Author Topic: California still leads the way (but not how Rafi and several others thought...)  (Read 8472 times)

Fenring

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No, Fenring, you're really not getting it.  Take a look at the trend line https://fred.stlouisfed.org/series/DRSFRMACBS.

It only goes back to 1991. How is that helpful, since the previous significant crisis was in the early 80's? The early 90's were more or less a boom period (not quite a wartime boom, but still a prosperity time), so that's a weak basis for making long-term forecasts. In any case, the graph shows homeowner delinquency rate, which is of course correlated to the mortgage market crisis but isn't directly the thing that failed. The problem wasn't just that homeowners began to spontaneously cease being able to pay their mortgages, which led to the crisis, like for instance if they all lost their jobs or something. The speculative nature of the trading is something not measurable in a simple graph like "homeowners going bust"; the growing instability of the traders themselves to accept these mortgages has little to do with the 15 year trend in people making their mortgage payments. Looking at a graph like this (even if it went further back) would be useless in assessing the mounting instability of the actual reality of what was being counted as assets on the books.

So yes, I think a real expert would have been able to assess the soundness (or lack thereof) of how they were doing their calculations. Real experts don't rely just on data models, but learn real facts on the ground. For instance, looking at the long-term trend-line for a corporation you're thinking of investing in is ok, and reading the quarterly statements is good too, but nothing can substitute for physically being on premises, knowing the operators involved, local conditions (if it's in another country), and other such details. No graph can replace real knowledge, and I believe that there were people in NYC with real knowledge prior to 2008. Greenspan can say whatever he wants, this was not some totally unaccountable blip in history, but worked based on the same physics other system work on for anyone who understands them to an extent. We haven't got that great a grip on this 'physics' but it's not just some unknowable mystery leaving us with only using trend-lines to think forwards.

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What good is a model that takes a rate that has been say stable at 1% but never less than 0.9% and never more than 1.1% and "predicts" that it will go to 4%?  Sure it could give you an idea of what could happen, but to bet on it would be folly.

You're right, it's not good. That's why using convenient models to justify dangerous behavior is bad science, even though it looks good in the board room. Do you seriously think executives green lighting these transactions were thinking of their little deals having a broader effect? Their business was to get their deals done that were right in front of them, not to worry about what happens when everyone else is doing the same.

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It's like betting your life savings on a 16 seed to win the NCAA basketball tournament.

If you're in the process of poisoning the other team's drinking water then maybe it's not such a bad idea. It just helps to know what is or isn't poison.

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I'm beginning to think that basic concepts of finance are not as basic as I believed.

Agreed. Actually, I don't think there are any basic concepts of finance. Most 'beginner' or introductory texts on economics strike me as being either so reductionist that they say nothing, or else so theoretical that they have nothing to do with reality. The fact is that complex systems analysis is the only basis of examining huge systems of numbers moving around, and anything less convoluted doesn't describe the reality. There's no equivalent here to Newtonian physics where the dumbed down version is pretty much accurate for large-scale events. In economics it really isn't.

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At their fundamental core, CDOs are tools to reduce risk exposure.  The idea that they were created by "wild dogs" is so beyond wrong I don't know how to even process it.

The wild dog analogy was in response to your agreement that banking is essentially based on greed first, which I translated as implying predatory behavior. Mixing metaphors by implying that CDO's, specifically, are the work of 'wild dogs' will tend to break down the metaphor, yes.

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Well you are right that banks are de facto public entities in our system.  You are beyond wrong to think they are trusted and not heavily regulated.  I'm not aware of any other industry that provides office space and internal email accounts to regulators that are permanently on site.  Over 10% of the employees of a bank are in compliance and regulatory functions.

It's the system that is bad, the rules are beyond arcane and complex.  That's on the government, who made the rules.

I think you missed my point here. It seems to be your contention that the government and its regulators are what cause these problems in the private sector, but when I say they need to be watched like a hawk you seem to double back and say that of course we keep an eye on them, through these regulators! If your point is that the regulation could be better, then...well, duh. But if it's that direct regulation is always going to lead to these kinds of problems then I wonder how you think the dogs will be kept on a leash since they control so much of the public well-being in their hands? Private/public ceases to mean anything at a certain point if the people in question can directly make or break the economy. And actually this is what the Fed does on occasion when it's threatened, which is to use the WMD of tanking the economy as a retaliatory measure against being prodded.

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I think you're confused about what fractional reserve means. It's not possible if you are dealing in an actual commodity.  How exactly would one loan out more gold than one has?  In order for it to be possible, you have to be issuing notes (in that case exchangeable for gold).  A bank with 100 gold bars, issues notes for 200 gold bars, knowing that since the notes are tradeable, its not likely to get a run on the bank for more gold bars than it currently has.

You're right that a side currency is usually in place to do this, but it doesn't have to be a currency controlled by the moneylender. Usually there has been more than one currency in place at a given time historically. Sometimes it's a fiat currency, sometimes bimetalism, whatever. In England they used to use sticks. An example of an alternate currency is a bank credit note, which of course is issued by the bank. But let's leave off alternate currency for a second and do a small thought experiment. If ten people each deposit $100 into a bank that previously had no liquid float, they now have $1,000. If they loan out $900 to someone else (10% reserve rate), their books are 'balanced': $1,000 assets, $1,000 debts. And now that same $900 is deposited back into the bank by nine other people(the person who borrowed it used it to pay his workers, let's say), and it's again loaned out to someone, this time to the sum of $810 (10% reserve rate again). The books are now balanced again ($1,900 of assets and debts), except there's a problem: on a potential $1,900 of debts the bank only has $190 on-hand, and additionally in this model there is actually only $1,000 of actual physical money in the system at all, of which currently $190 is in the bank and $810 in private hands. So we can see that it doesn't actually take the issuing of a secondary currency to create an effective increase in the money supply through a fractional reserve, although as I mentioned that is usually done too and if bank notes are involved it can increase at an even greater rate.

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Isn't this basically the plot of "It's a Wonderful Life"?

I forget :(

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Except, when your defaults are guaranteed by the government (Fannie Mae) and the government will loan you whatever you need (the Fed), there is no possibility of a "run on the bank".  This is related to point that Pyrtolin and I always argued about that with fiat money its not possible to have a default unless the government lets it happen.

It's not that a run on the bank can't happen, but rather because everyone trusts the government backing of the banks the psychological safety net prevents people actually believing that they must ever physically run to the bank to get their money out. Back in the day when there was no such assurance they'd assume their money was toast if they didn't get it back in their hands, whereas now people simply don't believe that will happen. It's that belief which the current system has achieved, but if literally everyone who had money in a bank account simultaneously went to withdraw it, of course the entire economic system would collapse immediately since it's a debt-based system. The money supply would contract to an infinitesimal amount compared to what it is now, and there wouldn't be enough money in the government's wildest dreams to back it up. Not even the Fed could print that much. As it is the FDIC only insures up to $100,000, but even so it could never pay back even that much to everyone if it had to. The actual FDIC reserve is tiny and IMO mostly serves to make people feel good. The real source would be the Fed, but at that point you'd be printing up the entire economic system from nothing, rather than pumping it in piecemeal as a stimulus. So yeah, there can be a run, but it would take a catastrophic fear from the public to generate it.

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One of the benefits of this way was the use of private greed and profit motivation to ensure that the money was going to good risks with strong ability to repay loans.  That worked for a really long time.

You mean for like 15 years? ;)

No, more like several hundred.

How do you figure? I meant specifically private greed backed up by the government, btw. Because prior to 1913 there were  bank crises all the time, with banks closing and people losing everything. The system was total chaos. We don't even remember them any more but there was major crises practically every decade back then (maybe more, I haven't looked at the dates in a while).
« Last Edit: February 13, 2018, 04:18:12 PM by Fenring »

Seriati

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Some pretty positive news for CA, I really found interesting that 20% of US growth came from the CA economy.  https://www.nytimes.com/2018/02/13/business/economy/california-recession.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=first-column-region&region=top-news&WT.nav=top-news

Of course there was also this tidbit:

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For California and the nation, there is a long list of things that could go wrong. A surging budget deficit could stoke higher interest rates. And if the recent upheaval in stocks signals a longer-term decline, it would hurt California in particular because its budget relies heavily on high earners whose incomes rise and fall with the market. President Trump’s moves to upend longstanding trade arrangements could be a setback for the state, home of the country’s biggest port complex. And because the growth of the technology industry has played a huge role in California’s recent boom, a drop in company valuations or in venture capital investments would reverberate swiftly through the state’s economy and tax receipts.

It's interesting that CA is so exposed to the stock market, which Greg hadn't mentioned and really has nothing to do with whether local policies have merit.

Also of interest, was something I had underappreciated, CA really benefits from controlling a large part of the country's ports and port fees.  That's another of those things that is undersold when you think of CA contributions to the country versus the country's contribution to CA (effectively CA grabs a rent on every made in China product sold in the US).


Seriati

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No, Fenring, you're really not getting it.  Take a look at the trend line https://fred.stlouisfed.org/series/DRSFRMACBS.

It only goes back to 1991. How is that helpful, since the previous significant crisis was in the early 80's? The early 90's were more or less a boom period (not quite a wartime boom, but still a prosperity time), so that's a weak basis for making long-term forecasts.

Which is why I said in my next paragraph that I couldn't find the longer chart, but that if you looked at it was long and stable.  Don't argue from ignorance. 

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In any case, the graph shows homeowner delinquency rate, which is of course correlated to the mortgage market crisis but isn't directly the thing that failed.

Sigh.  Really?  You think the primary thing that actually caused the crisis "isn't directly the thing that failed"?

