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The Rise of the (Financial) Machines
BartlebyScrivener writes "A New York Times Op-Ed quoting Freeman and George Dyson wonders if Wall Street geeks and 'quants' outsmarted themselves with computer algorithms to create the current financial debacle: 'Somehow the genius quants — the best and brightest geeks Wall Street firms could buy — fed $1 trillion in subprime mortgage debt into their supercomputers, added some derivatives, massaged the arrangements with computer algorithms and — poof! — created $62 trillion in imaginary wealth. It's not much of a stretch to imagine that all of that imaginary wealth is locked up somewhere inside the computers, and that we humans, led by the silverback males of the financial world, Ben Bernanke and Henry Paulson, are frantically beseeching the monolith for answers.'"
The quoted essay from George Dyson is available at Edge.
Second, I don't think the current financial problem world wide is the quants' fault. I think this credit crisis and market failure (although it might have a little to do with the quants) can be directly attributed to the world market investing heavily in the subprime mortgage bubble. Now, there's still software to blame, but it's not the quantitative analysis guys, it's the software in the hands of people who were in charge of buying bad loans and shipping them off to Wall Street to be sold to investors with a monthly mortgage check paying a huge return.
There was a This American Life episode on this sometime back that dealt with explaining the global subprime mortgage financial crisis (now known as a worldwide credit crisis). About 26 minutes into the first episode, you hear them talk about exactly this (you can stream the shows from these links or look at transcripts). Alex Blumberg & Adam Davidson are two producers of the show interviewing those involved. Enjoy this dialog from the show on the no doc loans these idiots were handing out like candy to anyone:
Alex Blumberg: But Glen didn't worry about whether the loans were good. That's someone else's problem. And this way of thinking thrived at every step of this mortgage security chain. A guy like Mike Francis, from Morgan Stanley, he told me he bought loans, lots of loans, from Glen's company, and he knew in his gut they were bad loans. Like these NINA loans. ... we did it
because everyone else was doing it.
... didnâ(TM)t seem worried at all:
Mike Francis: No income no asset loans. That's a liar's loan. We are telling you to lie to us. We're hoping you don't lie. Tell us what you make, tell us what you have in the bank, but we won't verify? Weâ(TM)re setting you up to lie. Something about that feels very wrong. It felt wrong way back when and I wish we had never done it. Unfortunately, what happened
Alex Blumberg: It's easy to ignore your gut fear when you are making a fortune in commissions. But Mike had other help in rationalizing what he was doing. Technological help. Mike sat at a desk with six computer screens, connected to millions of dollars worth of fancy analytic software designed by brilliant Ivy league math geniuses hired by his firm, which analyzed all the loans in all the pools that he bought and then sold. And the software, the data
Mike Francis: All the data that we had to review, to look at, on loans in production that were years old, was positive. They performed very well. All those factors, when you look at the pieces and parts. A 90% NINA loan from 3 years ago is performing amazingly well. Has a little bit of risk. Instead of defaulting 1.5% of the time it defaults at 3.5% of the time. Thatâ(TM)s not so bad. If Iâ(TM)m an investor buying that, if I get a little bit of return, Iâ(TM)m fine.
Adam Davidson: Wait Alex. I want to step in for a moment because this is a very important piece of tape. A big part of this story, of this whole crisis, is that a lot of really smart people, people who knew better, fooled themselves with this data. It was the triumph of data over common sense. Can you play that tape again?
Mike Francis: All the data that we had to review to look at, on loans in production, that were years old, was positive.
Adam Davidson: As we now know, they were using the wrong data. They looked at the recent history of mortgages and saw that foreclosure rate is generally below 2 percent. So they figured, absolute worst-case scenario, the foreclosure rate may go to 8 or 10 or 12 percent. But the problem with is the
My work here is dung.
Somehow the genius quants -- the best and brightest geeks Wall Street firms could buy -- fed $1 trillion in subprime mortgage debt into their supercomputers, added some derivatives, massaged the arrangements with computer algorithms and -- poof! -- created $62 trillion in imaginary wealth.
Thanks, New York Times. Does your average reader have the reading comprehension of a 9 year old these days?
Here's what happened in simple English: investment banks invented various ways of packaging mortgages into securities. They then convinced ratings agencies to give these new securities AAA status even though the ratings agencies didn't understand them. This gave mortgage brokers a license to commit fraud because they could give a mortgage to anyone with or without a pulse and there was a sucker just dying to buy that new mortgage from them. With such easy money available, real estate agents were able to pump and dump properties (strong-arming housing appraisers was a favorite tactic) like there was no tomorrow and convince people that housing prices only go up in a straight line. In the final act of the play, the investment bankers, mortgage brokers and real estate agents that caused this retire in the Cayman Islands while taxpayers are left to clean up the mess while we hope our economy doesn't literally implode.
I don't see what's so complicated about any of this. It's pure and simple fraud on the most massive of scales.
I'm a big tall mofo.
If civil engineers refused to back up their calculations with formulas derived from physics, they'd be liable when their structures fail. That's why they are lucky physicists -- at least the classical physicists upon which they base their calculations -- were fundamentally competent. The "quant geeks" are similarly limited -- but their problem is that their "physicists" are better than Court Astrologers -- but not by much.
Seastead this.
But they can. They did. The '90s tech bubble burst. The funny money that was created in the run up was promptly transferred into real estate. Lenders, overcome by a similar greed that overcame retirement investors, lent to people they knew they shouldn't have (or should have known). And voila. We have a horrible mess - basically, we think we have a lot more money than we actually do. The only viable solution? We need to realize the loss. It was never our money in the first place.
Or the Gov't and certain social engineering groups forcing the banks to make loans to people who wouldnt normally qualify under any circumstances...
