Blame Game Redux: 8 More Things to Blame for This Crisis
When I write, I don’t always know what will be popular, and what won’t. Personally, I thought my article Rethinking Insurable Interest was the more innovative of my two articles yesterday, but Blame Game made the splash. Well, perhaps no surprise, the crisis has the attention of all of us. I just have broader interests; I want to write about a wide number of things.
My readers took me up on my request, and gave me more targets to blame. Let me expand on them:
21) The Rating Agencies — that was a popular choice. Yes, the rating agencies messed up. They always do. Their job is an impossible one. Should they be proactive or reactive? Should they rate over the cycle, or be instantaneous? Should they care about systemic risk issues?
Where they did err? They competed for business, leading underwriting standards lower in structured finance. They overrated the financial guarantors, who were their major clients. Away from that, they made mistakes, but every firm offering opinions makes mistakes. I make mistakes regularly here.
22) Matt give me another party to blame, and I will let him speak for himself: I have one more to add - the Office of the Comptroller of the Currency. Not only did they fail to regulate the national banks, they also stone-walled State and local governments from bringing suit (claiming jurisdiction, but never following up on claims).
Add to that the divided regulatory structures that encouraged regulatory arbitrage. That encouraged diminished underwriting standards.
23) Investment banks. They asked the SEC to waive their leverage limts, and now none of the big guys are left as standalone publicly traded institutions. They made a lot for a while, and then lost more.
24) Then there were the carry traders who have now gotten carried out on their shields. There were too many players trying to clip uncertain interest spreads, from hedge funds to Japanese housewives…
25) House flippers — whenever investors get to be more than 10% of a real estate market, beware. Sad, but I heard an ad on the radio for buying residential real estate in order to rent it out. It is not time for that yet.
26) The quants — they enabled models that gave a false sense of security. They did not take into account decreased lending standards, and assumed that housing prices would continue to go up, albeit slowly.
They also assumed that various classes of risky business would be less correlated, but when hedge funds and fund-of-funds take many risks, returns become correlated because of investoors entering and exiting sectors.
27) The tax havens and hedge funds. Hedge funds are weak holding structures for assets. In a crisis they can be sellers, because they want to lower leverage.
28) Mainstream financial media — CNBC, etc. They were relentless cheerleaders for the bull markets in stock and housing. This isn’t a compliment, but financial radio makes CNBC sound cautious. FInancial radio seems to be a home for hucksters.
And, that’s all for now. If you have more parties to blame, feel free to respond. One final note on my point 16, diversification, from the prior post: Many quants did us wrong by focusing on correlations stemming from only boom periods. There are many problems with correlation statistics in finance, but the big problem is that correlations are not stable even during boom times, much less between booms and busts. In a bust, all risky assets become highly correlated with each other, invalidating ideas of risk control through diversification.
My view of diversification is holding safe assets and risky assets. High quality short-term debt does wonders to reduce the volatility of results. Other hedges are less certain. Nothing beats cash, even when money market funds are open to question.
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This article has 5 comments:
- Joe1234987
- 5 Comments
Oct 11 02:54 PM- bearfund
- 506 Comments
Oct 11 06:45 PMThe market is doing something that needed to be done a long time ago: raising interest rates in a big way. IBM just paid 7.4% to issue 10-year notes. AAA-rated GE is paying 10% on preferreds. These interest rates are starting to look almost reasonable, but there's much farther left to go. One of the worst balance sheets on the market is still paying 4.2% on 30-year paper. That must end before a recovery will be possible.
If the government shows restraint with the printing presses (not likely) and top corporate issuers start having to pay 15% to hang short-term paper, it'll be time to consider bonds again. Until then you are not being compensated for the various risks - credit risk is actually one of the less worrying ones - and should stay in gold or, if you must be in paper, CHF and JPY. If you want some upside potential (gold never has any; its value is unchanging), short the back half of the Treasury curve. We're almost there, folks. There's only one paper asset left for the bear to ravage, one massive 10 trillion dollar bubble left to burst. Let's get that over with and then on to a slow recovery.
- ussmex
- 7 Comments
Oct 11 11:15 PMWe all understand that residential mortgage underwriters relaxed their standards, making it easier for people to speculate and leverage to the hilt. I work in the industry and can assure you that, as you would expect, that particular trend has reversed itself.
I recommend two additional changes that, along with more stringent underwriting guidelines, would help prevent the type of froth we've seen in the last few years:
1) As much as possible, remove the human element from residential appraising. 90% of the data needed to determine the market value of a home is online, or in county records, or contained in existing appraisals. Outfitted with the right software, a computer could do 90% of an appraiser's job. The extent of human involvement, at least in non-rural areas, should be limited to snapping interior and exterior photos to prove that the home is whole, properly maintained, and not a risk.
A legitimization of automated appraising would not only improve a mortgage customer's experience, but it would significantly reduce the gaming of the system by corrupt appraisers and loan officers. With people involved there are as many potential appraised values for a given home as there are personalities and levels of ethics. To this day loan officers are still looking for appraisers who know how to "push value" and get away with it. Lenders increasingly use automated valuations to check an appraiser's work. We need to advance the automation to the point where it's providing the bulk of the analysis.
2) Reduce and simplify the closing documents a mortgage customer is required to sign. Most refinance signings happen in the evening at the customer's home. If you had experienced a taxing day at work and a mobile notary arrived at your door with 50-100 documents for you to sign, what are the chances that you miss one of the crucial details in the loan's terms? For example, what if your loan officer had repeatedly assured you that the loan featured no penalty for pre-payment. What if the loan Note said the same thing, but buried in the stack of documents was an Addendum to the Note that established a 3-year pre-payment penalty? What are the chances that you would notice it? I can tell you from experience that the current system allows unscrupulous loan officers to manipulate borrowers. The three-day right of rescission on all refinance loans is supposed to treat this problem, but it's not working. Most of the homeowners that called me in the last few years to refinance out of pay-option ARM loans (negative amortization) didn't truly understand their loan and weren't aware of their pre-payment penalty (usually six-months of interest or up to 3% of the unpaid balance). Many of them had been told the loan was a 30 year fixed and had been enticed out of much more stable loans with the teaser payment. At one point I was receiving at least one of these types of calls on every working day.
I recommend eliminating the signing requirement on all closing documents aside from the Note, the Deed, the estimated settlement statement, and a one or two page summary document that states, in clear, simple sentences, the terms of the loan and how it functions. I know I'm leaving out a few other key docs, but basically everything else should be put to the side for review at the borrower's leisure during the rescission period.
George Soros submitted some intriguing commentary in the Wall Street Journal suggesting that we fashion our mortgage market like the one in Denmark. Perhaps one of the "maverick" presidential candidates would like to tackle that. From what I remember George W was friends with the guy who ran Ameriquest, arguably the most crooked large-scale home lending operation the country has ever seen. I don't ol' W will have much to offer as a fix.
- LCACM
- 35 Comments
Oct 12 02:01 AMWall St. did not expect to be crushed by the sucking sound that Ross Perot warned us way back in 1992.
- lorange
- 3 Comments
Oct 12 12:46 PMMore by David Merkel