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The problem wasn't just that homeowners began to spontaneously cease being able to pay their mortgages, which led to the crisis, like for instance if they all lost their jobs or something. The speculative nature of the trading is something not measurable in a simple graph like "homeowners going bust"; the growing instability of the traders themselves to accept these mortgages has little to do with the 15 year trend in people making their mortgage payments. Looking at a graph like this (even if it went further back) would be useless in assessing the mounting instability of the actual reality of what was being counted as assets on the books.

What that graph showed is a fundamental change in a metric that was fundamental to any plausible calculation of risk - you literally could not have validly calculated risk without that metric.  Given the leverage that was in play, and the order of magnitude of that change in that chart, makes it completely obvious what happened.

Seriously you can literally read all about it.

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So yes, I think a real expert would have been able to assess the soundness (or lack thereof) of how they were doing their calculations.

I see.  So there were no "real experts" in the entire credit industry, the ratings industry, with the regulators, with the investor community (which included almost every single sophisticated investor on the planet).  Yep, you're probably right, a "real expert" would have seen the "obvious."

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Real experts don't rely just on data models, but learn real facts on the ground. For instance, looking at the long-term trend-line for a corporation you're thinking of investing in is ok, and reading the quarterly statements is good too, but nothing can substitute for physically being on premises, knowing the operators involved, local conditions (if it's in another country), and other such details.

Except the "facts on the ground" were exactly what caused them to predict the stability of the mortgage default rate.  Literally, decades upon decades of data from thousands of banks across the country.

But I'm sure you're right, that you could have walked into someone's - what?  house - and seen the problem, if only someone had done their "job."

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No graph can replace real knowledge, and I believe that there were people in NYC with real knowledge prior to 2008.

I see.  So "no graph" of millions of data points spanning decades can replace "real knowledge".

Honestly, don't ever cite a study to me again.

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Greenspan can say whatever he wants, this was not some totally unaccountable blip in history, but worked based on the same physics other system work on for anyone who understands them to an extent. We haven't got that great a grip on this 'physics' but it's not just some unknowable mystery leaving us with only using trend-lines to think forwards.

Again, it literally was such a blip. 

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You're right, it's not good. That's why using convenient models to justify dangerous behavior is bad science, even though it looks good in the board room.

Yeah, but that didn't occur so moot.

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Do you seriously think executives green lighting these transactions were thinking of their little deals having a broader effect?

Yes, literally they were.  In fact the entire purpose of this industry was to spread credit risk of an industry - collectively - across a bigger and more diverse group of lenders than was other wise possible.

These transactions were literally designed to exploit the seeming national immunity to a mortgage crisis to smooth out the local risks of one.

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Their business was to get their deals done that were right in front of them, not to worry about what happens when everyone else is doing the same.

That's sort of true.

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If you're in the process of poisoning the other team's drinking water then maybe it's not such a bad idea. It just helps to know what is or isn't poison.

I agree.  Congress poisoned the water.

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I think you missed my point here. It seems to be your contention that the government and its regulators are what cause these problems in the private sector, but when I say they need to be watched like a hawk you seem to double back and say that of course we keep an eye on them, through these regulators!

No my complaint is with people like Greg that constantly want government to solve the problems it created.  This crisis was directly the result of deliberate government policy.  The fact that industry responds to incentives is just a fact.  Do you recall my example of an industry forming to carry ocean water from the beach to the end of the pier. 

These CDOs don't ever get this crazy, maybe they never form at all, without government pressure to force lending into areas where the borrowers couldn't repay it.

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If your point is that the regulation could be better, then...well, duh. But if it's that direct regulation is always going to lead to these kinds of problems then I wonder how you think the dogs will be kept on a leash since they control so much of the public well-being in their hands?

Personally, I take the government funding out of their hands.  I can not comprehend - at all - why our government lends money to banks to exploit us.

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You're right that a side currency is usually in place to do this, but it doesn't have to be a currency controlled by the moneylender.

It actually does.  The lender has to have the power to create/issue more of the "money" than they have assets.  Whether it's because they can create bank notes, or because the government gives them massive loans for nearly free is immaterial when the government policies are mandatory.

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If ten people each deposit $100 into a bank that previously had no liquid float, they now have $1,000. If they loan out $900 to someone else (10% reserve rate), their books are 'balanced': $1,000 assets, $1,000 debts.

Lol that's not how it works.  In your example, the bank would have a $1,000 in deposits, and be able to loan out $10,000 for a leverage ratio of 10:1.   Like I said though, it's not that straight forward, and the actual leverage ratios were several hundred to 1.

If banks could only lend out the amount of their deposits we'd never have had this crisis, and of course our economy would be less than a hundredth of its current size.

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It's not that a run on the bank can't happen, but rather because everyone trusts the government backing of the banks the psychological safety net prevents people actually believing that they must ever physically run to the bank to get their money out.

Actually, you're wrong.  It literally  can't happen in a fiat currency system unless the government lets it.  The government can always print more bills to cover the shortfall. 

A classic run on the bank only works against a system that has a specific backing (like say a gold standard), or one where the government lets a bank collapse.

Did you ever hear of SDIC insurance?  99% of the population is literally immune from a "run on the bank" problem - as guaranteed by the federal government.

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One of the benefits of this way was the use of private greed and profit motivation to ensure that the money was going to good risks with strong ability to repay loans.  That worked for a really long time.

***

How do you figure? I meant specifically private greed backed up by the government, btw. Because prior to 1913 there were  bank crises all the time, with banks closing and people losing everything. The system was total chaos. We don't even remember them any more but there was major crises practically every decade back then (maybe more, I haven't looked at the dates in a while).

Sure, individual banks.  And because of that problem individual bankers were risk adverse.  They'd do "silly" things like insist on proof of ability to repay, deny loans to people they thought were bad risks, and insist on 20% down on a mortgage.

None of which served Congressional desires to have easy credit flood the market and put people in homes.  So  they meddled.  They insured the bank accounts.  They removed the regulations separating wall street banks from main street banks, and allowed both to operate at higher leverage ratios.  They specifically forced banks to lend into neighborhoods that had bad credit.  Politicians actually made claims that it was discriminatory to ask for proof of ability to repay.  Then insured mortgages, and even "helpfully" reduced the amount down on insured mortgages to less than 3%.  They changed tax policy to make mortgage interest deductible (even though rent is not and it's very likely that renters need more help).  Then aggressively investigated banks who didn't make politically desirable loans, and complained loudly whenever credit markets "contracted" (and not about the risk they were avoiding, but rather the "greed" that was causing bankers not to make loans).

TheDrake

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Politicians actually made claims that it was discriminatory to ask for proof of ability to repay.

That sounds pretty much wrong to me. I think what they were saying is that you have to ask everybody for the same proof, if you're going to ask. NINJA loans weren't a government creation. They were about subprime lenders filling an unquenchable thirst for more MBS. Banks took these risks thinking "oh well, we can always foreclose" - except that because of grossly inflated real estate market, the burst bubble dropped all those loans underwater.

Greg Davidson

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You think the primary thing that actually caused the crisis "isn't directly the thing that failed"?
Okay, maybe we are closer to understanding the difference of opinion. I don't disagree that government policies to encourage home ownership contributed to the default rate. However, without the actions of Investment Banks and the ratings agencies, we would have had a problem scaled at $7T based on the value of housing and not a crisis concerning $54T (see Greenspan testimony 10/23/2008). So there is some degree to which "government" policies contributed to the default rate (along with private sector mortgage lenders and actual borrowers who also count as private sector actors and not the government). But you are not losing 800,000 jobs per month, with the collapse of the auto industry imminent, all just from the collapse in housing prices. The much larger sums of money beyond real estate played a much more prominent role in causing damage from the collapse.

But let's also be crystal clear that "government" is an overly broad term, because we have two political parties in the US that implement government policy in very different ways. And anti-government rhetoric is a common weapon in the Republican quiver, but we need to hold the parties accountable for when they specifically take the lead for actions which turn out disastrous.

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From his earliest days in office, Bush paired his belief that Americans do best when they own their own homes with his conviction that markets do best when left alone. Bush pushed hard to expand home ownership, especially among minority groups, an initiative that dovetailed with both his ambition to expand Republican appeal and the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards.

Bush did foresee the danger posed by Fannie Mae and Freddie Mac, the government-sponsored mortgage finance giants. The president spent years pushing a recalcitrant Congress to toughen regulation of the companies, but was unwilling to compromise when his former Treasury secretary wanted to cut a deal. And the regulator Bush chose to oversee them - an old school buddy - pronounced the companies sound even as they headed toward insolvency.

As early as 2006, top advisers to Bush dismissed warnings from people inside and outside the White House that housing prices were inflated and that a foreclosure crisis was looming. And when the economy deteriorated, Bush and his team misdiagnosed the reasons and scope of the downturn. As recently as February, for example, Bush was still calling it a "rough patch."

The result was a series of piecemeal policy prescriptions that lagged behind the escalating crisis.

"There is no question we did not recognize the severity of the problems," said Al Hubbard, Bush's former chief economic adviser, who left the White House in December 2007. "Had we, we would have attacked them."

Looking back, Keith Hennessey, Bush's current chief economic adviser, said he and his colleagues had done the best they could "with the information we had at the time." But Hennessey did say he regretted that the administration had not paid more heed to the dangers of easy lending practices.

And both Paulson and his predecessor, John Snow, say the housing push went too far.

"The Bush administration took a lot of pride that home ownership had reached historic highs," Snow said during an interview. "But what we forgot in the process was that it has to be done in the context of people being able to afford their house. We now realize there was a high cost."

For much of the Bush presidency, the White House was preoccupied by terrorism and war; on the economic front, its pressing concerns were cutting taxes and privatizing Social Security, a government retirement and disability benefits program. The housing market was a bright spot: Ever-rising home values kept the economy humming, as owners drew down on their equity to buy consumer goods and pack their children off to college.