NY Times praising the new program in 1999
Bill Clinton admitted the democrats stopped any oversight of Fannie and Freddie:
"CHRIS CUOMO, ABC NEWS: A little surprising for you to hear the Democrats saying, "This came out of nowhere, this is all about the Republicans. We had nothing to do with this." Nancy Pelosi saying it. She signed the '99 Gramm Bill. She knew what was going on with the SEC. They're all sophisticated people. Is that playing politics in this situation?
BILL CLINTON: Well, maybe everybody does that a little bit. I think the responsibility the Democrats have may rest more in resisting any efforts by Republicans in the Congress or by me when I was President to put some standards and tighten up a little on Fannie Mae and Freddie Mac."
Im not completely blaming the democrats, but they certainly set up the framework for the housing bubble and the subprime mess we are in now
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This might make an interesting defence for the crooks and gamblers who caused the problem through their greed and incompetence, but I'm not sure it deserves a place on what is generally a science/IT website.
The guys running the big investment banks and financial institutions believed what they wanted to believe..or believed whatever they had to believe that would give them multi-million $$ bonuses. If the computer models had predicted doom, they would have stopped relying on the models. The models were like magic mirrors that made them seem much bigger than they were.
1. House prices and property keep on rising. If you buy a house now you can sell it next year for say 15% more. Gear up, buy and then let out your property to make even more money. Look at all the TV proggys on making money from houses to prove this point. Whatever price you pay is not an issue. Borrow at 7 times your earnings and 125% of the said value of the property is no problem. Fill your boots and make a ton of money, guaranteed. No risk.
(Don't listed to those old type bank managers who were so unhelpful and whom banks fired years ago in favour of salesmen selling whatever they could. They knew nothing).
If in the unlikely event someone could not pay their mortgage (very rare event) the property would absolutely be worth more than their mortgage arrears. Even better sell the loans to some other sucker. No risk here.
2. As you all know interest rates are undeniably under control and will never significantly rise as our central banks are such clever chaps (and chapesses) and have everything under control. So we will see a low interest rate environment for many years, so no risk here.
3. Inflation is absolutely under control and will never get out of hand, again thanks to the geniuses managing our economy. So no worries here.
4. Gearing is good and isn't risky, if you are really clever. Gear up as much as you want and to make even more money at little risk. Better still borrow in say Yen at very low rates. The Yen will never rise against the $/£ to any degree, so no risk here.
5. Banks and bankers are very clever people and know what they are doing. Look at their pay and bonus packages to see how astute they are. Shareholders would never allow incompetents to have such large pay packages if they were not undoubtedly geniuses. With the bankers at the helm nothing can go wrong, obviously. No risk here.
Risk Calcs = 1 + 2 + 3 + 4 + 5 = naff all risk so fill your boots.
What could possibly go wrong?
The subprime money was backed by property. Adding shiny metals into the equation does not fix the problem.
This isn't the reason for what's happened. But a lot of people hate math.
They've obviously been using Reason - no, not the virtual synth package, but the one described in Dirk Gently's Holistic Detective Agency:
Gordon's great insight was to design a program which allowed you to specify in advance what decision you wished to reach, and only then give it all the facts. The program's task, which it was able to accomplish with connsumate ease, was simply to construct a plausible series of logical-sounding steps to connect the premises with the conclusion...
...The entire project was bought up, lock, stock and barrel, by the Pentagon.
Douglas Adams
Shesh... and the guy also predicted Wikipedia and Microsoft (or did he *cause* them?)
(Since DGHDA also contained a fair bit about computer music, I assume that the name of the synth package is no coincidence).
In a survey of 100 programmers, 111111 thought that duck-typing was a good idea.
Of course Im a troll... If you want to ignore the truth...
Democrats, Republicans, Banks, Home Builders, Brokers, Speculators, Greed all played a part in this, and if you want to ignore this then... how does that saying go...
"Those that fail to learn from history, are doomed to repeat it."
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Check out this 47 minute video for a very easy to understand and clear explanation.
http://video.google.com/videoplay?docid=-9050474362583451279
Unless you've been through university on some Economics degree - you were probably unaware of this.
The real problem is that Greenspan and Bernanke seem to have failed both basic economics and remedial math. Also, they must have been absent on the day that Keynesian monetary policy was explained.
As unpopular as it may be with some people, what you are seeing today are the fruits of Reagan-era economic policy, "Reaganomics" or as G.H.W. Bush called it "Voodoo Economics."
Basically, the Fed. has kept their lending rates artificially low for the past 20+ years. They have kept this rate well below the rate of inflation. Banks are paying and charging interest using this rate as the basis, since this rate essentially determines the "cost" of money.
Keeping this rate below the inflation rate encourages spending and borrowing rather than savings. After all, why save at 1% when inflation is 8% and you can borrow at 6%? By borrowing now, you can increase your buying power immediately, and get more for the same amount of money, instead of losing money in a savings account.
That's all fine, assuming your wages increase along with the inflation rate, but for most people, they haven't. When wages are not increasing to match the rate of inflation, then people are effectively getting a cut in pay and can afford to buy less stuff. (Obvious, right, but many people need this simple fact explained to them.)
So, as mentioned above, the low Fed. rates encourage borrowing, and even with the modest income increases most people can afford to keep on borrowing, but only for so long. Unless wages make a dramatic increase, borrowing consumers reach the point where they have borrowed all that they can afford to borrow. They reach the point where they are making minimum payments on their loans, paying bills, and for food, energy and other essentials, and there is no money left over. Upon reaching this point, even the most obtuse consumers will cut back on spending and borrowing. Those who don't will default and go bankrupt, whether they file papers to seek bankruptcy protection or not, they will for all intents and purposes be bankrupt.
