Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

So they all knew it was a bubble, now?

by Jerome a Paris Fri Aug 17th, 2007 at 06:20:36 AM EST

As the markets keep on going through turbulence, and many conflicting opinions are heard as to whether this is just a harbinger of things to come (my position) or just a "welcome correction" (still that of most "serious" pundits and the conventional wisdom), what's most striking to me - and very revealing on its own - is how suddenly everybody is talking about the real estate bubble as it if were the most obvious thing.

The very people that, in many instances, denied that there was any kind of bubble, or that house prices were a problem in any way, and denied that market valuations of certain assets were completely unreasonable, are now saying, in hindsight, that it was indeed a bubble and, while they are still saying that nothing much will really happen fro mthe end of the bubble (other than silly people getting punished), they are already hard at work trying to pin the blame elsewhere.

"A cheerleader, moi?", they ask, outraged.

But their new attitude ensures, right now, that the crisis WILL spread. Let me tell you why.


Thus, Martin Wolf, the senior economics correspondent of the Financial Times, the European business version of a Broder in Washington:

 


Fear makes a welcome return (FT, 15 August)

The world has witnessed four great bubbles over the past two decades - in Japanese stocks in the late 1980s, in east Asia's stocks and property in the mid-1990s, in the US (and European) stock markets in the late 1990s and, finally, in the housing markets of much of the advanced world in the 2000s. There has been too much imprudent finance worldwide, with central bankers and ministries of finance providing rescue at virtually every stage.

This is a polite version of my "Bubbles" Greenspan moniker: cheap money, especially in times of turmoil, has cause runaway asset price inflation. But as wages were under control thanks to the Chinese, there was nothing to worry about. But now, this is deemed "imprudent". And a classic mania:


The process starts with "displacement", some event that changes people's perceptions of the future. Then come rising prices in the affected sector. The third stage is easy credit and its handmaiden, financial innovation.

The fourth stage is over-trading, when markets depend on a fresh supply of "greater fools". The fifth stage is euphoria, when the ignorant hope to enjoy the wealth gained by those who came before them. The warnings of those who cry "bubble" are ridiculed, because these Cassandras have been wrong for so long. In the sixth stage comes insider profit-taking. Finally, comes revulsion.

Ridiculed we were indeed. But whether this takes the form of Jim Cramer begging the Fed to bail out feckless financiers, or Wolf's more prudent assertion that the "central bank must save not specific institutions, but the market itself," two thing are certain, and undoubtedly acknowledged by all: that there was a bubble, and that it has come to and end. That people say that this is just the beginning, or that it is a healthy correction to still high levels is mostly irrelevant, because what matters is that the notion of the end of the bubble is now widely public, because this is the single most important driver of things.

To make it simple: market psychology has flipped - from "prices will continue to go up" to "prices will no longer go up" - and thus the herd will stop buying. It doesn't really matter if it starts selling, or if it holds tight - buyers have become scarce (both because they suddenly don't think it's a good thing to buy, and because banks have stopped lending them money to do so - that's the credit crunch bit of the current crisis), and people don't expect prices to go up anymore. That, in itself, in enough to cool the markets. No expectations of quick gains and fewer buyers means, at the very best, stagnant markets.

But too many things in recent years have been predicated on ever increasing prices. Ninja mortgage loans (no income, no job, no assets) can only be repaid by flipping houses. Too many private equity buy outs of corporations made sense only in the expectation of a quick resale within 2-5 years at a premium. Now these homeowners and the companies have to live with crippling debt burdens - and many will collapse under that weight. That means, down the road, houses dumped on the market, and companies going bust, with the attendant layoffs, loss of pension and loss of healthcare. To be honest, the scale and the timing of these phenomenons is still very hard to pin down, which explains why prognoses go from 'speed bump' to 'major economic depression.'

But again, the end of the great bull market is, in itself, enough to seriously cripple what has been the main engine of growth in recent years: construction, financial engineering and increasing debt. Wages, which remained stagnant in supposedly booming economies, are not going to go up now, and the lower ability of households and corporations to borrow yet more money will necessarily cause ther spending to shrink.