Lawrence Lindsay, Bush's first chief economic adviser, said there was little impetus to raise alarms about the proliferation of easy credit that was helping Bush meet housing goals.

"No one wanted to stop that bubble," Lindsay said. "It would have conflicted with the president's own policies."
  http://www.nytimes.com/2008/12/21/business/worldbusiness/21iht-admin.4.18853088.html

TheDeamon

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As long as we're going to be content to categorize them as wild dogs looking for their meat then you shouldn't have any qualms about treating them like a kennel and putting a leash on them.

I'm beginning to think that basic concepts of finance are not as basic as I believed.

At their fundamental core, CDOs are tools to reduce risk exposure.  The idea that they were created by "wild dogs" is so beyond wrong I don't know how to even process it.

I understood it. Maybe it would help Greg if you compared it to insurance "risk pools" as his rooting around in health care issues should have introduced him to it.

It is only a small step away from the origin of insurance back in the Age of Sail where any particular voyage (particularly long ones)  could be a ship's last even though ship's seeing decades of service wasn't uncommon, even then. But as the cost of trans-oceanic expeditions were enough to ruin investors should "their ship" get lost, they "spread the risk around" (via Lloyds of London) and made the British Empire a reality in the process.

yossarian22c

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I’m pretty sure Greg gets it. The problem wasn’t only that the cdos that helped hide the risk due to negligent ratings agencies. The result of a housing decline with just those components would have been bad but probably wouldn’t have sunk any major firm or bank. It was all of the derivative bets on the cdos that made a 1 dollar decline in the cdo a 5-10 dollar loss for the firm. The derivative bets coupled with high leverage levels turned a economic downturn into an economic crisis. You can reasonably argue what role government policy had in the 1 dollar decline. But the additional 4-9 dollar loss plus high leverage is almost exclusively private sector.

Seriati

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Greg, you'll love this article.  It's a pretty resounding condemnation of the finance industry.  https://www.theatlantic.com/business/archive/2016/09/fairfield-county/501215/

You'd probably be surprised to know that I agree with a good chunk of it, though I think it misses the boat on the resolutions (higher taxes on the rich is political claptrap that doesn't address any of the underlying concerns and ignores that they will literally move out of state).  It glosses over a lot of facts (like that the CT rich pay an enormous amount of taxes in CT, literally dwarfing the taxes of everyone else).  It also misses that the best cure would be to incentivize better investment practices, practices that generate better jobs, rather than taking and redistribution.  Put the smart people to work on the problems you want them to be solving.  But its a good critique about why market success is no longer translating as directly as it once did into more industry and better jobs.

I actually, came at this because of a continuing fascination I have with the "1%" concept.  CT as a whole already has a 1% line that's over $600k, and given the concentration of wealth in Fairfield county, I bet the line there is closer to $1m.

Edited to add: Just found this directly on the 1%er question.  Fairfield county's line is about $1.4m.  https://www.nytimes.com/2016/09/25/business/your-local-1-percenters-may-not-be-as-rich-as-you-think.html
« Last Edit: February 16, 2018, 09:31:22 AM by Seriati »

Greg Davidson

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Yossarian, some of the cdos were leveraged between 10 and 20 times.

Seriati/TheDaemon,
I fully understand risk pools, and the whole notion that in an orderly market with many independent actors, even if some behave irrationally there should be others who recognize the irrationality and self-optimize by betting the other way. Michael Lewis's The Big Short was about a few individuals who just did that, but the problem was that so many many others all bet the wrong way. This was specifically what Alan Greenspan confessed as a "fundamental flaw" in free market economic theory - in a functioning market, enough people are supposed to recognize irrationality and in their own self-interest pursue an arbitrage that richly rewards them by providing a market correction. It is a beautiful and elegant system, and it often works - but liberal economics (Post Keynsian and others) recognizes that it does not always work, and that vulnerability to catastrophic failure legitimizes some level of government regulation

Seriati

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Yossarian, some of the cdos were leveraged between 10 and 20 times.

Actually, they were all leveraged more than 20 times (that's before you add on synthetics) and before you consider that the banks and mortgage cos were themselves leveraged (with the banks being several hundred times) and that the investors often also used leverage to increase their stake.

The CDOs were so inherently leveraged that the lowest tranches of debt were expressly considered equity rather than debt because of the risk.

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Seriati/TheDaemon,
I fully understand risk pools, and the whole notion that in an orderly market with many independent actors, even if some behave irrationally there should be others who recognize the irrationality and self-optimize by betting the other way.

Greg, you've already lost me here.  You can't claim to understand these risk pools, then assert that the actors were behaving irrationally.  They literally were not being irrational.  Betting against them would have been irrational.

In fact, to put into terms anyone here can understand.  The concept on a CDO getting a triple A rating is like loaning someone $800 on a collateral of a $1000 gold bar.  There's no "irrationality" on that. 

To see the whole picture, you'd also see someone else loaning $150 at B, someone loaning 100 at junk and someone putting in $25 in equity.  That's $1075 on a $1000 gold bar - what gives?  You don't sell the bar for 10 years, it's a bet that the increase in the gold bar is greater than the cumulative interest.  Given the AAA stuff has a very low interest rate because it's over collateralized, you can easily get there.  In fact, the certainty on getting there was 95% plus, and the risk of default on the triple A?  less than 0.4% (and there were specific measures to require selling the collateral to de-risk if it even looked likely - unfortunately this doesn't work when there is an industry wide event and everyone is selling).

When you look at the interest rates that actually apply in a CDO (ie the mortgage interest rates, versus the note rates) mathmatically even with a default rate that's off 2 standard deviations the bond holders - all - get paid, it takes an even bigger swing to put the AAA at risk.  Unfortunately that's what we got.

Fenring

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But since the "AAA" CDO's were not actually AAA, that utterly defeats this kind of risk calculation, does it not? We're talking about fraud, not about whether legit AAA assets ended up tanking by coincidence.

TheDrake

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The best reform in the financial industry would be to create disincentives for risky play. The traders, firms, stockholders, everyone should be made aware of risks fully and take their lumps if investments don't work out. Real fiduciary responsibility would have a fund manager with compensation pegged to performance. Pension managers should somehow be held accountable, though I'm not sure how. Firms should go bankrupt and their equity chopped if their portfolios turn into a flaming bag of poop. There are ways to stop financial collapse without rewarding people whose risk assessment failed them - whether that risk was "understandable at the time" or "foolish".

It's like people who think they can win roulette by doubling their bets each time. What are the odds it will be black 7 times in a row? I've been watching the table all night and its never happened! The historical data has spoken!

Seriati

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But since the "AAA" CDO's were not actually AAA, that utterly defeats this kind of risk calculation, does it not? We're talking about fraud, not about whether legit AAA assets ended up tanking by coincidence.

Not sure what you think AAA is, but there are new CDO assets being issued now that are AAA.  The rate is based on the risk of default, nothing more. 

And we're literally not talking about fraud at the CDO formation level.  Fraud that occurred, occurred at the lowest levels - the borrowers lying about their ability to repay, and the mortgage companies lying about the diligence they performed.

Fenring

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And we're literally not talking about fraud at the CDO formation level.  Fraud that occurred, occurred at the lowest levels - the borrowers lying about their ability to repay, and the mortgage companies lying about the diligence they performed.

Well that's not what plenty of experts have claimed. Sure, maybe some borrowers lied, but frankly the bank has free reign to look at assets and debts and can judge for themselves. They're not supposed to just take a borrower's word for it. Unless, of course, the mortgage broker has 'advised' the borrower to make certain unjustifiable claims and that the bank wouldn't question it. This is something I understood was happening all over the place, where loans even the borrower didn't think they should be able to get were being thrown at them. Rather than acting as gatekeeper for bad loans the banks were actively soliciting people to invest in real estate. In a strict sense this kind of arrangement is a two-way street since a person would have to agree to this, but I think most people don't know squat about the market and will trust a broker when they're told it will be ok.

TheDrake

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And never mind the mortgage originators. They were flipping those subprimes along to purchasing banks - sometimes a string of them - to the point where sometimes it wasn't even possible to find out who did hold which mortgages or what their lineage was. The whole idea that you can bundle a bunch of risky subprimes into a pile and then have it be nice and safe was ludicrous. It is true that credit card debt kind of works that way, but there is a reason why they are charging 24.99% APR to people who are poor risks.

The time bomb of debt structure where the interest rate starts out low (introductory) and then spikes 2-3 years down the road certainly contributed also. Not fraud, but certainly not conducive to stability.

The credit rating agencies themselves were highly culpable, maybe to a level of fraud.

Seriati

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And we're literally not talking about fraud at the CDO formation level.  Fraud that occurred, occurred at the lowest levels - the borrowers lying about their ability to repay, and the mortgage companies lying about the diligence they performed.

Well that's not what plenty of experts have claimed.

Which experts?

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Sure, maybe some borrowers lied, but frankly the bank has free reign to look at assets and debts and can judge for themselves. They're not supposed to just take a borrower's word for it.

If you think they had "free reign" you should read the linked article.  Banks were expressly constrained from using measures of borrower quality that could have been linked in any way with discrimination based on race.  That literally meant if borrowers in a neighborhood defaulted more, but the neighborhood was majority minority, a bank could be faulted for measures that said lend less or don't lend at all in that neighborhood.

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According to one enforcement agency, "discrimination exists when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants." Note that these "arbitrary or outdated criteria" include most of the essentials of responsible lending: income level, income verification, credit history and savings history--the very factors lenders are now being criticized for ignoring.

https://www.forbes.com/2008/07/18/fannie-freddie-regulation-oped-cx_yb_0718brook.html#119eef46364b

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Unless, of course, the mortgage broker has 'advised' the borrower to make certain unjustifiable claims and that the bank wouldn't question it.