This is, essentially, what has happened to the U.S. economy. The orgy of spending and borrowing has ended because the sun has come up and all the drunkards are staggering home after the party with massive hangovers.
This is also why injecting $700 billion to buy "bad" debt won't solve a thing. Even if the gov't buys the debt, the consumers will still owe that debt, and the conscientious ones will still try to pay it. As long as the consumers have to pay that debt, spending in the short term will be curtailed.
In the short term, there is no easy fix. In fact, many would think the cure to be worse than the disease. The long term cure is to return to the days of higher interest rates, less spending and more saving. Quite simply, Greenspan's little experiment on the American people has failed to produce the endless growth that he promised.
Just be sure to wear the gold uniform when you beam down -- you know what happens when you wear the red one.
Now, there are several ways you can do this. One is to run a massive monte-carlo simulation on all the input data, something that all financial software supports. There is a problem with this though, and that is that it requires some massive CPU power. Even a smaller bank would require many hundreds if not thousands of CPU's chugging away for 12 hours or more to come up with the proper numbers.
The solution they've come up with is called "historical VaR". What they do is to use the historical market data for the last year instead of random data which would be used otherwise.
The obvious problem with historical VaR is of course that it doesn't take unexpected market movements into account. If a drop such as the ones that we have seen recently haven't happened in the last year, VaR won't take such a scenario into account.
So, in short, VaR only really works in "normal" market conditions. It doesn't take extreme movements into account.
Look, if you live in an environment where you are under pressure to sell loans regardless of the risk, then you are likely going to wind up with computer models that tell you that it is going to work.
Computer models always carry the assumptions of the authors and those assumptions can be altered to suit climate. In the case of Wall Street, the assumption was likely the number of defaults on an M.B.S. as a function of credit score... and the thing is, that I bet that is spooking everyone is, that, credit score may not be a good predictor of repayment. I bet a lot of people had a decent credit score, right up until they mailed in the keys to their house.
This is my sig.
I am a quantitative analyst. True, there were many modeling flaws with the way ABS and MBS were priced, which made it appear that they were very safe and had good returns. Now when that happens what do you do ? You borrow short at a low rate, and invest in that secure product which produces a higher rate.
On a free market, this will quickly rise the short term interest rate (demand increase and the supply of saving is finite) and slowly drive down the return on mortgages as more house are being built.
On the US market it will not rise the short term interest rate because it is set by the FOMC, it will instead create inflation. Thus, the money used to invest in those mortgages will not be lended by someone, it will be printed. There is no direct mechanism by which the lending dry itself out... the guys at the FOMC have to figure there's going to be inflation.
So yes, there have been many mistakes in modeling, but such mistakes are bound to happen, in any industry, and they will have bad consequences (they're mistakes!)
The problem is the federal reserve system which magnifies the effect of financial mistakes by a few order of magnitude by disconnecting the interest rate market from reality.
\u262D = \u5350
from the 1999 NYT article above...
"Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits."
as you mentioned its not the small credit unions, or the smaller banks, its the large national banks that are having trouble, becasue they were afraid of politics from people like ACORN who would publicly deride them as racists if they didnt loan money to the poor...
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We'll all be paying for this for decades (unless we're among the hundreds of thousands in the UK, and probably millions worldwide, who will end up unemployed as a result of the bonus-chasing pinstriped bastards who caused all this), and the same situation will arise again when another bunch of fraudsters figures out a way to multiply money in a totally fictitious manner.
One swallow does not a fellatrix make
The author has a fundamental disregard for the actual underlying causes of the current economic crisis - the housing bubble. It cannot be that housing prices inflate over 300% (yes THREE HUNDRED PERCENT) in a mere ten years, while real inflation adjusted income remains the same. Sub-prime mortgages don't exist because there's a new generation of people out there who suddenly decided to default on their loans. They exist simply because no one can afford a house anymore.
Whoever you want to blame: "greedy" banks who made "irresponsible" loans (yeah, who ELSE were they going to loan the money to? There were no more buyers able to afford homes at those prices), the Fed for continuing to mismanage monetary policy (but the Federal Reserve has a history of doing this, dating back to its inception in the early 20th century), or creative accountants who tried as hard as they could to hide the shortcomings in these new "structured investment vehicles", the driving force behind today's (and tomorrow's!) economic woes is the pop of the biggest housing bubble in history.
The interesting thing is that the government has opted to print money to try to "save" the financial system and keep housing prices artificially inflated - as if anyone cares. The only person who cares about the price of their home is the person who wants to sell it. If you wanted to buy a house this year and sell it in 2 years for near 100% profit, well, welcome back to the real world again. This move on the part of the government will soon result in a collapse of the dollar.
But I was laughed at by some in July when the market was close to what many thought was a "market bottom" for saying the stock market was going to plunge lower. Guess what folks - we're still not at the bottom, despite being very near post-dot com bust lows. As a trader I watched the Dow drop 700 points in 5 minutes on Friday, only to bounce back positive, and then plunge again. This kind of volatility is NOT indicative of a bottom, it's indicative of a move to NEW lows. Housing prices should (if past bubbles are any guide) drop around 50%, which means they still have another 30% to go. Government interference in this correction will only serve to bankrupt an already insolvent US government, and destroy the US dollar's desirability on world markets.
The only people who are to blame are the greedy individuals who thought that the path to riches lay in buying real estate and "flipping" it a year or two later, with minor renovations - as well as a monetary system that is designed to spend today and pay tomorrow.
Seven puppies were harmed during the making of this post.
As unpopular as it may be with some people, what you are seeing today are the fruits of Reagan-era economic policy, "Reaganomics" or as G.H.W. Bush called it "Voodoo Economics."
