I won't speak on this plan, but at least one Wharton professor did a real good job summing up the whole housing mess when up in front of congress last month

YouTube -

Tanta-

You have repeatedly asserted that these instruments will not go away.

Would you be willing to invest in these at face value? Do you know anyone that would?

The reason originators will be required to retain some credit exposure is that no one is going to want to buy an securities where the originator is not holding a part of the issue. If the originators retain nothing, they have zero incentive to for good underwriting.

One would think professional investors would refuse to buy any security they could not understand but we all know that's not the case. Simpler structures should help since at least investors might have a clue what they are buying.

I still don't see what kinda of regulation would help on the investor side. Unless you are accredited investor, you already can not buy unregistered securities of any type. I don't think the government should be in the business of trying to protect accredited investors from their own stupidity.

The meltdown has made clear that additional consumer protection regulation. The easiest and probably most beneficial is to require standardized disclosure of terms similar to credit cards. A standard disclosure would make it much easier for borrowers to compare loans.

Linneman's proposal is just nuts. Write downs do not improve future bank cash flows. It's just useless accounting trickery. Spending tax payer money on outrageous severance packages is something only some who did their PhD at the University of Chicago could support.

Re: Can we talk?

How about no!

Thursday, February 28, 2008
Some insurers reckon they can teach investment bankers a thing or two about handling risk

Market Pipeline: Some insurers reckon they can teach investment bankers a thing or two about handling risk

Re: So what can banks learn from the insurers now the boot is on the other foot? Raj Singh, a former investment banker who recently became chief risk officer of Swiss Re, points out that the banks' risk models, which try to put a value on how much they should realistically expect to lose in the 99% of the time that passes for normality, draw on reams of historical data. But this can produce a false sense of security.

Insurers looking at, say, catastrophe risks have relatively few data points and thus tend to have a healthy scepticism of models. They more often brainstorm their own scenarios. “In insurance, we have to think the unthinkable all the time,” says Mr Singh, pointing out that the industry came up with a scenario of a multiple plane crash above a metropolitan area well before the attacks on New York's World Trade Centre in 2001.

Tanta-

Sorry for my misuse of terms. I knew that a CDO wasn't an MBS, but thought an MBS was a form of CDO.

CDO: An investment-grade security backed by a pool of bonds, loans, and other assets. Link.

Isn't an MBS a CDO, since it's a security backed by a pool of loans?

I guess it's one of those things where the definition fits but an MBS is not a CDO simply because it is an MBS, which has a narrower definition.

Ok Miss Tanata,

How about this: A person uses a Fed bank to judge risk:

E.G: Leverage ratio 5.00% 6.33%

A Fed bank should set examples of risk and accounting standards.

FEDERAL HOME LOAN BANK OF ATLANTA - Quarterly Report (10-Q) Item 2. Management's Discussion and Analysis of ...

Should an FHLBank be unable to satisfy its payment obligation under a
consolidated obligation for which it is the primary obligor, any of the other FHLBanks, including the Bank, could be called upon to repay all or any part of such payment obligation, as determined or approved by the Finance Board.

FHLBank Chicago will submit a Capital Structure Plan to the Finance Board
outlining a conversion under the GLB Act, along with strategies for
implementing the Plan.

"Paucity of the underlying material"

How about the fraudulent intent of the folks wrapping their toxic waste in layers of AAA ratings, and lies that it is all "good" paper.

We forgot the three sigma stress test.

Quite simply, wall street invented a new new new way to lose money at lightspeed.

Now, while I didn't attend Wharton, I sat through a few roadshows by their best and brightest at Fed brownbags in Philly, and was not significantly impressed. This is just more of the same.

What is patently obvious is that during a bubble, you can slice and dice absolute common manure and call it boutique fertilizer and make a ton of money from idiots.

Now, on to the next bubble, the fed bail out bubble of idiot homebuilders by giving them the ability to reduce their previous tax payments and get a refund based on today's losses.

Oh yeah, how many homebuilders are still puking out a dividend too, plus big bonuses for their CEOs?

All in all, we are getting what we deserve. A total collapse of confidence by the public in Wall Street will serve them well.

I predict the financial sector employment will fall below 5% of the general economy private sector employment. Half of the banks and half of the securities firms on wall street are superfluous, and if they are illiquid, oh well.

Someday this war's gonna end...

Tanta,

Nice post.

Its funny because the words "securitization" and "regulation" often appear in the same sentence or paragraph, but with too little sense being made in between.

IMO, we should hold to a "consenting adults" idea of securitization. What to say to an IB that wants to package toxic waste and sell them ONLY to unsuspecting rich people (aka "hedge funds")? Go for it!