Again, I have not yet talked in any way about the cost of the financial bubble itself - only about the expected changes in economic behavior due to new conditions. The financial meltdown, if there is one (as I personally think there will be) will only add to that and make thing worse by weakening banks, causing asset dumps and bringing down all sorts of asset classes down, and all the business they underpinned.

For samples of what might happen, read this Hedge Fund Sell Outs Threaten Markets or this excellent summary by stoneleigh over at the Oil Drum: The Resurgence of Risk - A Primer on the Developing Credit Crunch.

Without going into these scanrios, what strikes me, again, is how quickly the pundits have flip-flopped to the new common wisdom of the bubble and are out looking for scapegoats.

Here's Martin Wolf, again:


Financial markets, and particularly the big players within them, need fear. Without it, they go crazy. Moreover, it is impossible for outsiders to regulate a global financial system riddled with conflicts of interest and dominated by huge derivatives markets, massive trading by highly leveraged hedge funds and reliance on abstruse mathematics and questionable statistical models. These markets must regulate themselves. The only thing likely to persuade them to do so is the certainty that the players will be allowed to go bust.

"they go crazy" (i.e. they overpay for assets) "conflicts of interest" (i.e. cheerleaders profit from higher prices) "highly leveraged" (i.e. too much easy debt) "questionable statistical models" (i.e. models work only so long as there are no crises). And the culprits are indeed now all over the media:


Rating agencies hit by subprime probe

The European Commission is to investigate credit ratings agencies amid growing dismay over their slow response to the subprime mortgage crisis.

Officials in Brussels, and many other critics, believe the ratings agencies failed to act quickly enough to warn investors about the risks of investing in securities backed by US subprime mortgages - the sector whose troubles triggered the recent global market volatility.

In the US, Barney Frank, Democrat chairman of the House financial services committee, said he planned to hold hearings on the agencies' performance next month. He said the agencies had "not done a good job" in the current crisis.

Rating agencies got paid by banks to provide ratings. Good ratings meant more sales by the banks. Of course there was pressure for rating agencies to be optimistic. Thier only restraint was their reputation, and we saw how effective that was for Arthur Andersen. Plus, the more they rated junk bonds favorably, the easier it was to refinance dodgy companies, and the fewer defaults there were, thus providing more fuel for that cycle.

This has been said for months by the Cassandras but, as usual, investigations get started when it's too late. Hopefully, this will at least lead to a fundamental rethink of the role of the rating agencies in the lending markets. Giving such a fundamental gatekeeper role to private entities essentially paid for by sale-side bankers is not a good way to avoid bubbles.


Limitations of computer models

"Models (ours including) are behaving in the opposite way we would predict and have seen and tested for over very long time periods," said Lehman Brothers last week.

A glance at recent financial history shows that this type of "rare" event is not so unusual at all.

(...)

"People say these are one-in-a-100,000-years events but they seem to happen every year," says Satyajit Das, a consultant to hedge funds and investment banks. "This episode should make people ask questions about models - I think it could lead to a real reassessment."

Any such reassessment could have far-reaching consequences. The spread of financial models is at the heart of the growth of modern banking. Indeed, were it not for modern computing power, this decade's remarkable explosion in finance would not have occurred at all.

(...)

But while computers are often able to operate better than humans in "normal" markets, this month's events demonstrate that during times of stress they have some crucial flaws. One problem is that models typically predict the future on the basis of past data. This can lead to distortions, given the speed at which the financial industry is currently evolving. Indeed, many of the instruments at the heart of the current credit storm barely existed before this decade - which means that computers can only model these markets based on the benign conditions of the past few years.

Another big problem is that computer models do not always take account of the way that their own behaviour is affecting markets.

The dirty secret of bankers is that they are bad at science and maths, and do not understand that a model, however sophisticated, cannot provide output of a qaulity better than the input. Lots of data does not mean better data; what makes data "good" is qualitative analysis, i.e. risk assessment by bankers doing their job instead of relying on fancy models. They do use extremely smart mathematicians to play around with data, but these guys' jobs are not that of bankers. I mean, "models typically predict the future on the basis of past data" - anybody that has ever bought any financial instrument gets told (or sees written in small print) right from the start that the past is no indicator of the future...

Thus, models work until they don't. LTCM's lesson has visibly not been learnt.