This has nothing to do with Reagonomics. The idea behind Reagonomics was to lower the upper tax brackets from 70% down to a flatter rate so that people would be encouraged invest to invest their money and thus create a greater supply of consumer goods. This did exactly what it was supposed to do, as a whole the prices of consumer goods and commodities alike have largely been low, as investors sought the cheapest means of production. The essence of Reaganomics is that, we all have lots of stuff, and well, we do. So this aspect of Republican economics totally worked. Even Barrack Obama concedes, in his book, that in the USA, poor people have lots of stuff.
The critique of Reaganomics is, that, with its focus on investment, wage earners get screwed. You'll never see Democrats complain about having lots of stuff, and indeed, some will quitely condemn having so much stuff. Instead, you'll see them bemoan the social instability caused by Reaganomics. When you have investors able to shift their money around rapidly, you can leave social problems both when the money comes in and when it leaves. For every Silicon Valley or Shanghai or Dubai there is a Detroit. SO, the socialist retort is to not allow capital movement at all except via the will of the people, and, as a consequence, you can have a stabler society, except that, everyone has less stuff. North Korea is very stable, just like dead people are, and no one really has anything.
So now onto interest rates. Whether or not the Fed flooded people with low interest rates is not really the problem. You have low interest rates and low inflation because you need low inflation to have savings.
I do agree with you, though, that debt repayment by consumers will suppress economic growth in the short term, however, falling fuel prices will mitigate this somewhat. The problem is that everyone has borrowed too much. I've not seen too many figures indicating how much credit people are seeking, and, a ready indication of that figure would be a good tool for the fed to have and the people to see. I do believe that we shall public indebtedness decline and perhaps sharply. Just from my own perspective I've paid down about 30k worth of debt this year and I certainly have no plans to borrow soon, if ever. Like, I don't know that I'll ever take out another expensive car loan again...
But, if this happens, you see, people will need to save their money somewhere and it turns out that this savings can only go into precious few places. It can go under the mattress, which is stupid, it can go into commodities, which, I've argued might not be a bad move, or it can go into federal debt (treasuries), bank savings instruments, or securities, but all of those instruments are available to businesses as a means of obtaining cash for expansion and, you guessed it, the production of additional supply.
So, the moral of the story is, whether consumers choose to borrow and repay or save and buy, doesn't effect the overall course of Reaganomics all that much. All Reaganomics says is that investors are allowed to move their money about, just like consumers. The greatest irony of Reaganomics, we have achieved a sort of genuine sort of defacto socialism with it. There's a large percentage of the population that already does own stock of some kind, so much so, that one might well said that we as a people collectively do already own all the means to production.
This is my sig.
as you mentioned its not the small credit unions, or the smaller banks, its the large national banks that are having trouble, becasue they were afraid of politics from people like ACORN who would publicly deride them as racists if they didnt loan money to the poor...
Riiiiight, the large banks are such big pushovers that they would rather face bankruptcy than be publicly derided.
Sounds ridiculous when it's phrased like that, huh? The funny thing is the CRA loans you're all whining about tended to have lower interest rates and be safer investments than the other subprime mortgages. They were less likely to be packaged into the securities that actually caused the crisis.
I know you really would rather blame black people than admit the free market failed, but the free market failed.
I'm confused, and wondering what you're talking about.
The original leverage ratios were set by Basel, which pegged them at 8% (or 12.5:1). In 2004, this was updated. It's still 8%, but now assets are risk-weighted.
Claims on depository banks were were given the following risk weights:
AA- 0%
A- 20%
BBB- 50%
B- 100%
(worse) 150%
Unrated 100%
And to make matters worse, claims on securities firms were defined to be the same as claims on banks.
And the kicker, claims secured by residential mortgages were weighted at 35%.
As such, though the leverage ratio was officially 12.5, somebody who held nothing but mortgages could be levered up 35:1. And if you owned some bank issues, you could get nearly infinite.
But I'm wondering... what makes you think that these limits were going to be further increased?
The Voodoo Economics attack was at the Laffer Curve, which claimed that there is a ideal point of taxation that maximizes government revenue, and above that, people don't do economic activity and therefore taxes decline. Reagan predicted that his tax cuts would increase revenue, which was NOT the case, but it did free up capital, got the economy going, and tax revenues DID increase in time. Also, we have really cut taxes... I'd like them lower and flatter, but we can't do that without cutting the government. Taxes are running around 17% of GDP and governments expenditures at 20% of GDP... I'd like to see those both around 10% or less.
The real thing that Reagan cutting taxes did was:
A) transfer wealth to current savers (money in 401k and tax deferred annuity programs) had deferred 70% (or 90% at some point) taxes, and could now take it out at 30% in the early days
B) allow middle class people to build wealth... middle class people get paid a wage/salary, whether that wage/salary is 20k or 250k, they pay taxes on their labor, and if the rates are high, they can't build wealth, if they are low, they can work overtime/part-time second job, and use that extra money to build wealth, at 70% - 90% taxes, they can't
C) stopped the real estate only system... the tax code HEAVILY favors real estate investors -- you can tax defer the capital gains forever by buying a new property (important when Capital Gains rate was 40%, where Obama wants it, less important at the 15% it is now -- and you can depreciate property... if you can buy a building for 3M, and depreciate it over 30 years, you have 100k in "losses," so if you are making 100k/year in profits renting it out, it's tax free... sure your depreciation gets paid back when you sell the property as a capital gain (so you convert ordinary income, taxed at 40% with FICA into capital gains at 15%), and can be deferred on an exchange
The problem is Obamanomics is that it is NOT Clinton-style populism and fiscal conservatism (at least when paired with a GOP Congress), it is NOT FDR/LBJ New Deal/Great Society program heavy, it is European style socialism... heavy on regulation, income redistribution, etc... capitalism produces more gains/growth, but also downturns... Americans suffer more in economic downturns, but we benefit more in upturns... You can't have the upside without the downside, which is what people apparently want.