I think you're confused about what the mortgage companies were doing.  They weren't connecting borrowers to brick and mortar banks.  They were actually making the mortgage loans, then selling blocks of dozens or hundreds to a bank at a time.  The only person that met the borrower, worked at the mortgage company and was very likely compensated based on the numbers of closings.

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This is something I understood was happening all over the place, where loans even the borrower didn't think they should be able to get were being thrown at them.

Yes, it was happening everywhere, and it was literally the government's plan that it do so.

The time bomb of debt structure where the interest rate starts out low (introductory) and then spikes 2-3 years down the road certainly contributed also. Not fraud, but certainly not conducive to stability.

I am with you there.  I always thought "introductory rate" mortgages, interest only mortgages and balloon mortgages should have been illegal for non-sophisticated persons.  On the only hand, it was express government policy that it would have been discriminatory to exclude them, where everyone expected home prices to keep rising.

TheDrake

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If you think they had "free reign" you should read the linked article.  Banks were expressly constrained from using measures of borrower quality that could have been linked in any way with discrimination based on race.  That literally meant if borrowers in a neighborhood defaulted more, but the neighborhood was majority minority, a bank could be faulted for measures that said lend less or don't lend at all in that neighborhood.

And demographic data is somehow more important than verifying the Individuals income, job history, expenses, debt, and credit history? It was lazy and unnecessary to clump people based on zip code.

As for the "outdated criteria" line from the Boston Fed that continues to echo around the minority blame-o-verse, here's a more detailed review that rebuts the critics in 94 a couple of years after it was published.



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Allowing for different coefficients for whites and minorities, our analysis supports the
Boston Fed's conclusion that approximately half the difference in denial rates can be
attributed to differences in the financial characteristics of the borrowers and the
neighborhood characteristics of the property; the remaining half can be attributed to
differences in treatment by race.

So the banks at best threw the baby out with the bathwater and just said to hell with it, everybody gets a loan, rather than cleaning up their act. Were the feds applying pressure? You bet, they should have been. Minority applications that had unverifiable information were denied 82% of the time while non-minority got away with it 52% of the time. The way to adjust would have been to verify all data for all customers - no discrimination problem. But that would have meant tighter underwriting standards and a slower process.

Fenring

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And we're literally not talking about fraud at the CDO formation level.  Fraud that occurred, occurred at the lowest levels - the borrowers lying about their ability to repay, and the mortgage companies lying about the diligence they performed.

Well that's not what plenty of experts have claimed.

Which experts?

We're not going to play that game. Any link I can submit you can just as easily copy paste another, or simply reject anything in it. The conversation would devolve to a no true Scotsman about who is really an expert so I think we'll skip it. Suffice to say that sources I trust explain it in a way that's fairly clear and not as complicated as you make it out to be. It's so simple that it's almost silly; they wanted in on the flowing cash and management obliged them to follow suit.

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If you think they had "free reign" you should read the linked article.  Banks were expressly constrained from using measures of borrower quality that could have been linked in any way with discrimination based on race.  That literally meant if borrowers in a neighborhood defaulted more, but the neighborhood was majority minority, a bank could be faulted for measures that said lend less or don't lend at all in that neighborhood.

I agree with what Drake said about this. Trying to claim that this was all about demographic data is to ignore the majority of the calculations that go into a loan calculation. The borrow's income history, cash flow, and debt ratio, would be by far the most relevant factors. The things you mention were no doubt in play, and in fringe cases may well have been the deciding factor, but in that case we're already talking about people who were borderline for a loan in the first place.

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I think you're confused about what the mortgage companies were doing.  They weren't connecting borrowers to brick and mortar banks.  They were actually making the mortgage loans, then selling blocks of dozens or hundreds to a bank at a time.  The only person that met the borrower, worked at the mortgage company and was very likely compensated based on the numbers of closings.

Uh-huh...and the banks would have just accepted anything handed over to them without question? And that's the mortgage broker's fault because...? Let's say a broker accepts idiotic mortgage agreements and runs a bad business; so what, the bank is just going to buy into that, hook line and sinker? That would make the bank incompetent. It seems to me far more likely (and to be fair I haven't studied to business relationships between brokers and banks at that time, so I'm speculating) that the brokers accepted deals in such a way that they knew the banks would accept it, since the bank's interest is obviously the limiting factor in that arrangement. If the bank refuses it then the broker's business model fails. So once again it comes down to what the banks were clamoring for. Whether the broker connects people directly with a bank branch or else organizes their own assets differently before passing them off makes little difference; either way they're a middleman that answers to the bank's policy.

It's like you're arguing that, person X didn't really buy all that unhealthy candy, it was the vendor who packaged it in a fancy box labeled "healthy food", so person X isn't to blame. Well he is if he's supposed to be an expert on nutrition! But actually this goes back to my previous point, which is that in addition to this behavior having been fueled by blind greed, at the same time I believe there were very few legitimate experts who understood what all of this meant, so at the local level those indulging in the greed might well have thought "well this is sketchy, but what's the worst that can happen?" I don't doubt they were ignorant of what the aggregate activity would result in, even though I'm equally convinced that they knew they were conducting a shady operation. They just thought they could get away with it.

ETA - I'd like to additionally ask, Seriati: what interest do you have in trying to apologize for bank behavior during this period? I get that you're against government interference and messing up the economy, which is a position I respect even though I don't believe it's accurate in all case, but even so I wonder why in addition to blaming government you also seem to want to absolve the private sector of responsibility, as if it has to be one or the other. I would think at the very least that the blame would lie with both parties (although I do happen to think the private sector is 'mostly' responsible in this instance).
« Last Edit: February 21, 2018, 12:33:21 PM by Fenring »

TheDrake

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The regulation in this area does make mortgages more difficult. I just closed on a house, and the bank had to pull "official" W-2, even though I had my Turbo tax printout of EIN numbers and everything else. I also had to cough up paystubs verifying my start date for employment, since my current job started during the calendar year I was applying. I don't doubt for a minute that, back in 2006, as a Rich White Guy the bank would have clapped me on the back with a wink and underwritten it. Especially since I had been banking with them for a decade. While the Poorer Black Guy would be forced to dig up all the notarized information. I'll accept the hassle so we can get equality of treatment.

And, that treatment would have also allowed me to easily claim a job I didn't actually have, if I were unscrupulous and being egged on. Or if I was trying to cash in on the housing market and I was trying to buy up property to flip and that was my only actual source of income. Because its no surprise that lots of the foreclosures involved "investors" intent on flipping their way to riches. They were even happier about mortgages with introductory rates than people intending to live in the home with their families.

I must have had about 20 friends come up with half-assed ideas to buy up as many houses as they could and cash in. I did my best to dissuade them, as far as I know none of them followed through. But many many people did.

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This would explain why, as the researchers put it, “the rise in mortgage delinquencies is virtually exclusively accounted for by real estate investors.” The share of single-mortgage borrowers who couldn’t keep up on their loan payments barely budged between 2005 and 2008.

flip flip flipadelphia

I continue to be baffled by the narrative that the financial meltdown was caused by poor people and government control.

Seriati

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And we're literally not talking about fraud at the CDO formation level.  Fraud that occurred, occurred at the lowest levels - the borrowers lying about their ability to repay, and the mortgage companies lying about the diligence they performed.

Well that's not what plenty of experts have claimed.

Which experts?

We're not going to play that game. Any link I can submit you can just as easily copy paste another, or simply reject anything in it. The conversation would devolve to a no true Scotsman about who is really an expert so I think we'll skip it. Suffice to say that sources I trust explain it in a way that's fairly clear and not as complicated as you make it out to be. It's so simple that it's almost silly; they wanted in on the flowing cash and management obliged them to follow suit.

I should have said, "what claims"?  Honestly, I'm not trying to play a no true Scotsman argument.  I just doubt your experts made a claim that the fraud was in the construction of the CDO portfolio or denied the fraud at the mortgage company level.  Again, this is a dispute over a fact. 

Go do the research and show me why you believe this fact is wrong, or link me to these experts so I can see what you're talking about.

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I agree with what Drake said about this. Trying to claim that this was all about demographic data is to ignore the majority of the calculations that go into a loan calculation. The borrow's income history, cash flow, and debt ratio, would be by far the most relevant factors. The things you mention were no doubt in play, and in fringe cases may well have been the deciding factor, but in that case we're already talking about people who were borderline for a loan in the first place.

To both you and Drake, did you read the article I linked, or even the paragraph I quoted?  They were literally being told that looking at the sensible measures you just described was evidence of illegal discrimination for which they would be held to account.

And Drake, in 2006, mortgage's were being issued without verification to all borrowers.  Look up what "sub-prime" means, read about no verification loans, throw in some references to the year you're looking at.  There's tons of information out there, which is one of the reasons I find this conversation so frustrating.

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Uh-huh...and the banks would have just accepted anything handed over to them without question?

No, not "without question," based on representations of the mortgage company that they had conducted the diligence (which it later turned out they had not done in significant numbers of cases), and generally on the requirement that the mortgage company repurchase any defective mortgages or replace them with an equivalent or better qualifying mortgage.  Again, with one mortgage that may be high risk, though it's not if the mortgage company did what it said and can honor it's agreement to replace or repurchase, but with 100?  It's literally not high risk once you consider the default rate means that 96+ out of that hundred wouldn't default (on average).

Is it sinking in - at all - how key the default rate was to everything?

When you consider that the industry wide impact meant that the buy-backs couldn't be honored, the protection turned out to be worthless.

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It's like you're arguing that, person X didn't really buy all that unhealthy candy, it was the vendor who packaged it in a fancy box labeled "healthy food", so person X isn't to blame.