But blaming rating agencies and computer models, of course, is a way to avoid the real debates, the ideological ones - that over the supposed superiority of the "efficient markets" to drive economic behavior, that over the insistence that things be valued in dollars (discounted cah flow) or be worthless, and that over the idea that greed is good and leads to socially acceptable outcomes. The core of the Reagan-Thatcher revolution is that greed (especailly that of financiers capturing future cash flows of the real world for their personal, immediate profit) spontaneously improves the common good, and that all regulations and taxes that limit it should be dismantled.

Well, we're about to see the price of that grand collective delusion. But we, especially those of us that call  ourselves progressives, should not mistake our target. Bankers and financiers should be made to pay for their follies but that is only a small part of it. The big thing is to blame it on the failed, and utterly dangerous, ideology of the efficient markets/society doesn't exist/government is the problem crowd. otherwise it will start again - and not only that, but their proposed remedy WILL be lower wages, fewer worker rights, lower taxes and the other usual "reforms."

Again, the fact that a bubble is now publicly acknowledged ensures that there will be a major economic correction, irrespective of whether there is a full financial meltdown or not. There will be pain. There will be calls for bailouts. There will be further pressure on the lower and middle classes to bear the brunt of the price. Unless we have a coherent alternative economic discourse on the crisis - that of strict regulation of the financial world (real regulation, not the busybody but pretend kind like we have right now), bankers will continue to capture wealth, even as the pie shrinks.

Display:
http://www.dailykos.com/story/2007/8/16/134516/013
Thanks for your support over there.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Aug 16th, 2007 at 01:48:29 PM EST
J, this is a fantastic diary!

What I'd like to know is how it will affect us.

Is the bubble casino simply an imposing edifice in the center of downtown society where the rich go to play? If the casino burns down, will we suffer?

Or will the banks get back to investing in assets, or providing the means for entrepreneurs who create assets?

I assume that the UK will be hard hit, because the export of financial legerdemain from the Square Mile is so crucial to that economy. But what about all the other smaller hard-working countries of Europe?

You can't be me, I'm taken

by Sven Triloqvist on Thu Aug 16th, 2007 at 04:01:54 PM EST
[ Parent ]
I don't know if you'll take this as a compliment or what, but this at the beginning had the rhetorical tone of a Glenn Greenwald bit on media disingenuity (i.e. when the media is all of a sudden shocked that something bad is happening when it was obvious to some long before).

Good piece.

by R343L (reverse qw/ten.cinos@l343r/) on Thu Aug 16th, 2007 at 07:39:27 PM EST
[ Parent ]
I'll take it as a compliment!

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 12:20:33 AM EST
[ Parent ]
LTCM's lesson has visibly not been learnt.

And this radio interview I just listened to with the author and protagonist of Confessions of a Wall Street Shoeshine Boy does not encourage me that it ever will be, particularly regarding:

  • bankers' concern for "the little guy"

  • bankers' pouting expectations that it's the Fed's responsibility to bail them out "for the good of the economy" when their excesses cause disasters

Depressing to see facile stereotypes of bankers confirmed so accurately by their own words in this way.

Truth unfolds in time through a communal process.
by marco on Thu Aug 16th, 2007 at 03:08:55 PM EST
From your excellent post...

But blaming rating agencies and computer models, of course, is a way to avoid the real debates, the ideological ones - that over the supposed superiority of the "efficient markets" to drive economic behavior, that over the insistence that things be valued in dollars (discounted cah flow) or be worthless, and that over the idea that greed is good and leads to socially acceptable outcomes. The core of the Reagan-Thatcher revolution is that greed (especailly that of financiers capturing future cash flows of the real world for their personal, immediate profit) spontaneously improves the common good, and that all regulations and taxes that limit it should be dismantled.

This time we have to make sure it is not their truth that becomes the common wisdom.

Money is a sign of Poverty - Culture Saying
by RogueTrooper on Thu Aug 16th, 2007 at 03:15:52 PM EST
this point is almost never discussed in the DailyKos threads, and never picked up on the site otherwise - and the diaries of mine that insist most on it often don't get recommended.

It's disheartening.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Thu Aug 16th, 2007 at 03:51:42 PM EST
[ Parent ]
Yup. See my comment below.
by afew (afew(a in a circle)eurotrib_dot_com) on Thu Aug 16th, 2007 at 04:05:10 PM EST
[ Parent ]
I've found that most people who read blogs tend to do so to feed their sense of outrage. They are noticibly less keen about doing anything about the causes of that outrage.