Guess what, subprime defaults are still under 10%, and even if they rise to 25%, that still means that 75% of the people with subprime mortgages were able to buy houses that they weren't otherwise. So "blaming" subprime is silly... the problem is that the holders of the banks mistook the risks, but nobody cared because as long as prices went up, they WERE risk free.
The problem in the boom was people took 2/28 and 3/27 loans... these were priced at 30 year loans (for amortization), but after 2 or 3 years, they reset from the low "teaser" (often 1% - 2.5% higher than the prime mortgages) to a high rate that would be 10% - 11%... The people getting them often didn't know that if interest rates STAYED the same, their rate would go from 7% - 11%, and they were qualified at the 7%... they assumed that sure the loan rate would "reset," but if interest rates could go up, they could also go down...
Brokers, new in the field, said things like "prime rate is stable, long term rates shift," because you had a 2 year stretch without the Fed moving it's rates. If someone had a low credit score now, they weren't going to be better in 2 years, because new home owners underestimate the costs of owning a home... but on paper, if you had some blemishes on your report, in Fannie Mae conforming only REALLY looked back two years (looked at 4, but mostly at 2)...
If you had a business or health failure, and took a LOT of hits on your credit score from not paying bills but nothing before/after, maybe you were better in two years. Most subprime people have a bunch of problems that are permanent. But, even if your score didn't improve, you could always refinance with another 2/28 in two years, giving the brokers your new equity in the house to try again...
So nobody worried, because with the market going up, if you couldn't make the payments, you could refinance out of trouble.
What caused normally cautious lenders to make subprime loans in the first place?
I see where you're going with this. You're blaming the "Community Reinvestment Act" (CRA) that basically forces banks to lend to people they wouldn't otherwise lend to (i.e. people with bad credit) because they have to fulfill racial quotas.
I agree with you that this is part of the issue. But this whole problem is so far beyond liberal/conservative or Republican/Democrat. The problem is that we have a fairly corrupt system right now and everyone in power is culpable.
How about one of the reasons they made subprime loans was because they made money from them and they didn't have to bear the risk? You know, good old fashioned banker greed. So CRA was pushing them in that direction - but they were more than willing to go along!
I'm a big tall mofo.
Quite a few of the larger banks avoided this mess too. JP Morgan, Bank of America and Wells Fargo are among the most notable. It is clearly a case that badly managed banks who ignored historically proven risk management practices to chase increased returns got burnt. NOBODY WAS FORCING THESE BANKS TO DO THIS.
Yes, it was public policy to encourage lending into inner cities. But NINAs, interest-only, HELOCs and ARMs? I DON'T THINK SO, and the fact is that these wacky loans are the biggest part of this.
Riiiiight, the large banks are such big pushovers that they would rather face bankruptcy than be publicly derided.
No, jackass.
The banks faced lawsuits.
From folks like ACORN.
Like this one:
Case Name
Buycks-Roberson v. Citibank Fed. Sav. Bank Fair Housing/Lending/Insurance
Docket / Court 94 C 4094 ( N.D. Ill. ) FH-IL-0011
State/Territory Illinois
Case Summary
Plaintiffs filed their class action lawsuit on July 6, 1994, alleging that Citibank had engaged in redlining practices in the Chicago metropolitan area in violation of the Equal Credit Opportunity Act (ECOA), 15 U.S.C. 1691; the Fair Housing Act, 42 U.S.C. 3601-3619; the Thirteenth Amendment to the U.S. Constitution; and 42 U.S.C. 1981, 1982. Plaintiffs alleged that the Defendant-bank rejected loan applications of minority applicants while approving loan applications filed by white applicants with similar financial characteristics and credit histories. Plaintiffs sought injunctive relief, actual damages, and punitive damages.
U.S. District Court Judge Ruben Castillo certified the Plaintiffs suit as a class action on June 30, 1995. Buycks-Roberson v. Citibank Fed. Sav. Bank, 162 F.R.D. 322 (N.D. Ill. 1995). Also on June 30, Judge Castillo granted Plaintiffs motion to compel discovery of a sample of Defendant-banks loan application files. Buycks-Roberson v. Citibank Fed. Sav. Bank, 162 F.R.D. 338 (N.D. Ill. 1995).
The parties voluntarily dismissed the case on May 12, 1998, pursuant to a settlement agreement.
Plaintiffs Lawyers Alexis, Hilary I. (Illinois)
FH-IL-0011-7500 | FH-IL-0011-7501 | FH-IL-0011-9000
Childers, Michael Allen (Illinois)
FH-IL-0011-7500 | FH-IL-0011-7501 | FH-IL-0011-9000
Clayton, Fay (Illinois)
FH-IL-0011-7500 | FH-IL-0011-7501 | FH-IL-0011-9000
Cummings, Jeffrey Irvine (Illinois)
FH-IL-0011-7500 | FH-IL-0011-7501 | FH-IL-0011-9000
Love, Sara Norris (Virginia)
FH-IL-0011-9000
Miner, Judson Hirsch (Illinois)
FH-IL-0011-7500 | FH-IL-0011-9000
Obama, Barack H. (Illinois)
FH-IL-0011-7500 | FH-IL-0011-7501 | FH-IL-0011-9000
Wickert, John Henry (Illinois)
FH-IL-0011-9000
Yeah, THAT fucking Barack Obama.
I guess we now know what "community organizers" do, eh?
Only most of the loans that were rolled into the mortgage-backed securities were made by institutions that were not governed by the CRA.
