all got carried away and all deserve some blame here, but even more blame belongs with the politicians that forced these changes for their own ends, regardless of what was best for the poor that they claimed to care about.
Megan --
First, if Byron is so correct, could you explain these two facts: (1) neither Fannie nor Freddie was a player in the CDO market proportional to their size, and (2) private ABS issuers and commercial banks were the primary issuers of subprime mortgages?
Second, you don't provide any sort of argument as to why this was the case. You just slap your MBA on the table and assert loudly that other people with MBAs weren't at fault. This isn't an argument: it's an assertion that you've thrown your diploma on top of.
Third, there is no way to cut a AAA security out of a subprime mortgage pool without credit-default swaps. In order to cut that AAA tranche, you have to squeeze every last bit of risk out. Some of the risk goes to the lower-rated tranches of the ABS, but that last bit of risk has to be shunted to someone else. Which is where the CDSs come in.
On a micro level, any particular transaction of this type can look sane -- except for for conservation of risk. You don't eliminate the risk; you put it somewhere else, and the CDS is one of the primary channels through which it travels. In essence, you had suckers on all sides of that AAA bond -- the people with the low-rated tranches; the people holding the CDS; the original loan guarantors who sold the loan to the pool -- betting that they're going to get a chair when the music stops.
No one did. So we're all boned.
C'mon. Make the case for Fannie and Freddie being the case.
-- ACS
If we can get people to trust neither states nor markets - then I think we are actually going to make some real progress. But it may take you off the tidy ideological maps (including those insipid ones drawn by libertarians.)
Megan, it's refreshing to finally see mention here--after reams of talk about "causes"--of the Commodities Futures Modernization Act.
Only, the mention wasn't by you.
Sorry, BY got p0wned except at the end. This is a Republican meme trying to trace the default back to increased minority ownership and Freddie Mac and Fannie Mae loans. The problems were liar loans and the swaps and CDO's, among other examples of greed and irresponsibility.
CRA-motivated loans tend to be the opposite of subprime loans, most of which were issued by mortgage brokers and mortgage companies and financed by investment banks, none of which were covered by the CRA.
• The CRA has been around for three decades and the financial instruments that allowed the subprime mortgage industry to rise and crash came into existence within the past five years.
• Investment banks, not the federal government, had the appetite for risky loans.
The Wall Street-based market for reselling subprime created the demand for riskier loans. Because the debt would be sold into the market and not kept on the lender's books, many lenders did not bother to verify a borrower's income or assess ability to repay the loan.
Let me get this straight Megan; If you were not aware of credit default swaps prior to the US economy getting ass-f%#$ed by them - and if you were further unaware that banks were chopping up mortgage debt and selling it as a commodity; that is, you didn't think bankers could be that stupid - well then, you're uninformed, so SHUT UP! Don't express your opinions and don't judge people who thought all of this was great idea. I'll take your advice and shut up, when you answer a simple question - have you been right about anything in the last ten years?
I don't know the answer to this, though I probably should - are CDSs and similar instruments regulated in Europe, Japan or other major markets? It doesn't mean we should blindly follow others, but I would like to know what the norm is. My very imperfect understanding is that the Gramm amendment clarified an unclear situation - that nobody was sure what regs (bucket shop?) applied to these derivatives - maybe none, maybe some, maybe a lot - and that was a problem.
Quoting Greg Panfile from earlier:
Well, the SEC says:
So who was doing all that wealth-creating? And who opposed regulating Fannie Mae or Freddie Mac?
Not who you think, no matter how much you bluster.
Would you like some pie? I understand the crow is ever so fresh. I'll understand if you don't talk, though, wht with taking your own advice and all. Just nod. I'll give you a big ol' piece.
Taibbi is making the utterly ridiculous assertion that mortgage defaults were not an important component of this crisis. That is far, far more lunatic than anything Byron York is saying.
No, Taibbi is making the utterly accurate point that the types of defaults that led to this crisis have little relation to the GSEs because they were predominantly (a) subprime or (b) jumbo. What you are doing is misdirecting. York is full of shit. He wants to blame the crisis on otensibly (but not really) Democratic firms and minorities. Neither of which played an important part. This was caused by the housing bubble in Southern California, Florida, Arizona and Nevada -- something that had little to do with qualifying mortgages or black people. By not pointing out the fact that York is full of shit, you are being dishonest at best, and flat-out racist at worst. Based on your prior work, I am very disappointed.
Anybody who wants to read about CDSs can do so here, in a nice intro from Gretchen Morgenson written in February:
http://www.iht.com/articles/2008/02/17/business/17swap
York doesn't deserve attention, but Taibbi does because he's more than a hack, even if his aggression gets ahead of what he knows.
It's not entirely clear from Taibbi's post whether he understands CDSs or not (and that in itself is a problem), but we'd be making the same mistake we're accusing him of if we assumed that he didn't.
Let's look at this line: "Because what we're talking about here is the difference between one homeowner defaulting and forty, four hundred, four thousand traders betting back and forth on the viability of his loan."