Political wanking*, if you will.

If I had enough "face" I would ask John Aravosis how he thought the issue should be addressed. I rate him as one of the best tactical campaigners on the left wing blogsphere.

God love Atrios but he does not know how to use the work wanker properly. ;-)

Money is a sign of Poverty - Culture Saying

by RogueTrooper on Fri Aug 17th, 2007 at 06:06:52 AM EST
[ Parent ]
That should be "word wanker"

oops.

Money is a sign of Poverty - Culture Saying

by RogueTrooper on Fri Aug 17th, 2007 at 06:07:28 AM EST
[ Parent ]
The dirty secret of bankers is that they are bad at science and maths, and do not understand that a model, however sophisticated, cannot provide output of a quality better than the input.

What's all the more ironic is that these private sector organisations are behaving as bureaucracies where the bankers who aren't so hot at modelling ignore the advice of the physicists and mathematicians they lured out of academia with big salaries...

Sounds like "market pressure" is really working to optimise outcomes there...

by Metatone (metatone [a|t] gmail (dot) com) on Thu Aug 16th, 2007 at 03:47:38 PM EST
given that he is one of the math guys employed by "bankers"....

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Aug 16th, 2007 at 03:50:07 PM EST
[ Parent ]
I think we'll se a new idealistic Mig on his return. We were talking about it on Monday.

You can't be me, I'm taken
by Sven Triloqvist on Thu Aug 16th, 2007 at 04:03:31 PM EST
[ Parent ]
Was he talking about yurts?

Hopefully, as you say he will have enjoyed time away from work.

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

by ManfromMiddletown (manfrommiddletown at lycos dot com) on Thu Aug 16th, 2007 at 04:13:20 PM EST
[ Parent ]
He's lactose intolerant as far as yak's are concerned, so I think yurts would be a steppe too far.

But we were talking again about a bucolic centre of creative and intellectual excellence ;-) ETopia

You can't be me, I'm taken

by Sven Triloqvist on Thu Aug 16th, 2007 at 04:22:34 PM EST
[ Parent ]
I think ETopia needs young people, lots of 'em, I saw some lovely ones chained to the gates at Heathrow.  Great comments they made, too.  The police chief very nervous.  He has zero intention of hurting the children of the well-to-do, but there are orders... oh shit.

Hold on.  Great diary!

I second Sven's questions.  Maybe add one of my own.

How are the divisions within the banking community?  If I've understood things, you--Jerome--are working for a prudent company that listens to its staff and projects over the long term.  You call a pox on financiers, reminds me of the italian film about the mafia bag man...  Confessione D'Amore.  Or was it confessioni?  I've searched but I can't find it.  I've got the title wrong, surely.  A grey-suit guy who lives in a hotel in Switzerland as does nothing all day, never leaves the hotel.  Once a month, he goes to the bank.  My wife thought it was way too bland, so she went to bed, and then the guns came out.

So I wonder how the financial community divides up, as percentages.  If sixty percent are progressive, then they are in the position of the rest of us.  So how do they suggest we behave, in order to reach a position of maxium renewable power for minimum loss of pleasure.

Heh!  ETopia must also have accomodation for the elderly, and a very liberal policy towards substances which alter behaviour, such as coffee, tea, or electricity.

Ho!  

Don't fight forces, use them R. Buckminster Fuller.

by rg (leopold dot lepster at google mail dot com) on Thu Aug 16th, 2007 at 07:12:55 PM EST
[ Parent ]
Plus what Chris said.

Don't fight forces, use them R. Buckminster Fuller.
by rg (leopold dot lepster at google mail dot com) on Thu Aug 16th, 2007 at 07:39:13 PM EST
[ Parent ]
on my own employer, for what I hope will be understandable reasons. I'll stick to the safe side and say that I don't really know what's going on in other parts of the bank. It is supposed to be a rather conservative institution, and it is not a high flying investment bank focusing on hedge fund clients, so I hope that it will end up being safe, but I don't really know.

