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posted by dsk on October 7th, 2008 at 8:30AM
>And it was wrong for consumers to live beyond their means and take on debt they can't afford.
I can see this happening.
>So it was wrong for the lenders to give out risky loans.
But why did they do it? Lenders were giving out 20, 30, 40 year mortgages to 'subprime' (i.e. high-risk borrowers). The only way you can rationally justify those loans, under a free-market, is if house price would continue to rise at the level that they did forever. Nobody was that stupid, not the internet peanut gallery who saw this as a bubble years ago, and certainly not the financial guys making millions forecasting markets, nor the banks who put up their own money. Rick, you can not convince me people were that stupid. When it comes to their own money, people are smart. When it comes to billions of dollars of their own money they are very very smart.
Everyone knew that the incredible rise of house-prices was going to drop dramatically within a few years. Even without this, real-estate is cyclical, it goes up and it goes down. So why would a bank issue a 40 year mortgage to a person who has little chance of paying it back, and with the knowledge that house price will stop rising at the level that they did (and even fall). There had to have bee a massive market distortion for this to happen. Banks which operate billions of dollars are not that stupid - and you're trying to tell me that they are.
This market distortion could only have been caused by government.
I've read a few articles on this. Here's two of them:
http://www.investors.com/...=306370789279709
http://www.bloomberg.com/...sid=aSKSoiNbnQY0
The articles may or may not have gotten the whole story. They may or may not be right. But what they say makes infinitely more sense to me, than what you're trying to convince me of (that is, entities with billions of dollars whose sole reason for existing is to lend money, in fact don't know how to do it. That the right market strategy for them to make money is in the hands of a random software developer from Seattle).
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posted by rick on October 9th, 2008 at 5:09AM
Some random researching led me to http://www.letxa.com/articles/25 this article.
What are financial derivatives? What are Credit Default Swaps (CDS)? They are sort of like insurance against loans, except they are not regulated as insurance, so they are more like bets against the borrower being able to repay the loans. But since they are simply contracts between entities, there is no regulation to ensure that the sellers of CDSs actually have a capital reserve in case the borrower defaults on a loan. Also, as the article points out, they can sell multiple CDSs on a single loan, even to entities that aren't lending any money.
Knowing this, a series of mortgage defaults can trigger an avalanche of claims that can overwhelm banks that sell these derivatives. |
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posted by rick on October 7th, 2008 at 8:09PM
No argument here. That's consistent with some articles I've come across. Specifically, http://query.nytimes.com/...on=&pagewanted=1 this one about Fannie Mae responding to pressure from the Clinton Administration to lend to low-income borrowers.
I'll bring up another http://www.nytimes.com/20...n01NhrLJAjQLHx5V w&oref=slogin article though. The investment banks successfully pushed to remove regulation that dictated how much money they had to keep in reserve to buffer against losses from failed investments. So the banks have to accept some of the blame as well. |
posted by dsk on October 8th, 2008 at 12:26AM
>The investment banks successfully pushed to remove regulation that dictated how much money they had to keep in reserve to buffer against losses from failed investments.
Ok. So now you explain to me how being allowed to hold a lower reserve of cash makes banks issue irrationally risky loans. I can't see a correlation between the two. In fact, I could make the case that it should make banks more prudent.
Anyway, the most I could say is that they would have less money to throw around on bad loans - which might have meant an eventual bailout of $500 billion, instead of $700 billion. But it doesn't address the fundamental issue I had with your reasoning. Mainly why banks would exhibit irrational behavior in the form of lending to people that have little chance in paying those loans back (and all this with full knowledge that house prices were not going to go up forever), in the first place. The answer to this question has nothing to do with deregulation, and almost certainly implies market distortion.
Deregulation might have increased the eventual losses only by the happenstance of coming about during a time of this distorted behavior but clearly, could not be the root of the problem itself. With or without deregulation we were heading towards this crash.
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posted by rick on October 9th, 2008 at 4:32AM
The problem is two-fold: The banks had more capital to dump into failing investments, thus digging themselves into a bigger hole; and they no longer had the reserve to guard against failing investments. It's hard to say how much it would have helped, although I don't believe it would have required $500 billion to fix. Heck, I don't even know where the $700 billion figure came from.
As for why banks would take on risky investments, subprime loans charge higher interests, which generate more profit for them. And as you said, as long as housing prices kept rising, it didn't matter that some borrowers couldn't afford the loan, because they could simply foreclose and sell the house at a higher price for a profit. The banks saw this trend and tried to capitalize, but they couldn't predict when this trend would stop in time.
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posted by dennisn on October 7th, 2008 at 10:24PM
No. The the banks did not behave recklessly. They knew they had government backing, and thus could safely take on far more risk than a free market would possibly have allowed. In an unregulated environment, they would have risked being unemployed, and thus would have self-regulated themselves. With government intrusion, essentially none of these risks or signals are relevant.
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posted by dsk on October 9th, 2008 at 9:56AM
>Housing prices were rising, which makes subprime mortgages essentially a non-risk
Oh come on. I'm 100% sure Banks didn't think this way. These Banks that were in business for decades through many market cycles. These Banks also issued mortgages that would last decades. It is a huge risk to believe that house prices would go up /at the level that they did/ for long enough time for them to break even. House prices were going up in Canada too. Ontario was going through a boom. Alberta housing market was exploding, but you didn't see Banks going crazy, lending money to anyone that asked. Why? Because they didn't an implicit agreement that government would guarantee subprime loans. They didn't have government pushing them to make subprime loans. They didn't have Fannie and Freddie.
>A lot of these loans were bought out by Freddie and Fannie afterwards anyway, so the original lenders didn't have any risk.
There it is. It's not the fact that house prices were going up that was the problem. It's the fact that lending to a particular high-risk high-reward demographic, carried no risk - which rationally promotes that action. You want to engage in high-reward behavior if the risk is removed.
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posted by rick on October 9th, 2008 at 5:02AM
Yes and no.
The banks knew they could safely take on the risk, because of two reasons:
- Housing prices were rising, which makes subprime mortgages essentially a non-risk
- A lot of these loans were bought out by Freddie and Fannie afterwards anyway, so the original lenders didn't have any risk. And Freddie and Fannie was backed by the government, so you are correct there.
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