That was one of the concepts behind Glass Steagal. IB's have no access to the discount window, are not insured by the FDIC, employ leverage, and deal mostly with wealthy individuals and institutions. They should therefore be "ring-fenced" from deposit-taking institutions. Why not go back to that model? Let the IB's shaft their rich customers with impunity as long as they meet all those reg's brokers have to study when they take the Series 7 exam. What if they fail? Who cares. Dozens of them have failed over the years. Aren't the IB's bigger now? Yes, but only because we (well, actually, Phil Gramm) tore down Glass Steagal, and the brokers were forced to compete against banks using their balance sheets -- something largely unheard of in the past. So they grew and grew, and presto, they became too big to fail.

Its ironic though: Glass Steagal was torn down in the name of innovation, and now the industry faces regulation that stifles innovation. Which basically means the G-S "reform" failed.

So let's turn back the clock, and leave it that. Its the simplest solution.

I agree that CDOs are dead. They never made sense to me. It was a terribly leveraged vehicle that if fails, fails catastrophically. I think that boring pass-through securitizations would survive. And I'm torn on structured MBS. On one hand, it's giving the investors a choice of risk/reward. On the other hand, the lower tranches are also highly leveraged which is not easy to understand at first glance. And they also tend to fail catastrophically when default events are no longer uncorrelated.

one other thing that you will sometimes see that often confuses people: market participants frequently refer to first-lien subprime MBS as "home equity loan ABS." how's that for stupid?

Re: There is some sense in here--but you'll have to go dig it out yourself. I've sighed so much I need a good drink.

If you didn't see this on check it out:

Mocking Finance Web Videos

The Big Picture

What a bunch of hooey. I understand less now than I did six months ago. B.S. is the lingua franca of high finance.

"According to Wharton finance professor Richard J. Herring, for decades, mortgage securitization was backed by government guarantees through Fannie Mae and Freddie Mac, and it worked well."

tanta, i love the way you are a stickler for detail, and this statement just drives me crazy. the early securitizations were NOT backed by government guarantees, the COLLATERAL was backed by guarantees. The securitization itself, the debt from securitization, was NOT backed by GSE's. (ok, there were some issued directly from fnma and fhlmc, but for the most part, wall street did the securitization.)

The risk that securitization was meant to REDISTRIBUTE was PREPAYMENT risk, not credit risk, (since the collateral was guaranteed). The reason you could get a 12% coupon and a 5% coupon was due to the yield curve and DURATION RISK, not credit risk.

This provided a true added value from the underlying collateral to pension funds and insurance companies who were trying to better match the DURATIONS of their assets and liabilities.

i have other thoughts, but it really is important to understand that there were other risks, important risks, that securitization did a reasonable job of redistributing, that were not about credit.

humbly
meli

con't.
It's key to understanding how this all went awry. When we started securitizing mortgages, the general coupon was 12% (there were still 17's out there) because your biggest investors out there had very limited need for an asset with a duration similar to a 10 year treasury. They needed short assets but more importantly, they needed LONG duration assets. The early securitizations took a product and repackaged it to fill a need. In the process, newly created demand helped mortgage rates to fall from 12 to 7, and have been in that vicinity every since.

In the last couple of years, the process worked the other way. The hedge funds found themselves with unlimited ability to leverage and they were looking for ASSETS, and wall street bypassed the regular originators of mortgages (banks, highly regulated and to fnma and fhlmc guidelines) for the mortgage originators (unregulated and to guidelines written in the wind).

imho
meli

Actually, I think it tells us a lot about how so many things that people like to think of as "planned" were really just ad-hoc accretions over a long period of time involving a lot of different participants.

oh i agree. i guess i should have said "how's that for confusing?"

the story-line i've heard is that the "home equity loan ABS" market developed distincly from the "residential MBS" market because it was originally just securitizations of prime second-liens. then people started securitizing first-lien subprimes (mid-90s?), which were considered "different" because they were mostly cash-out refis for people with bad FICO scores, so they went into the "home equity loan ABS" sector (different investor base than the MBS market), and it stuck.

...you see, because apparently in the old days, people who invested in subprime deals were something called "credit specialists."

So,

If whole SFR mortgages bundled didn't minimize the risk properly then maybe syndicated SFR mortgages will?

Nobody would be stupid enough to try that, would they?

Uh oh.

Bacon dreamz, that's the same story I've heard. It must be true.

well presumably your wrinkled snout watched it all happen first-hand, so i'll trust you.

i remember when pension funds would send people out to banks and spot check loan underwriting standards, even on gse mortgages, because it affected prepayments (which might be defaults disguised by the guarantee).

it was all about duration.

whatever. i forgive you. i just hope you're sticking to brownies and cheesecake these days.

Well, there were only so many brownies you could eat . . .

I always baked things for people under the theory that the fatter they became, the better I looked. So much easier than dieting

And, btw, this is a MOST excellent thread. Thank you Tanta I'm learning from it.

I keep waiting for someone to call you a dirty liberal for talking about government regulation.

Well, I would, but I don't think Tanta is dirty.

"More regulation" is as phony a panacea as "less regulation".

They're both merely excuses for not doing one's own risk assessment - believing the government will do your due diligence for you is as stupid as believing the market will do your due diligence for you.