No, it's more like what I'm telling you, is that Congress decided to subsidize corn to such an extent they found it was cheaper to use it to make High Fructose Corn syrup and use that in every food product at the store instead of natural sugar.  That it became so profitable to use HFC syrup that even after adverse health effects began to be suspected, Congress subsidized it and discredited the research.  That after people became more concerned Congress changed the labelling laws to make it so you couldn't identify the HFC in a product and insisted it be labelled corn sugar instead.  And then after decades of it's inclusion in every packaged food, the "unproven" link between HFC and obesity still not "proven" yet every American obese, you tell me that it was nothing but the Super Market's greed cause they wanted tasty food to sell.

At least that's how your position looks to me.  You picked who you want to be mad at - and I grant you bankers are often crappy people - and ignored absolutely every factor that caused the problem other than the one you think makes them look bad.

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ETA - I'd like to additionally ask, Seriati: what interest do you have in trying to apologize for bank behavior during this period?

None.  My interest is holding the government accountable for the problems it causes.  Diverting blame away from the government is one of it's best skills.  Think about it, our healthcare system is messed up right?  Government is at the root.  Poverty rates have done nothing but increase as government programs to treat poverty have increased.  Public education funding increases never leads to better public education results.  What exactly does the government do well?

There is nothing about what I'm saying that "absolves" the private sector of a share of responsibility, but not understand where they actually failed, confuses your solutions and has you advocating for changes that don't fix the problem.

TheDrake

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To both you and Drake, did you read the article I linked, or even the paragraph I quoted?  They were literally being told that looking at the sensible measures you just described was evidence of illegal discrimination for which they would be held to account.

I did read what you linked, which is why I looked for the phrase's origin from the Boston Fed study. I saw nothing credible in the op ed from Forbes that showed a single example of a bank using objective criteria correctly and getting in trouble for it. The Boston Fed publication, and reaction to discrimination claims, had its origin in the mid 90s.

Partly as a result, I contend that banks expanded their definitions as their choice on how to respond to the claims of discrimination. While they also had the choice of reducing their no-verification offerings to people who were not minorities.

I'm happy to be corrected with any of this, but some dude's opinion from the Ayn Rand Institute without his sources isn't going to hold much water.

As I understand it, CRA does mandate that you operate in poor areas, you can't just be a rich people bank. So, therefore, it becomes illegal for a certain size institution to, say, only service loans for $500k and up. Or, establishing a limit of $80k income to get in the door. But I haven't found anything that doesn't say that you must ignore income to mortgage ratios. It also says that you can't charge people more for their checking account in a poor neighborhood than a rich one. Certainly those actions might reduce a bank's risk, and so I concede that it does force a bank to manage it in a more complicated way than they might do without such a mandate. But I wouldn't stretch it to be a primary cause.

Fenring

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But I haven't found anything that doesn't say that you must ignore income to mortgage ratios.

That's because there isn't. It's inconceivable that the government would require banks to ignore this and approve mortgages where the ratio is garbage. That doesn't discount the possibility that the banks were squeezed in various ways by the government and decided to make up for it this area, by messing with their own algorithms for calculating loan risk. I'll try to address Seriati's other points a little later if I have time.

Seriati

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Fine, here's a link with facts about the deliberate government policies that pushed this bubble:

https://www.forbes.com/2009/02/13/housing-bubble-subprime-opinions-contributors_0216_peter_wallison_edward_pinto.html#3cecab6d778b

Here's a good descriptive write up of No Doc loans http://www.thetruthaboutmortgage.com/no-doc-2nd-mortgage/.  And here's a simple write up the private side issues and general concepts https://www.thebalance.com/mortgage-crisis-overview-315684.

There's lots of write ups that can help you see these issues more clearly.

TheDrake

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Gee thanks for helping me see so clearly, I'm so myopic I need my hand held.

Condescension aside, those are useful links with some actual numbers in it and I'll respond back after I've had a careful look.

TheDrake

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Thanks for the links, they were helpful. I was definitely underestimating the impact of CRA. Especially the government applauding relaxed standards without qualification. A few things.

CRA impact started in 95, but the housing market didn't appreciably bubble until about a decade later.

CRA has a number of ways to "score" including opening ATMs in underserved neighborhoods, it doesn't specify mortgage as far as I could tell.

CRA definitely encouraged relaxed standards in poor neighborhoods, take Watts for example. It doesn't excuse relaxed standards in OC or Manhattan, which also happened - and those defaults were far more damaging than defaults in a run down Detroit suburb.

Small operations, like the many fly-by-night mortgage originators never had to worry about CRA because they didn't cross the large institution threshold. As far as I can tell, CRA doesn't come into play in the secondary mortgage market - which is the major way that BofA and others wound up holding debt.

Despite the caveats, there was a clear climate created by government policy that encouraged the behaviour. And given the idea that the banks knew they were holding dangerous debt, it does make sense to pass the buck by reselling as mortgage backed securities. But they shouldn't have been labeled as super-safe, just like junk bond funds shouldn't have been rated higher than the junk bonds that were inside their portfolio.




TheDrake

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Studies have suggested that only 6 percent of subprime loans were extended by CRA-regulated lenders to either lower-income borrowers or neighborhoods in the lenders' CRA assessment areas.

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Of course it wasn't the CRA that caused everything. The CRA was a factor in lowering lending standards. This was a necessary, although not sufficient, cause for the mortgage mess.

A fair, if somewhat biased, assessment

Seriati

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TheDrake, that's actually a really good piece that explains clearly how the CRA impacted the industry.  The part's where it describes the interactions between the regulators and the lenders and how that was perceived by the industry are dead on accurate.

I do think you managed to pull out quotes that completely misconstrue what the article actually says.  I'd recommend everyone read it.

TheDrake

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I didn't mean for the quotes to be representative, they are part of a picture. I do think the "necessary although not sufficient" statement is pretty close to my view, which is stronger than when we began the discussion.

It does also describe how informal pressure was applied even when there weren't actual mandates, which I appreciate more now. It wasn't as clear and certain as "Memorandum 2198-5: Now you must offer no-money-down loans". As companies often do, they took the easiest and simplest way out, then they got hooked on the higher interest rates and spread them to the non-CRA world.

Seriati

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Well to be fair, I often forget that things that I think "everyone knows" because of my background, are not always things everyone really does know.  In this case, it's the concept of regulation by enforcement that seems to be not generally understood.  Most of the sophisticated financial players are heavily influenced by "soft" expressions by the regulator, whether it be an announcement of exam priorities or a speech at an industry event.  Often, even without a regulation ever being passed, an industry will implement wide spread changes based on these kinds of signals. 

Regulation by enforcement is the most blatant exercise of this, where a regulator doesn't change the expressed terms of a regulation, rather they change how they enforce it.  Often they settle the first few cases with little more than an admission by the party charged and a waiver of the penalties that could have been brought.  The entire point being to let the industry know they are serious and to start to create a record that they can enforce it. 

When I read those statements about the interactions between regulators and industry, it's things I know have happened, I literally see it every day.  When others hand waive over the reality because they can't point to a change in a statute or a new rule it comes across as incredibly naive and uninformed.

TheDrake

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So that type of enforcement is public record if they levy fines, etc, is it not? Is this a situation of selective enforcement where everybody is doing a thing, but you can use it for punishment against people who are doing another thing wrong to get what you want? I do think the government has a very legitimate interest in making sure that traditional banking services are available in poor neighborhoods - I'd hardly be comfortable scrapping CRA and watching all the banks evaporate from poor areas and leave it to the pawn shops, payday loan stores, and check cashing stores.

I certainly don't want the other end of the spectrum, for which I'm still not positive how to allocate blame since there is some clear discrimination by neighborhood that had nothing to do with loan terms and structure that needed to be eliminated.

And it remains the case that they pushed these practices way beyond CRA areas. I don't find it terribly credible that the agencies responsible were using their pressure tactics to spread such loans to Seattle and Santa Monica.

It doesn't help that real estate across the board has a clear and undeniable racist element to it, and a history of pushing people of color into higher subprime loans even when they should have qualified (on the numbers) for loans with better terms. A gung ho bank advocate however would just call all action in this area unfounded and simply pressure from a government run amok to grant favors to poor people that vote for them.

Seriati

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The point of regulation by enforcement is that its a public record regardless of whether there are fines.  Regulators will enter "consent decrees" against a person where they levied no penalties, but put in an lengthy  description of the conduct they didn't like.  It's not so much what's meant as "selective enforcement," but rather a way they announce a displeasure with a current practice or an intent to change the current understanding of the law.

Here's a link to just one example, though this isn't the actual legal filing, this is an extended write up pretty only issued to show, in this case, the SEC's thinking.

https://www.sec.gov/litigation/investreport/34-81207.pdf

What should strike you, is that there's no clear regulation directly on point for coin offerings (which is what people would find if they went looking for a coin offering law), this is an announcement that other regulations should have been considered as applying.

You can also see a number of these changes in recent ICE enforcement actions.

TheDrake

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Sure, that makes sense and I've seen that before. It is a clarification that digital currency is not immune from SEC oversight, but that they're choosing not to do anything - for now. This isn't really much more than when the USGA or MLB publish notes clarifying scenarios in their rulebooks, is it?

The generic rules are pretty clear, at least to me. Don't sell people shares of any business venture without thinking you might run into the SEC, especially if your commodity is volatile and based on net worth that is difficult to assess. I've been waiting for cryptocurrencies to get reigned in for a while - many are wild ponzi schemes the way they are entirely regulated right now. (Stephen Segal is promoting BitCoiin - spelling theirs) Similar applications happen for Internet gambling (especially DFS).

It happens when a law grants them wide powers, and the interpretation clearly falls to someone - which is the regulators. The law still exists, and the clarifications exist. To support the idea that the banks "had to" offer no-money-down loans, to that end I would expect to see a document like this that addresses that specifically (even though its not a law, but rather a clarification of a law). I'll see if I can't hunt one down when I have more time, I'm sure it would be illuminating.