Nice try though.
when you use words like "socialist retort", "socialism", you make all your readers think that you are a brainwashed holistic economics zealot that thinks there is only unbounded and uncurtailed wild west capitalism and its counterpart strict socialism in the world, and lose them.
and let me break another news while im at it : there is a third concept : balanced economies. economies in which existentially critical services are controlled by government (like military, police, justice, healthcare) and all the remaining sectors are properly regulated so that no self interest group, criminals, fraudsters, scamsters can do stuff to break the entire system.
what im describing is europe.
judging from the success of europe in the last 20 years (in all respects, including better distribution of wealth), and the extent that u.s. sank ( to the point of sinking ENTIRE world economy with itself), i'd say that that holistic economic rant of yours have no substance anymore.
so please, stop it at least from now on, and conceive something new. reagan, republican eras are dead. and they wont return. neither the stupid 'let businesses be' 'youll kill jobs' 'market can solve' stupidity and accompanying wild west behaviour will.
Read radical news here
First let me say, I don't think your analysis is wrong per se. At the level of the mechanics of where the crisis happened and how it played out in the minds of the people in the middle of it, it is perfectly valid.
However, this whole line of analysis is very much like analyzing a car wreck and concluding that the cause of accident was the driver's excessive application of braking and over correction. The driver was dead drunk. The underlying cause was the fact that his reflexes were so shot he couldn't react properly. It is largely irrelevant what the details are of how he lost control of the car, he was bound to do so under the circumstances.
Likewise the so called 'financial crisis'. Think of our economy/financial system as a bit like a building. Every part of the structure both adds 'load' to the building, and also supports the weight of the other component parts. As long as enough structural integrity exists to support the load at every given moment, the building stands.
Unfortunately what our whole society from top to bottom has been doing is looking at this structure and saying to themselves "you know, it is a waste of money to have that beam be 150% stronger than the load it is carrying" and then someone comes along and removes the beam and replaces it with one that's only 105% strong enough so they can use the extra materials someplace else, make more return on their investment.
Well, that could only go on for so long, and naturally people got a bit nervous and engineers pointed out that the building maybe was a bit shaky, so we invented a way to tie all the beams together more securely "well, if one fails its ok, if we spread out the load enough then no one part of the building will be overloaded".
Until finally one day the wind started to blow... Once one single part, ANY part of this massively over leveraged structure reached its failure point there was no margin left anywhere to take up the extra load anymore! Every part was already stressed to the absolute maximum limits of its capacity. And as long as things had kept going on an even keel it was inevitable that the search for profit would create even more leverage until inevitably the whole structure became so intolerant of even the slightest disturbance that it had to come crashing down.
The really disturbing part of this is that, as any engineer can tell you, when you reach this kind of situation of critical instability any small problem results in a cascade failure of the entire system. Every industry, practically every business, is leveraged out so far that even the smallest dips in cash flow result in immediate insolvency, which then propagates down the supply chain and up the 'wage chain'.
This thing is like an avalanche coming down the side of a mountain at 300 mph. The snow all around it looks all nice and quiet, but that means nothing. This thing has momentum, large momentum, and there isn't any stopping it because there's no redundancy left in the economy to act as a brake. No bailout plan or insurance scheme or nationalizing of banks or any other action anyone can take now is going to stop it until it gets to the bottom of the mountain.
The sad fact is we clearly saw, or should have seen, it coming. The system gave us every sign of being ready to fail. What was the 97 Asian financial crisis except a localized version of the same thing? It just didn't get big enough to build up the momentum to smash the whole system. Only one wing of the building fell off that time. If we had exercised any prudence whatsoever we would have taken the hint. But 'This American Life' certainly has it right in the sense that greed and hubris overrode common sense.
And look at where we are now. Hope you all have a nice supply of canned goods stashed. Best case scenario is they're about to get a lot more expensive.
"Malo periculosam, libertatem quam quietam servitutem." -- Jefferson
Hahaha wow you're ignorant...
You say the banks were forced into making bad loans by the CRA, and faced lawsuits for not doing so.
Then you cite a case where THE CRA IS NOT EVEN INVOLVED. Did you actually READ what you cut and pasted?
I'm used to having to get proper cites to disprove people, you just made it easy.
People should go to jail, and the system should be reformed so it cannot happen again. But then, the "system" is being managed and communicated by the same folks who have been involved in the scheme, or their best friends.
The Discworld variant...
Justice is the sheep getting arrested while an impartial judge declares the vote void.
Plaintiffs filed their class action lawsuit on July 6, 1994, alleging that Citibank had engaged in redlining practices in the Chicago metropolitan area in violation of the Equal Credit Opportunity Act (ECOA), 15 U.S.C. 1691; the Fair Housing Act, 42 U.S.C. 3601-3619; the Thirteenth Amendment to the U.S. Constitution; and 42 U.S.C. 1981, 1982. Plaintiffs alleged that the Defendant-bank rejected loan applications of minority applicants while approving loan applications filed by white applicants with similar financial characteristics and credit histories.
Did you read the allegations you posted? This is not a case of oh no you don't give poor people enough loans. This is an accusation of hey you give one group loans while not doing so for other races with the same credit background. Redling is a terrible practice.
Xavier Rabourdin for president 2012
Gold is useless except as decoration. It only has value because people have been conditioned to think it does. The same is true for dollars, euros, or any other currency. The gold standard is no less abstract than any other form of currency, since the value a gram of gold has is entirely arbitrary and not inherent in any way.
Forget magic. Any technology distinguishable from divine power is insufficiently advanced.
"Are you telling me you made a bet with Broadman that The Broken Drum wouldn't catch fire?"
"Yes, it's called in-sewer-ants"
If a job's not worth doing, it's not worth doing right.
