But what I think it’s not including in that story is the extent to which these Wall Street guys honestly thought that what they were doing wasn’t that risky. They thought that a Double-A- or Triple-A-rated security had so much protection through various ways, there’s just no way this thing could blow up. And I would say that, in terms of going forward, one of the challenges we as the public and citizens and our government is: How do you create a financial system, how do you create an economy that both gives us the safety that we need to both be happy and to prosper and to take risks without destroying our selves but doesn’t create those fatal levels of complacency?
This is from a Russ Roberts podcast, with much more in the conversation.
It all depends on whom you mean. Those on the front lines passing emails about what crap they were producing, not so much. Those on the top who could only see how much they were making and demanding more, sure. The former can only lose sooner by not complying or later by complying. The latter make sure they clean up while they can, and lobby hard to be saved when they can’t. It isn’t a matter of knowledge or not but winning from ignorance and losing from knowledge. Private gains and social losses certainly isn’t the way.
Is there any place you know of with a concise explanation of how the ratings sector has changed? Something like:
1. Here’s what went wrong with ratings.
2. Here’s the way we’ve changed the way we do business.
3. Here’s why the ratings systemic-failure component 2008 can’t happen again.
Here is what I think happened: the low interest rates nudged people to stretch for yield. There not being enough of the required or sought-after AAA securities, “don’t worry, we’ll make more.” How? No problem, housing never goes down, so a relatively diversified bundle of housing could be made AAA. Well, housing never goes down as long as there aren’t low interest rates causing people to oversupply AAA-rated credit products feeding the home price and credit boom. “See! House prices go up!” Rinse, repeat.
Fannie Mae and Freddie Mac were government entities in all respects except their technical designation as private companies. They had special federal borrowing rights, a special regulator controlled by congress, their management was appointed by congressional committees, and they had the implicit backing of the federal government.
Fannie was a government agency until President Lyndon Johnson took it off budget (and off the government’s balance sheet) in 1968, to reduce the official government deficit at the time of the Vietnam War. The implicit government guarantee gave them the power to borrow whatever funds they wanted, to buy mortgages and issue mortgage backed bonds. This was $5.4 trillion at one point in the last two years before collapse, including $1.4 trillion in sub-prime mortgages.
The federally approved ratings agencies S&P, Moody’s, and Fitch owed their profitability to political favor, and they came under pressure to give AAA ratings to the new mortgage backed bonds and the highly technical (and now understood as risky) CDO’s (collateralized debt obligations). This allowed the bonds to be sold to financial institutions around the world. This put a stamp of approval on bonds by Fannie, Freddie, and huge volumes from private issuers.
Government oversight committees did not mistakenly overlook these developments; this was all government policy.
If these businesses had been designated as official agencies of the government, then the financial crisis would be correctly seen as a failure of a massive, off-budget, government program. However, because they were unofficial government agencies (the creatures of government policy, power, and influence), the cry is that the free market has failed. So, in the greatest irony, government argues for greater regulation and management of business and the people’s lives.
This is brilliant. That said i have to ask ” but what changed” fundamentally to the extent that after the dot Com worst stock bubble possibly ever that we created a near depression less than 10 years later.
Thanks for the compliment.
I suggest that big government plans produce big failures.
I don’t have much insight into the DotCom bubble. Maybe it was a “real” bubble, an overestimate of the profits which could be captured from using the internet.
Our socialists in government did worry about how to restore the wealth which was “lost” in the bubble. Of course, much of the paper gain was not real, so it really wasn’t lost.
I think our socialists put that crisis to use. They thought they could put people back to work building houses, and no one had ever lost money on houses. The catch: they needed more people to buy houses. So, they spun the theory that unreasonably tight credit and racism was withholding the financial resources which would allow many of the poor to buy a house.
FanFred was the mechanism for making that credit and funds available.
I think our leaders were truly surprised that this fell apart. Houses were safe, real investments made out of physical stuff. How could their prices fall? Well, yet again, government can do things in the market which private companies either can’t do or are afraid to do. (smile)
For most of the housing details,
http://easyopinions.blogspot.com/2008/10/we-guarantee-it.html
We Guarantee It
A collection of references to information about the causes of the mortgage and financial crisis. How the government directed massive resources by implicitly guaranteeing the actions of Fannie Mae and Freddie Mac.
Since you [didn’t] ask,
http://www.ritholtz.com/wp-content/uploads/2016/01/mortgages.png
Would you tell me what you think that chart means. What does it say about what?
For example, it says nothing about who originated or aided in originating the sub-prime loans.
As a chart of percentages, it does not indicate relative volumes of loans, or even volumes of loans from year to year.
Yes we tend to paint people like bankers as all bad all the time but they are not.