Seriati

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Sure, that makes sense and I've seen that before. It is a clarification that digital currency is not immune from SEC oversight, but that they're choosing not to do anything - for now.

No, it's literally the opposite.  This is the SEC telling everyone that they will be taking action against unregistered coin offerings.  It's had a direct impact on every legitimate coin offering since.

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This isn't really much more than when the USGA or MLB publish notes clarifying scenarios in their rulebooks, is it?

It's more equivalent to when a professional sports league starts suspending players for conduct that they never issued suspensions on before, significantly - without changing the rules or issuing direct statement.  The first few hit feel really targeted.  This is a consequence of a system where a "rule change" requires publication, comment periods, financial justifications and can be overruled; but a change in how you bring cases happens instantly.

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I've been waiting for cryptocurrencies to get reigned in for a while..

Many of the Cryptocurrencies are not generally going to be regulated by the SEC, the SEC is interested in the coin offerings.  There are other regulators who are interested in the currencies themselves.

TheDrake

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It's more equivalent to when a professional sports league starts suspending players for conduct that they never issued suspensions on before, significantly - without changing the rules or issuing direct statement.  The first few hit feel really targeted.

You mean, like when they finally started suspending players for domestic violence incidents when they previously had turned a blind eye? Like Adrian Peterson, who had his lawyers cry foul. Hey that's excessive! hey that's unfair!

.. hey, you hit your four year old.

I'm not saying every regulation fits this analogy. I'm sure sometimes its more like the inflation of Brady's football.

There are applicable rules and the expectation is evolve their enforcement according to intent and severity of an infraction. Be transparent about legitimate efforts to comply. Acknowledge that you do, in fact, have a problem with your standards and practices. Maybe don't pull a Wells Fargo and show just how willing you are to screw over the general public.

It reminds me of the credit regulations that came out - companies finally being forced to show people what 29.99% interest really means. Highlighting in closing documents what the payments will look like each and every month of the loan. Appropriately advising customers that they are choosing an extremely risky path and helping them contemplate the potential scenarios and consequences. Being a partner rather than a predator - especially when you tend to hard sell minorities into unfavorable deals than others.

Seriati

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It's more equivalent to when a professional sports league starts suspending players for conduct that they never issued suspensions on before, significantly - without changing the rules or issuing direct statement.  The first few hit feel really targeted.

You mean, like when they finally started suspending players for domestic violence incidents when they previously had turned a blind eye? Like Adrian Peterson, who had his lawyers cry foul. Hey that's excessive! hey that's unfair!

No that's conduct that was clearly illegal (and is under law).  More like if the Commissioner hates Gatorade baths, and starts calling in players that dump Gatorade on their coach and making them sign apologies admitting that they could have been suspended for violation the celebration rule, but the league agreed to let them off the hook.

The idea being that either the Gatorade baths stop or you've been "fair warned" that the conduct is now punishable.

For it to be regulation by enforcement it's reflective of a change in what people thought was acceptable or appropriate behavior.  We're talking, for example, about lowering generally accepted credit standards.

TheDrake

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It's clearly illegal to discriminate also. But they say "hey, that's not discrimination?!" But the Boston fed study came out and showed clear discrimination. So they absolutely did get fair warning. And didn't correct the problems that were systemic. When it was clear that all financial numbers being equal (credit score, employment history, debt-to-income, etc) resulted in unequal approvals based on geography and/or other indirect metrics that disfavored certain areas and as a result, certain groups of people.

I'll reiterate, I'm not suggesting that the government regulators don't carry blame, just that WF, BoA, and other institution deserve a massive helping of blame.

Bear in mind here that CRA was created in 1977, giving 20 years of fair warning prior to visible expansion of the rules in 95 at least in part intended to make it more consistent.

BTW, the only penalty under CRA is that you don't get to participate in M&A or branch creation. Not exactly a  heavy stick. So WF doesn't get to acquire Wachovia. Is that sufficient reason to put your portfolio and the solvency of your bank in jeopardy?

An example from California spells this out.

This entire set of regulation is to protect equality of opportunity - that a guy who wants to start a food truck business in Fresno has the same chance as the guy in Santa Monica. I think the penalty is appropriate and not draconian. If you don't make that opportunity available, then you don't get to acquire even more banks and further limit opportunity.

We're clearly never going to see this close to the same way, but I appreciate the effort and discussion.

In my objectivist world, such efforts would be unnecessary. People who run banks would see all individuals as deserving of opportunity based on merit, and not as part of some collective demographic. People who didn't operate this way would have big depositors leave, and the market would sort itself out. They would evaluate the small business based on its plan and the person who would run it, not based on some statistical model that says that 26 year olds from the same neighborhood generally do X or Y.

Seriati

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It's clearly illegal to discriminate also. But they say "hey, that's not discrimination?!" But the Boston fed study came out and showed clear discrimination. So they absolutely did get fair warning. And didn't correct the problems that were systemic. When it was clear that all financial numbers being equal (credit score, employment history, debt-to-income, etc) resulted in unequal approvals based on geography and/or other indirect metrics that disfavored certain areas and as a result, certain groups of people.

No, that's literally the opposite of what occurred.  What you are discussing, equal credit profiles different results is overt discrimination.  The reaction that forced a change in standards was to look at the aggregate impact on different races, where the borrower profiles by race were different.  In effect, half of one race didn't even qualify  for sub-prime, while only a quarter of the other was in that boat, the regulators came in and said, you need to get both races to 25% or we'll investigate you.

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BTW, the only penalty under CRA is that you don't get to participate in M&A or branch creation. Not exactly a  heavy stick. So WF doesn't get to acquire Wachovia. Is that sufficient reason to put your portfolio and the solvency of your bank in jeopardy?

This is the most naive thing you've said, it reflects a complete incomprehension of how modern banks work.  A modern bank is an interconnected web of thousands of entities, that engages in m&A transactions internally and externally that require regulatory approval several times a week.  This penalty would destroy a bank.

TheDrake

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This is the most naive thing you've said, it reflects a complete incomprehension of how modern banks work.  A modern bank is an interconnected web of thousands of entities, that engages in m&A transactions internally and externally that require regulatory approval several times a week.  This penalty would destroy a bank.

If that is true, why am I reading articles about banks having to gear up for scrutiny and community activists responding to pre M&A activity? If I go to Wells Fargo's quarterly filings, will I see hundreds of acquisitions? I don't claim to be a subject matter expert in banking, so I could easily be wrong.

I point you back to my linked article - that the bank in question was specifically called out for not making loans available in Fresno.

Here's a company selling CRA compliance services: Trupoint

I'd go into specific points, but I doubt they'd be met with anything but an unverifiable claim that that's not how it really works, and I'm being even more naive.

Is belittling me helping you to advance your arguments, to educate, or to otherwise accomplish some goal? I don't think I deserve that.



Fenring

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Alright Seriati and Drake, I finally found a bit of time to read those links, and in some cases read all further links on the linked pages. I have a few comments, but first I'll respond to a point in one of Seriati's Business Insider articles:

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[Question] I thought you said CRA loans caused this crisis.

Nope. It isn't losses from CRA loans that drove the crisis (although they are disproportionately responsible for losses at some banks). Instead, the CRA required lax lending standards that spread to the rest of the mortgage market. That fueled the mortgage boom and bust.
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Banks making CRA loans initially expected that defaults would be higher due to lax lending standards. When they discovered the low-income borrowers had an unexpected propensity to pay their mortgages. After years of data poured in showing that borrowers were paying mortgages despite high LTVs, low down payments and unconventional income measures, bankers began to believe that many of the traditional measure of credit worthiness were overly conservative.

Straight away this is a very telling answer, for someone whose thesis is that the CRA-mandated mortgage practices were the cause of the problem. The argument being made here isn't so much that it was directly the subprime loans themselves that collapsed due to default by the borrowers, but rather the issue was that the banks and mortgage companies began to use this new standard for other varied financial activities. In short, their entire business model became far less risk averse. Why might that be? Would it have been because they realized the error of their conservative ways previous to this, or could it possibly have been because they realized they could get away with running a casino not only without governmental objection but also in practice without serious consequences on the ground. In short, I rather imagine they were delighted at the turn of events that would allow them to pursue more and more questionable activities. I know the taste for financial organizations to engage in high-risk ventures wasn't invented as a result of the CRA laws because they had been doing exactly that for many years in other areas of their business, such as international loans to third world countries. True, that would be in a different department of the bank and have presumably nothing to do with the people making these decisions, but my point is that it wasn't the practice of banks to limit themselves conservatively and to be risk averse on principle. Take away the dam and the floodgates would inevitably open up. It's true that taking away the dam may have been precipitated by the government's social policies (and Drake seems to agree there is some culpability there), but bottom line if the financial sector has a taste for danger and will engage in it whenever possible, the fact that slightly imperfect legislation gives them license to do so doesn't strike me as being 'the government's fault', but rather an inherent property in an industry whose business is playing around with other peoples' money. Government might be able to forestall some of this through proper legislation, and drop the ball with improper legislation, but to me that's neither here nor there.

Now, in terms of home mortgages themselves, the banks could very well have made adaptations in certain neighborhoods to try to offset their hesitation to offer mortgages there. This could have been a special project of sorts, or an exception to their normal practice. It would have complied with the regulators, who were pushing a social agenda of granting 'equal' treatment to poorer areas, while not compromising their general practices in other markets. But instead they lowered all standards over time to be similar to what should have been special-case scenarios to comply with the political climate. They may have gotten the idea to do it from the regulation, but the regulation certainly didn't make them do any such thing. That was their bright idea. What a coincidence that altering their business practices in this way resulted in windfall profits. Yes, I'm sure they were chaffing under the necessity to make all that money.