The people who made this a catastrophic mess (as opposed to just a nasty mess) are the credit rating agencies (Moody's et.al.) who pretended there was any way to make a security (mortgage-backed or otherwise) exactly as low-risk as a U.S. Government obligation. Far fewer folks would have been legally allowed to purchase these products if the ratings had reflected the actual risk inherent in them and thus the potential impact to the economy of a failure in MBSes and CDS insurers would have been far, FAR less.
Moody's played exactly the same role in this debacle as Arthur-Anderson played in Enron's and I personally think they *ought* to suffer the same fate AA did so that future ratings agencies understand that failure to perform due diligence jeopardizes their company's existence. Wall Street understands Moody's role in this and the broad market continues to tank in spite of Bernanke's and Paulson's actions because we don't trust the ratings given by Moody's to other financial products or even companies so nobody knows how much risk they are really sitting on.
Let me say this clearly -- the heightened leveraging of the investment banks caused some problems but it isn't the leveraging that made this a catastrophic problem. The problem is catastrophic only because (a) folks who shouldn't have been allowed at all to be exposed to these risks were allowed to buy in and (b) folks who should have been allowed to take these risks weren't prepared through proper compensation for the risks they took on. All because the credit rating agencies did garbage-class work.
Until the credit rating agencies get as scared of the consequences of their negligent actions as accounting firms were post-AA this will continue to be repeated every time some finance person imagines up a new way to pretend to eliminate risk from investments which are fundamentally risky.
The mortgages backing the securities were only a small part of the problem.
Calculating the values of the debt swaps as if they had independent risks, when they did not, is a bigger part of the problem.
The reality is that the smart ones weren't outsmarted at all.
;).
After all, the smart ones got paid very well and got big bonuses.
Sure some of them might be out of a job now, but since "everybody was doing the same thing, it wasn't their fault" AND it made their bosses rich too, so they'll soon be rehired to do the same thing all over again. After a nice holiday in the bahamas or something
It's the stupid ones who don't get it, and don't see how all this "fancy math" is actually just adding games to the casino. But a casino where if the smart ones lose "too big", the stupid ones have to pay.
Call me cynical but that fancy math is almost like the finance equivalent of the "Chewbacca defense".
Think about it, if the "fancy math" was really to reduce risk, stuff wouldn't be blowing up so regularly e.g. 1987, 1997 (remember LTCM?) and 2008.
Do people really think the smart ones don't know what they are doing when Warren Buffet himself came out and referred to their schemes as "financial weapons of mass destruction"?
They probably were thinking: "I hope he shuts up before the sheep realize what's happening".
Privatize the pain, socialize the pain.
Now if they actually started putting a special tax/levy on finacial institutions that'll be progress. Then at least they'd have to pay for their own bailouts.
The first mess was the stock market crash of 1987. They came up with something called "portfolio insurance". They combined program trading, futures, and options into an incomprehensible stew that was supposed to allow a mutual fund to buy highly profitable, highly risky stocks but insulate itself from their risk. It went haywire and the market crashed.
The second time was Long Term Capital Management in the mid-to-late 1990's. It isn't clear what they were doing, but it almost caused a worldwide financial collapse and required government intervention.
This time it was financial deregulation, predatory mortgage lending, collateralized debt obligations, and credit default swaps. None of this stuff was understandable, including the mortgages and all the derivatives. Many mortgages violated Truth in Lending laws. They misled the prospective homeowners about the terms, and put them in fine print that an average person couldn't understand.
The underlying problems are these:
1. Financial derivatives. They take stocks, mortgages, and bonds and bundle them into other financial instruments, such as index instruments, and mortgage bundles. They do other things like splitting the interest from the principal and putting them into separate instruments. They then create futures, options, and options on futures for the bundled instruments. Options on stocks and bonds are reasonable and understandable. Futures on real commodities are understandable and valuable to producers and users of the real commodities. The rest of the derivatives add more and more complexity.
2. Allowing derivatives to settle in cash. This turns the derivatives into side bets on the real financial instruments. This is how 4 trillion dollars in mortgage and other bonds turned into 62 trillion in credit default swaps. A speculator doesn't have to hold the bond to buy "insurance" that the bond will pay off. A speculator doesn't have to hold a stock or borrow and short it (creating an obligation to buy it to close the loan) to place a bet on its price.
3. Arbitrage trading strategies that connect the derivatives side bets to the real market. The side bets don't remain side bets. The trading strategies do things like enabling speculators to drive down the prices of stocks while bypassing the discipline of the short sale procedures (which were also relaxed due to financial deregulation). These procedures include requirements for the stock price to go up on the transaction preceding the short sale (the "uptick" rule), and requiring the short seller to actually borrow the stock before selling it.
4. Financial deregulation that allowed all of the above problems to fester, and in some cases explicitly placed some of the financial instruments outside the scope of regulation. We can thank Phil Gramm, John McCain's best economic buddy, for this part of the problem.
5. Allowing some derivatives to be traded in unregulated markets and concealed in financial reports. The scope of the problem was allowed to be invisible.
6. Faulty models of the derivatives markets. The quants' algorithms were based on faulty models. Based on an op-ed in the Washington Post, the models appear to assume simple linear market behavior and normal random variability. They are most likely based on faulty economics like the "efficient market hypothesis" that is a fundamental principal of "free market conservative" economics. Markets simply are often not efficient. Charles Mackay (author of Extraordinary Popular Delusions and the Madness of Crowds) is every bit as good a describer of markets as Adam Smith. Since the derivatives and quants became more central in the markets, we have had more Mackay markets than Smith markets.
My suggested solution is to require any derivatives to settle in the underlying financial instruments or commodities. No purely cash settlements would be allowed. As a transitional provision, I would suggest immediately imposing a stiff tax on any derivative settlements that are made stric
The gold standard is no less abstract than any other form of currency, since the value a gram of gold has is entirely arbitrary and not inherent in any way.