All I can say is that I expect my particular sub-business to be reasonably immune - and, even, to regain in favor as "stodgy and boring" becomes "safe and sound" (as a financial technique) and to keep the edge provided by the fact that renewable energy needs are unlikely to go away.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 12:26:59 AM EST
[ Parent ]
Several bankers and analysts i've spoken with in recent weeks (days) have commented that windpower is overvalued.  One even said under current conditions wind stocks will "get hammered."  This goes against what i believe, which is that the windpower pipeline remains fundable.  I wonder what will actually happen.

"Life shrinks or expands in proportion to one's courage." - Anaïs Nin
by Crazy Horse on Fri Aug 17th, 2007 at 06:44:43 AM EST
[ Parent ]
is the equity side, i.e. the valuation of companies that own wind power assets and hope to make a lot of money on the basis of either of two things, taking into account stable cost base (mostly debt repayment):

  1. stable revenues (feed in tariffs and other similar arrangements guaranteeing the price for renewable energy): returns are almost certain, and thus valorised as such - very little risk, so project value raises to that of the equivalent of a safe bond, i.e. with similarly lowish return

  2. variable revenues, but predicated on market prices for electricity, which are seen as going up. This is a bet on higher oil and/or gas prices, but with a floor of sorts (i.e. the pricve for renewable power will never be less than something which is pretty easy to estimate)

The lending side - which is what pays for the construction of the wind farms - works mostly on the basis of the certain revenues, and thus risk is limited and well understood. Remuneration for banks was getting skimpy, and some terms were getting somewhat aggressive (counting 20 years of revenue instead of 15, for instance) but things did not become completely unreasonable.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 07:07:15 AM EST
[ Parent ]
I think ETopia needs young people, lots of 'em, I saw some lovely ones chained to the gates at Heathrow.  Great comments they made, too.  The police chief very nervous.  He has zero intention of hurting the children of the well-to-do, but there are orders... oh shit.

The entertainment of the police dealing with the children of the well-to-do can be quite amusing. but the truly entertaqining stories of those things will have to wait till an ET meetup occurs.

but an example that wouldn't be considered libelous, and involves the health service rather than the police. At the bottom of my street used to live a man who was truly certifiable, who one day over a truely minor provocation (someone else had used his favourite mug) he charged round his own kitchen, utterly demolishing every single cupboard and unit in a £10,000 fitted kitchen (and this was at the end of the 80's) he finished this off by running the full length of said kitchen and putting his head through the internal door. We decided that the only sane thing to do was to grab someone we knew who worked in the mental health field and send him down to have a look and work out if we should get him comitted so he could get propper help.

Half an hour later he came back and said to us that it was never going to happen,  his mother was a senior member of the comittee of a major charity, his father  was a major member of an international organisation. We were told that there was no way this man would ever be comitted, unless he killed someone, up untill tghat point he was merely eccentric.

Any idiot can face a crisis - it's day to day living that wears you out.

by ceebs (ceebs (at) eurotrib (dot) com) on Fri Aug 17th, 2007 at 06:28:43 PM EST
[ Parent ]
I think you know not what you are talking about, Sven.

Can the last politician to go out the revolving door please turn the lights off?
by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 03:38:34 AM EST
[ Parent ]
I'm one of the math guys employed by "hedge fund managers".