One link-within-a-link was to a meeting of the Federal Reserve board by one of its Governors, whose speech went into some details about the great market and how great it was that banks were being given incentives to sometimes minimize or do away with down payments for purchases. The link was provided so that the author could argue that these policies were being pushed from the top-down rather than invented by the banks. And yet what the author fails to mention is that policies greatly favored by the Federal Reserve branches would almost invariably be policies favored by the banks themselves. The members of such boards tend to be a conference between ex-bankers, those in the revolving door of high finance, and the occasional people appointed by government who perhaps don't have a direct background in major financial institutions. But overall the Fed certainly doesn't speak for Federal government, nor does it echo or puppet the current administration's policies. They have their own little society going on, and if the Fed board is glowing at the reduction in obstacles to granting mortgages one can be pretty sure that individual banks were feeling much the same way. Very rarely would the Fed ever adopt a position hostile to the financial sector, or even neutral towards it.

Seriati made the point that it was the government's own incentives that made room for all of this to happen. One way in which I'd agree with him is the assumed government backing behind Fannie Mae and Freddy Mac. One thing investors are is skittish, and knowing that their investments are backed up by taxpayer dollars is certainly a way to sell them a product they'll feel good about. Packaging and re-selling mortgage products through those two entities (which were previously government entities but no longer were by the 90's) was made quite alluring because of that promise of backing up their activities. So we could well make a case here that the implicit partnership between those two and the government was part of the problem incentivizing lax lending standards across the board. Why not, since they'll be nicely repackaged and sold through CDO's anyhow? But now we get to my main issue, and one I've mentioned many times on these boards, which is the lack of a clear line between government and the private sector.

It's one thing to argue that the government sticks its nose in and meddles in affairs it doesn't understand, creating problems. But it's another matter to discover why this often happens in the first place. Misplaced altruism, to do the right thing but mucking it up in the process? I don't think so. At best these meddlesome attempts could be explained as being moves by the Congress to satisfy the concerns of their constituents. But that would be giving them a lot of credit. But maybe the argument is that it's the executive branch doing these things. But even so...why would it, if not to achieve some political end? Usually political ends consist of satisfying special interests, and occasionally giving in to populist demands. Was there a populist demand in the 90's for easy access to mortgages? That I do not know, however it would strike me as odd if there were because it was a prosperous time and that's usually the least likely time to hear murmuring and discontent.

What strikes me as being far more likely is that during the boom time the banks were chaffing under the reality that it was the conservative loan approval policies that were throttling their ability to continually expand their business practices. They had maneuvering room to make more loans and knew the housing market was always going up, but with the need to enforce certain approval processes they were only so many loans they could make. It would be just like this industry to have privately lobbied the government to deregulate this area to allow for expansion, which they would argue would benefit both them and low-credit applicants in worse areas. It could be packaged as being a social program while in effect creating a whole market to access that previously the banks had to stay away from. Once the lobbyists were successful and the regulations were put in place the banks could easily remark that they 'had to comply' while in the meantime cashing their checks. I'm not saying this is 100% what happened, but it's the normal way of doing business. Whether it's regulatory capture (very common) or else lobbying to achieve private ends, the result is the same, which is that government ends up invariably being in the thrall of private money interests because politicians are corrupt. And don't even get me started on military lobbying.

I have no doubt Seriati is right that government action was somehow mixed up in the problem, but I am extremely skeptical of any interpretation of the scenario having been the well-meaning and cautious banks being put under the gun of the foolish regulators and being coerced into bad ventures against their desire. It just rings false, and doesn't match the facts as I see them. Looking again to the Fed board document I mentioned earlier, it's clear as day to see these lowered standards were being celebrated, not cursed, by those that stood to gain from all the hay being made. Watch some documentaries about that time, and listen to people who were in the business, and they'll say quite clearly that everyone was excited for all the action that was happening. There was very little sense that the banks were grudgingly complying with the evil government. On the contrary, the main point made in hindsight is that no one realized the danger of what they were doing, rather than recognizing it and feeling coerced into doing it anyhow to comply with regulations.

But my ultimate conclusion, again, is that the original sin here is the corrupt relationship between money interests and politicians. None of this could ever have happened, regardless of government meddling or anything else, if private interests had no leverage over politicians. It's the campaign finance situation, as usual, that was to blame here, and nothing in that sphere has changed since then. Maybe it's even worse. That private parties can exercise direct influence on the nation's leaders is a dreadful systemic flaw. But it's not a flaw to the interested parties because it's how they do business. But for the average citizen it's a disastrous arrangement. There shouldn't even be such a thing as lobbying, and certainly not in sectors that directly affect the overall health of the nation and its defence.

Seriati

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If that is true, why am I reading articles about banks having to gear up for scrutiny and community activists responding to pre M&A activity? If I go to Wells Fargo's quarterly filings, will I see hundreds of acquisitions?

I doubt it.  There's a difference between the major transactions you see filed, and the all the internal transactions they are required to get pre-approval for.

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Is belittling me helping you to advance your arguments, to educate, or to otherwise accomplish some goal? I don't think I deserve that.

You are absolutely right, I owe you an apology.  I'm sorry, I've been more rude than there is any reason to be on this thread.

Fenring, I'm not sure where you got the idea that bankers are crazy risk takers, or that there was any preference for "risky" mortgage loans, but it couldn't be further than from the truth.  You're talking about an industry with hundreds of years (in some cases more) of ingrained preference for conservative practices.  The way the system is set up, if they play it safe they literally can't lose.

Fenring

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You're talking about an industry with hundreds of years (in some cases more) of ingrained preference for conservative practices.  The way the system is set up, if they play it safe they literally can't lose.

"Conservative" is relative; that's a point made by the author of one of your own links. Practices one might have thought were conservative proved to be 'reliable' once the new subprime mortgages were being given out. It's up to you to decide whether this came as a surprise to them or whether they knew all along that even subprime loans are simply a question of balancing the risk agains the profits. Even if X% of those mortgages would default it doesn't matter as long as the overall profits exceed the losses. And by turning the mortgages into securities they had a practical way to spread out and guarantee that the risks would be roughly offset by the profits every time. You may take it on faith that they were surprised to find that this worked for them. I rather assume they knew it would before and wanted to get in on that. But when I say 'playing casino' I mean as the house, so while I personally do call this risky behavior, from the perspective of the banks it would look like a no-lose scenario over time. You have to read your own link to see this connection, though. The guy claims that it was the very success of the initial subprime loans (i.e. people didn't default very much) that got them thinking to apply riskier behavior to their entire enterprise, which in turn resulted in disaster and then was blamed on the government. Sounds like a self-serving argument to me.

TheDrake

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Fenring, I'm not sure where you got the idea that bankers are crazy risk takers, or that there was any preference for "risky" mortgage loans, but it couldn't be further than from the truth.  You're talking about an industry with hundreds of years (in some cases more) of ingrained preference for conservative practices.  The way the system is set up, if they play it safe they literally can't lose.

Can you explain why these risks were taken in non-CRA areas - or why terms like low down payments were extended to affluent borrowers and developers? Part of the reason might be "hey Fannie Mae and Freddie are taking these kinds of loans now, so lets run with it! The government is taking more risk than we are anyway and we might as well make more cash."

As far as banks wanting to play it safe, I'd offer the wholesale collapse during the S&L crisis as evidence to the contrary. Didn't institutions fail to consider the risk of inflation on their operations? Or was it the evil fed that raised interest rates and destroyed them. After all, by your own statement they are supposed  to not lose if they play it safe. A bank shouldn't need lots of new mortgages and depositors to just take in their cut.

"Between 1982 and 1985, S&L assets grew by 56%" - so how do you grow by 56% in three years playing it safe?

Seriati

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Can you explain why these risks were taken in non-CRA areas - or why terms like low down payments were extended to affluent borrowers and developers?

Well yes.  The argument was that if the model was working for "bad credit risks" how could it not work for even better credit risks?  The advantages of the model were the "freedom" from traditional constraints (like 20%) down, the speed - these loans were able to process much faster and even entirely on line, and - at that point - the demand for more "sub-prime" fuel for the CDO market.  The fact that this whole thing was in response to government pressure, doesn't excuse the knock on that the industry added to it (I mean seriously, creating synthetics because there isn't enough product?).

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Part of the reason might be "hey Fannie Mae and Freddie are taking these kinds of loans now, so lets run with it! The government is taking more risk than we are anyway and we might as well make more cash."

Fannie and Freddie's position only makes sense because of direct government policy.  They not only guaranteed loans that they shouldn't have to encourage more home ownership, they also became some of the biggest buyers of the resulting CDOs.

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After all, by your own statement they are supposed  to not lose if they play it safe. A bank shouldn't need lots of new mortgages and depositors to just take in their cut.

They don't.  They can take their cut and play it safe.  But their growth will be far far slower, and their shareholders madder than the banks who "play it safe" by explicitly following government policies, you know, borrowing excessively for near free from the Fed, making high interest loans that are fully guaranteed (all profit, no risk), accelerating their "flipping" of loans into securitizations (gets them off their books, and lets them earn points again and again and again by recycling their capital).

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"Between 1982 and 1985, S&L assets grew by 56%" - so how do you grow by 56% in three years playing it safe?

S&L's were limited purpose  banks that were literally created as part of a federal program to encourage home ownership - sound familiar?  They were another system designed to accelerate the creation of mortgages.  I'm not an expert on the S&L crisis, but it looks like it was directly ascribed to federal policy changes.

Fenring

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As far as banks wanting to play it safe, I'd offer the wholesale collapse during the S&L crisis as evidence to the contrary.