It is less abstract in at least one very important way - the amount of work it takes to extract another gram from the ground and put it in a vault.
Modern currency has effectively zero marginal cost to make more of. There are pluses and minus to that fact - as in money can now represent something like the total value of the economy of the country rather than be limited to a pile of metal in a vault somewhere.
On the other hand it also makes it really, really, really tempting for the government to just print more money in response to any fiscal crisis with the obvious long term effect of devaluing all the money had been previously printed.
When information is power, privacy is freedom.
A huge point is completely missing: all of the houses were appraised at the values the mortgages were offered. These appraisals were done at market value and were accurate - if you can sell your house for $500,000 today, then it should be appraised at $500,000 today.
Uh no. The fact that a house sold for $500,000 does not mean it is worth $500,000 to another buyer. The whole point of appraising for loan qualification was to assure the lender had a good chance of getting their money back in case of a loan default. What happened was that appraisers were generally pressured into approving sale prices if they wanted business from the real-estate agents.
My take is that there were too many people involved in the process that were making money without any long term responsibility. Things might have been different if say 50% of the mortgage brokers commisions were based on loan payments.
The other big problem was that there was too much leverage in a speculative market - which is exactly what led to the 1929 stock market crash - and that speculation was driven by the Fed maintaining low interest rates.
This effect is called the "money multiplier", and it's been around LONG before anyone went off the gold standard.
Without the money multiplier, the industrial revolution would not have gotten very far.
The reason we're facing massive economic collapse is not because of debt defaults per say, but because the markets are so skittish that nobody is lending, thus the money multiplier is being squished into nothing.
This is exactly what happened during the depression, though for slightly different and more severe reasons.
Back then, the banks themselves went bust. The money multiplier was gone, and the money supply evaporated. This meant businesses could not get loans to weather the economic storm, so they went belly-up.. and unemployment skyrocketed.
The blessing here is most assets are covered by the FDIC now, when they weren't in the late 20's. This should help cushion the worst case scenario.
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Except that if you create more money, as you said, all money becomes worth less. This loss of value by the existing money IS the marginal cost of creating more money. This means it isn't all that tempting to print more money. Which is why our government typically doesn't use that method to pay more more spending. Instead they take out debt (a problem in and of itself), which actually has the effect of _removing_ liquidity.
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Crudely Drawn Games
Gold is useless except as decoration.
Tell me, sir, do you own a computer?
Pirate Party UK
That's just not true. One big advantage to gold is the quite unique trait of resistance to corrosion. Yes, it is quite soft and so can't be used in heavy-duty applications, but it does have a great many uses (electrical for one; as part of an alloy for another).
Here's a more complete list:
The problem at the heart of financial crises is fractional reserve banking. The empirically "stable" fraction is roughly 9.5% right now, and as "wealth" increases, that fraction decreases because real value isn't created to balance it out. The banks simply negotiate the most aggressive numbers they can get away with, and since all wealth is purely electronic, they can fabricate it out of thin air - they don't need to print it anymore!
The fact that money is so far removed from the concept of value, is the very reason the system has collapsed - you can only build so high on any given foundation.
-Billco, Fnarg.com
high time we kibosh the current Federal income tax system and come up with a consumption-based income tax system that encourages people to invest and save.
Oh, you mean a policy which favors the rich even more than it does today.
The only thing "fair" about the fair tax is it allows the "fairly" rich to hoard their money and never give back to society (despite conspicuous consumption, they don't spend very much of what they make). I suppose you could actually call it the "unfair" tax.
the Federal government sends a monthly prebate check to cover the 23% consumption tax on basic necessity items up to the Federal-defined poverty level.
So people at poverty level, who are exempt from federal taxes anyway, are also exempt here.. big deal.
Social safety net systems are funded by people who make their money on backs of the rest of the public, and who make use of military and police services in which people DIE to protect their wealth.
Some of those social safety net programs are worth considerably more than the simple taxes, to which these people are already exempt. (more on that below)
2. Because of #1, the advantages of "offshoring" your liquid assets are gone. That means potentially several trillion US dollars coming back to the USA to be invested in our financial institutions, which would quickly stop the slide in the stock market and provide a new liquidity base for loans and lines of credit.
what exactly is this snake oil?
Investment capital gains are already taxed considerably less than normal income tax at the income brackets you are talking about here.
What it WOULD do is, again, cause cash to the government to be further limited, and the resulting budget cuts won't be taken from military spending or pork.
They'll come from education programs, day care subsidies, and numerous other programs which make the daily lives of people at or below the poverty line "livable".
. With no more taxes on investments, foreigners will send several trillion dollars of investments themselves into the USA, since we will become the world's largest legal tax haven. Again, this provides a huge bolster for the liquidity base in our financial system.
Because we all know giving money to the already wealthy top echelons of business will definitely guarantee "trickle-down", rather than big fat bonuses, golden parachutes, and more funding for programs to offshore increasingly skilled professions for the sake of cheap labor.
4. With no more taxes on payroll, corporate income, dividend income, and capital gains, it encourages American companies to keep as much goods production in the USA.
Once again counting on the wealthy to give a damn about the great unwashed below their feet. Fox, please meet henhouse. hens, do you remember the gilded age?
With no more taxes on corporate income and capital gains, Donald trump could buy his kids platinum ferraris instead of the cheap, solid gold ones their friends make fun of.
Cities like Detriot and Cleveland could experience an economic boom as blue-collar jobs return to the USA under more advantageous tax conditions.
Because the massive corporate welfare system we have now just isn't enough right, surely adding more policies to put money into the pockets of the wealthy will encourage their generosity the same way such previous programs have.
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