That's the case, however indirectly, for both CDOs and CDSs.
CDSs, to quote Morgenson, were initially "a way to offset risk in their [banks'] lending or bond portfolios." CDOs are those portfolios. That is: a CDS is insurance against the default on a loan, and a CDO is based on the actual collateral (a house) the loan was used for. Both the insurance of a CDS and the asset-backed security of a CDO can be traded.
The market-value of both can vary according to how likely traders think it is that a loan or loans will be repaid.
Morgenson goes on to say that buying or selling CDSs became a way for hedge funds to bet on whether a company would fail. That includes companies that are involved in CDOs, but isn't exclusive to them. So Taibbi, in that sense, is kind of right.
The real problem, and here Morgenson makes a point similar to Richard Bookstaber, is that "financial history is rife with examples of market breakdowns that followed the creation of complex securities. Financial innovation often gets ahead of the mechanics necessary to track trades or regulators' ability to monitor the market for safety and soundness."
New financial instruments are invented (like CDSs, to offset risk). They come to have uses that were not foreseen (betting on companies' failures). They are entirely unregulated, since the law simply hasn't caught up with the markets. (Deregulation is a misnomer, since there was never any regulation to begin with for some of these securities). And given their brief life, we have no experience of how these securities will respond to various crises, or what will happen to the trillions of dollars that have been poured into them. Will their value evaporate? Will it double? Whoopee! Who knows!
It's a hard argument to make in America, but innovation isn't always good. The invention of financial instruments, and not their deregulation, is as much to blame as anything. How bout a moratorium on that?
Oct. 23 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said a ``once-in-a-century credit tsunami'' has engulfed financial markets and conceded that his free-market ideology shunning regulation was flawed.
``Yes, I found a flaw,'' Greenspan said in response to grilling from the House Committee on Oversight and Government Reform. ``That is precisely the reason I was shocked because I'd been going for 40 years or more with very considerable evidence that it was working exceptionally well.''
Greenspan said he was ``partially'' wrong in opposing regulation of derivatives and acknowledged that financial institutions didn't protect shareholders and investments as well as he expected.
You have no clue what your talking about, so why add to the confusion?
Megan, after reading your work for a long time, and recognizing that it's informed by a good education and a certain amount of experience and all that, I start to feel that the basic problem is that you have a curious talent for getting things backwards.
The people who have lost their credibility as a result of the financial crisis are the people who generally counseled that the US financial system and economy were mostly sound and there was no need to panic, right up through this summer. They are the people who argued that there is no way to reliably detect a bubble and that popping bubbles does more harm than letting them burst. That includes you, Alan Greenspan, the editors of "The Economist", and a long list of others. It is not people like Matt Taibbi who ought to be keeping their mouths shut because of the financial crisis. It is a rather different set of people.
No one is really concerned about CDS in a valuation sense (except CDS on sub-prime/CDOs, but that's minor and generally marked-to-market better than most mortgage products). The problem is that it makes every bank failure a systemic issue because we don't have a good way to handle all the outstanding derivative trades. It's not the reason banks are collapsing, but it's one more reason we can't let banks fail.
I am not in finance and want to know why naked CDS are not an issue. I don't think they are the root cause but I think they certainly helped propel this from a problem to a crisis (if that makes sense). Can someone please correct me? I am not a partisan and do not care if Byron York is right or Matt Taibi is right.
This brings me to a pet peeve that has been increasingly irritating me as the crisis wears on: people with little or no understanding of markets confidently opining on the causes of the crisis.
If Megan followed her own advice she'd never have opened her mouth about this stuff -- comical to see her accusing OTHER PEOPLE of not knowing what they're talking about. This is the same person who gave us "hedge funds are doing much better than heavily regulated investment banks" as a reason why deregulation was a good idea.
Taibbi is much more right than York on this one. The crushing blow here isn't the collapse of the mortgage market, but the contagion caused by the massive liquidity run and deleveraging afterwards, much of which was driven by poorly understood derivatives. People expected a ton of subprime-related stuff would have to be written down and thought the system could handle it, Bernanke was confidently saying back in March 07 that there would be no contagion. How wrong he was.
Also, a lot of the Fannie/Freddie move into Alt-As in 2006 and 2007 was the opening phases of the government bailout, it was a first attempt to help the private market with this crap by putting government guarantees behind it. (Housing market problems were pretty evident by mid-late 2006). Their earlier guarantees on Alt-As were more oriented by chasing profits, those guys should be hung for that, but it was still only a small minority of the bad mortgages.
Good Day:
I am certainly not an expert, but it seems to me that to move forward SOME guessing has to be done by someone, and the folks we currently have doing it are in part the ones involved personally in the mess.
Mortgages for those who could not hope to sustain payment for them are ALWAYS a bad idea, no matter the good one is trying to do. If we take that away from this mess, it won't have been "worth it," but at least we will have gotten something out of the screw up.
Jim