You don't even need to go into market-specific examples to show how silly it is to suppose that banks avoid risky behavior. If you literally go talk to an investment broker right now and talk about investment strategy they will openly mock how insurance companies make investments because they use conservative models that get relatively little return, compared to banks that rate to get a couple more percent on the same type of investment. Insurance companies set up their investments to be almost foolproof long-term, even though they do diversify their holdings like everyone else to include higher-return products. But overall their operating mandate is "we intend to be here in 200 years from now", which is very differently from an approach that looks at quarterly results and where the executives push maximum return. It doesn't take a rocket scientist to realize that the fraudulent practices being made at the branch level of Wells Fargo are an example of the trickle-down from upper management to get the numbers as high as possible. This is not the behavior of a conservative operation.

Fenring

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The argument was that if the model was working for "bad credit risks" how could it not work for even better credit risks?  The advantages of the model were the "freedom" from traditional constraints (like 20%) down, the speed - these loans were able to process much faster and even entirely on line, and - at that point - the demand for more "sub-prime" fuel for the CDO market.

You have more or less two options when inspecting the scenario we're discussing here. Either they were incompetent and didn't see why spreading this behavior to other areas of their business was risky, or they knew what they were doing (i.e. that it was risky) but only cared about the short-term results of it, assuming that if anyone paid the price for it that it would be 'the other guy.' I don't accept the 'but it wasn't their fault!' argument because they chose to expand behaviors unnecessarily. It might be interesting to inspect why they did this was it was an unforced error.

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The fact that this whole thing was in response to government pressure, doesn't excuse the knock on that the industry added to it (I mean seriously, creating synthetics because there isn't enough product?).

"Response" is such a prejudicial term. That's like saying that "in response" to the government handing out welfare checks to the needy some tycoon began robbing people at random and handing that money out to the middle class. "I'm just doing what they're doing, in a totally unrelated fashion! They started it!" What you might say is that a government program designed to help people in worse areas gave the banks the bright idea that they could expand their operations "safely" so long as the activities were masked under the guise of AAA securities. The inherent difficulty in unloading crappy mortgage securities by was fixed by packaging them in colorful AAA CDO's, and so this naturally led them to think "Wow, I wonder if we can do this trick in other areas", and of course they did. Basically their entire business practice became fraudulent, if I'm to call a spade a spade. The idea that the government 'made them' do this is laughable, although as I mentioned earlier, it's true that - under the assumption that the financial sector is a wild animal - the government ought to know that setting certain incentives may create undesired reactive behavior. As the analogy goes, it means the beast was incorrectly muzzled and a lot of people got bit.

This kind of subject always reminds me of video game design, specially for mass online or MOBA games. What balance teams have to contend with is that their desired balance design, which includes weapon/armor stats, special ability numbers, coding for interactions, etc., is rarely reflected in real world play. They think they've created a niche item for one type of character, for instance a mage, but for some reason the archer class finds a way to abuse it and it ends up being an archer staple and not even used much by mages. So then they try to rebalance it and it gets nerfed into the ground and useless. Or in an attempt to strengthen tank characters they create a new armor that turns out to be abused by DPS fighters due to a particular strategy players begin using and the tank class isn't helped by it much at all. To fix that the tanks are internally buffed, while the armor remains as is, and now the tanks are OP while the archers can't damage them very much, and to fix that a new bow is needed, etc etc etc. The balance issues are so complicated that any change to the ecosystem can have far-reaching and unintended effects, and that's not even getting into bugs and coding issues where implementing a change can often be difficult in its own right. And yet obviously the balance team does have to tackle these issues because there's a product on the market (the game) that has many players and time-sensitive needs. Now imagine the same situation in a national economy, but where life and death could be on the line for people in terms of the game producing the right results. A misstep in coding or implementation could cause economic catastrophe, and to make it worse, some people among the balance team have a vested interest in results that won't benefit most players. Oh, it's easy to say that this is proof that the government shouldn't be involved. But on the other hand if they weren't you'd only have to see what becomes of the ecosystem in order to realize how much a balance team is needed. People will always try to break a game - that's a fact every game designer knows. They will always try to create OP strategies, to abuse products that were meant for other purposes, to minmax their business model, and to tilt the system to their own advantage maximally. It's not just a maybe: it's automatic and will happen every time. The only scenario when players don't do this is when there's no advantage to it, and even then some will anyhow just because they can.

TheDrake

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They don't.  They can take their cut and play it safe.  But their growth will be far far slower, and their shareholders madder than the banks who "play it safe" by explicitly following government policies, you know, borrowing excessively for near free from the Fed, making high interest loans that are fully guaranteed (all profit, no risk), accelerating their "flipping" of loans into securitizations (gets them off their books, and lets them earn points again and again and again by recycling their capital).

This is precisely why I believe the biggest problem - and one created by government policy - is to bail out stockholders. Stockholders clamoring for high profits should eat the downside with no cushion, otherwise, why wouldn't they clamor for high risk with limited downside?

Stockholders (especially the executives) need to be left holding an empty bag when their gambles don't work out. Unfortunately, many of those stockholders were pensions and 401k. Pension managers don't want to miss out on high profit - even in an altruistic perspective they need to ensure that underfunded pensions can keep paying out. People with a 401k who choose a mutual fund rated "Income" rather than growth don't expect to lose half their value. And yet, if they don't, they'll be happy to do it again.

To Fenrings point, if you don't get kicked off the server and have your stats deleted for cheating, why wouldn't you cheat?

Speaking of gaming the system, I was reading a study about how bank behaviour changes when they are up for CRA examination (usually about every 5 years). They increase their CRA loans about 12 months before the exam to get a high score on lending but early enough that most defaults haven't happened so they can pass the "safe and sound" test. (Yes, on paper, the government says not to satisfy CRA by taking insane risks). Two valid ways to interpret this.

1. The government has set them an impossible task and this is the only way they can manage the demands and threats.

2. The banks choose the laziest way possible to meet the requirements, rather than spending extra time to qualify applicants from those areas to determine fitness.

I suspect it is somewhere in the middle, and people in CRA areas get crushed between two alternative realities. They either can't get any credit or loans, or they have crazy terms shoved at them and lack the good sense to avoid it - or grasp at it as the only way they know to refinance their house or start a small business.

Seriati

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You don't even need to go into market-specific examples to show how silly it is to suppose that banks avoid risky behavior.

Fen, seriously, you're crossing like six different regulatory regimes here.  Brokers /= banks, they have entirely different regulator and regulatory regime, they transact in securities (mostly).  Insurance companies are some of the most heavily regulated investors on the planet - there are federal and state laws dictated everything they do - heck, you can probably find your own state's insurance commission if you look.  Most of their investment program is dictated by law.  One of the reasons CDOs were so popular was that the AAA rating allowed insurance companies to put part of their portfolio into the asset class.

Meanwhile, traditional lending is so far down the risk scale from securities and structured products as not to be in the same league.  A 20% equity requirement on a loan is a huge safety cushion, 3% not so much, but still based on a very safe asset.  A broker meanwhile can give you 50% leverage to buy stock on a loan secured by the stock, and if that's volatile you can get hit with a margin call almost immediately.  Part of the primary appeal of CDOs is that the underlying assets are extraordinarily safe assets.

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It doesn't take a rocket scientist to realize that the fraudulent practices being made at the branch level of Wells Fargo are an example of the trickle-down from upper management to get the numbers as high as possible. This is not the behavior of a conservative operation.

Which mixes about a dozen different things.  You understand that a commercial banking operation has almost zero connection to an investment banking operation inside the same company? 

Fenring

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Which mixes about a dozen different things.  You understand that a commercial banking operation has almost zero connection to an investment banking operation inside the same company?

Actually this is something I've been meaning to look into. Legally, and in some ways functionally, the law required investment firms and commercial banks to separate and operate independently. Certainly we'd assume that the books of each of kept separate. And yet what I wonder about is whether there still isn't a fundamental connection between a brand's commercial and investment companies. Like, is the board consisting of the same people for each? Or maybe people in common? Or alternatively, do the CEO's of each confer with each other and basically plan their strategy in lockstep? The question for me boils down to - to what extent did complying with the law actually result in the full separation of those companies?

My point above wasn't the investment execs give orders to bank branch managers, but rather than the operating principles of a financial institution - whether an investment firm or a commercial bank - are going to be conducted with a certain mentality regarding the quarterly bottom line. So by 'trickle down' I could have specified that I was talking about the air in the industry, 'the way business is done' at the higher levels, which results in that kind of shenanigan at the lower levels. Never mind that we're talking about the behavior of investment firms at the moment, because I believe that the same 'sins' could be attributed to their commercial banking counterparts. One thing about which I know nothing but maybe you can shed some light on, is also how the commercial banks invest the monies that come to them. For instance, are there laws preventing them using those monies to invest in their sister-company of the same name?

Seriati

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Fen, investment firms are NOT investment banks.  Two completely different things.

I can't even begin to explain to you how complicated these entities are.  It's literally not uncommon for a major bank to have divisions directly competing with each and not even be aware of it.  I knew one bank that had four different operations that each thought that it was the "exclusive" part of the bank covering the exact same type of service.

Seriati

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I thought this was an interesting link https://www.usnews.com/news/best-states/rankings.  I don't much trust these kinds of rankings they tend to hide significant information, but it is interesting to this discussion in that it rates CA's economy very highly, but its Opportunity and Fiscal Stability very poorly, which is in line with an idea that there may be merit both to what Greg is saying and to what I've been saying. 

Apparently, CA has one of the worst income division problems in the nation, with its 1%'ers generating the vast majority of its tax revenue, and being heavily dependent on market gains.  That - to me - is a surprising fact pattern for a State that supposed espouses liberal policies.  CA came in last in quality of life (which again is a bit of a shocker) but it seems to be heavily connected to the expense of living there for renters and the high amount of people who can't afford to live in homes at all.

Still, wouldn't make too much of it, on some measures there may be less spread between 1 and 50 than there is between 1 and 2 on another.  Rankings inherently hide the scale and significance of differences.