Yes, CDOs are dead, and likely so are non-GSE MBS. Again, you can't compete directly against the GSEs, and there's fat chance of making the numbers work on the fringes.

p.s.: Everyone should note that Tanta called this way before it actually started happening.

I'm sorry, the market stopped being a free market when the Fed opened the TAF window.

I'm sorry, the market stopped being a free market when the Fed opened.

I apologize in advance for the ignorance that my question will express, but here goes: doesn't the requirement for originators to keep some credit exposure largely kill them because as a group, they never had that kind of capital (but made money by the fees of constantly writing new loans)?

I agree no regulation is needed - abolish the Fed, institute the gold standard, and most of these CDOs likely would not have happened in the first place.

Federal Reserve is the ultimate tool for creeping federalism in all aspects of life.

i don't think any additional regulation is needed, as long as everyone knows their place. Hedge funds were for 'sophisticated' investors. They are gambling. that's cool.

But they shouldn't have pension fund money. Period. If they couldn't get their fingers on the pension fund pie, then it's hard to see how they could get so big.

And then they should be allowed to fail. So should the investment banks.

I'm still not totally convinced that the world would have ended if Bear Stearns went under. I think the investment banking world and the hedge fund world would have ended, but all the rest of us would have been just fine.

Personally, i think the whole thing went bust when we allowed the investment banks to go public. The big constraint in the 70's and early 80's was that it was their own money on the line.

That has a way of focusing the mind.

i'm sorry...the above question isn't really on point. my original rant is to the statement by herring that tries to say that the original securities were safer because they were guaranteed by the gse's. they weren't. if they were safer, it was because they weren't trying to off-load credit risk. they were redistributing prepayment risk. And no, during that time there weren't securities backed by european mortgages.

his next statement, that the subprime market was more profitable, is patently untrue. It may have appeared to be more profitable, but it was a redistribution of credit risk from everybody who took their payout early to everybody left holding the bag.

ultimately, i don't see how it's been profitable at all.

Bill Gross--"In my opinion, the private credit markets have forfeited their priveleged right to operate relatively autonomously because of incompetence, excessive greed, and in minor instances, fraudulent activities."

Next bubble:

Yes. Commodities are the next bubble. The current one actually. In my opinion we are nearing the end of the boom cycle in commodities due to the credit crisis and resulting economic depression that will result.

Understand that dollars will become scarcer as the slump worsens, forcing down prices. Velocity is also likely to slow as a slump causes behavioral changes in how people treat money. It simply moves around much more slowly as people hang on to it for as long as possible.

"ginger, i'm an old lady, and in my tenure we never figured out a good reason to be securitizing european mortgages for exactly the reason you cite."

There were a number of reasons, some good, and some bad. European securitisations have never been off balance sheet, so that's not really an issue, but under Basel I you could get a lot of capital relief through securitisation. Even so, it was only in the last three or four years that spreads were tight enough for highly rated banks to consider it. For lesser rated banks and non-bank lenders (especially in the UK), securitisation was a very useful funding tool, much cheaper than the unsecured market and with a deeper investor base than covered bonds. Even for the big banks, some used securitisation to manage their risk exposure to certain sectors (usually with synthetic CLOs rather than mortgages, but not always). In recent years, when spreads dropped into the low teens for prime RMBS, even the big banks began to use securitisation to diversify funding and grow their mortgage books.

"If you're specifically off-loading credit risks, then it should all be about underwriting."

I'm not quite sure what you mean here. Could you elaborate?

Is it me or did that brownie comment go zooming over everyone's head?

got it, loved it

Zarley, you wrote:

"Next bubble:

Yes. Commodities are the next bubble. The current one actually. In my opinion we are nearing the end of the boom cycle in commodities due to the credit crisis and resulting economic depression that will result.
Understand that dollars will become scarcer as the slump worsens, forcing down prices. Velocity is also likely to slow as a slump causes behavioral changes in how people treat money. It simply moves around much more slowly as people hang on to it for as long as possible."

It is my understanding that towards the end of the any credit cycle, inflation begins to rise. Interest rates then begin to rise, which eventually makes borrowing expensive, thereby causing a contraction in the consumption sectors of the economy. Investors then will try and find somewhere to park their capital which is usually something "tangible". Gold and silver and are often viewed as "tangible." This will cause prices to rise.

This is evidenced by the three thousand year old traditions of hoarding stores of wealth that are physical, portable and easily devisable are hard to break.

In addition oil, grains and metals, also rise when inflation accelerates.
So while some commodities may fall (due to supply and demand factors) in price, I see physical metals rising. The rising price may mean defaults or consolidation in the equity markets for companies that use these resources and have weaker balance sheets.

I am bullish in the near term, but will use a hedged investment strategy via the options market and will obviously profit take sooner rather than later.

I think that GWB is the last cowboy.

If by "cowboy," you mean "rodeo clown," I'm in complete agreement.

Brownies?

Hey, Alice