Can the last politician to go out the revolving door please turn the lights off?
by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 02:50:03 AM EST
[ Parent ]
Now that I'm back from my 3-week blackout I can comment on this.
The dirty secret of bankers is that they are bad at science and maths, and do not understand that a model, however sophisticated, cannot provide output of a quality better than the input.
Even people who are bad at science and mats are bad at modelling, so nothing new there. And GIGO (garbage-in-garbage-out) is a cautionary concept that still tells you little about how to get good data
Lots of data does not mean better data
To think otherwise is to engage in what people call "datamining", meaning sifting data looking for correlations which may well turn up to be spurious (correlation is not causation - another catchphrase which is true but hard to put in practice productively)
what makes data "good" is qualitative analysis, i.e. risk assessment by bankers doing their job instead of relying on fancy models.
To put a contrarian/charitable spin on this, the hope seems to have been that the knowledge of bankers could have been translated into models giving rise to "expert systems" which would be able to do a banker's risk-assessment job. In other words, the philosophy of serious quantitative investing seems to have been to avoid acting on hunches: if you have an idea or a judgement you should be able to elucidate the reasons why and make a model about it. One of the fund managers I interviewed with nearly 3 years ago prided himself on a model of "no human intervention" precisely on this theory that if you have an intuition you should be able to make it a model.
They do use extremely smart mathematicians to play around with data, but these guys' jobs are not that of bankers.
My impression is that people are being hired on the basis of numeracy or IQ to the exclusion of funancial knowledge or experience, expected to be able to swim by themselves when thrown into the water, with little to no in-house training (all on-the-job, basically) and in many cases given very little, if any, exposure to "real" markets. Sometimes computer programmers, not portfolio managers or risk managers, or traders are in charge.
I mean, "models typically predict the future on the basis of past data"
Models have parameters. Parameters need to be estimated from past data.
- anybody that has ever bought any financial instrument gets told (or sees written in small print) right from the start that the past is no indicator of the future...
What the small print says is that past performance is not an indicator of future performance. This is intended to preven prople from marketing on the basis of a promise to obtain the same returns in the future as in the past. The disclaimer is always seen alongside displays of past performance intended as advertising, and is therefore being ignored both by managers (advertisers) and investors (consumers).
Thus, models work until they don't. LTCM's lesson has visibly not been learnt.
Hey, LTCM's predictive models are claimed to have worked in the end, what LTCM didn't have is proper risk management as they crashed because they didn't have deep enough pockets to weather one particularly bad adverse movement, and this is because they got greedy and reduced their outside investor base hoping to keep all the return to themselves, but reducing their capital base prevented them from meeting their margin calls...

By the way, a common accusation levelled against hedge fund managers is that if their models really work they keep them to themselves and only seek outside investors when returns are no longer that good, and make money from the (often outrageous) fees they charge. There is some truth to that.

Can the last politician to go out the revolving door please turn the lights off?

by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 03:15:20 AM EST
[ Parent ]
Even people who are bad at science and mats are bad at modelling

I mean even people who are good at maths and science are bad at modelling.

Can the last politician to go out the revolving door please turn the lights off?

by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 03:33:07 AM EST
[ Parent ]
Don't worry, I'm sure you'll find that in about six months time we'll be wondering what the panic was all about.

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Thu Aug 16th, 2007 at 03:57:05 PM EST
Maybe we could have a whip-round on ET and see if we can 'surge' some money at them.

If everyone in the UK put a fiver in the pot, we'd have - pocket money compared to the sums that are being talked about.

Oh well. It was a nice philanthropic idea, I suppose.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Aug 16th, 2007 at 08:25:00 PM EST
[ Parent ]
We could borrow it from the Chinese for you, and loan it to you.  Two hundred easy payments, rates as low as 4.5%...if ya can't beat'em, after all....

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Fri Aug 17th, 2007 at 08:24:33 PM EST
[ Parent ]
The big thing is to blame it on the failed, and utterly dangerous, ideology of the efficient markets/society doesn't exist/government is the problem crowd. otherwise it will start again

It will start again - nothing is more sure. But how far down do things have to go for a modal shift to happen? For it to be impossible for these lying bastards to spin their way out of it with the help of their "expert" crony journalists? How much pain to how many people, where in society? So that the deluded masses stop believing this is a system in which they are going to win?

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Aug 16th, 2007 at 04:03:22 PM EST
I have zero debt and some technical skills, which might earn me a belt to strap myself down on this roller coaster ride. The air is foggy and I can only see 10 feet in front of me, all I can do is hold on.

But how far down do things have to go .... So that the deluded masses stop believing this is a system in which they are going to win?

When the government can't even understand the derivatives market, the public has no hope of understanding the economic system on an intellectual level. The only way is through re-understanding the physical limits of the planet. There are still plenty of old folks around that remember what it was like to be poor, and thus frugal and perhaps a bit more realistic about how to live as they had no other choice.

you are the media you consume.

by MillMan (millguy at gmail) on Thu Aug 16th, 2007 at 05:44:37 PM EST
[ Parent ]
No one truly understands the derivatives market. That's because derivatives are the financial equivalent of vapourware. You're not buying a thing, you're buying a promise. Eventually - as with the credit bubble - you're not even buying a promise, so much as the possibility of a promise.

There's a lot of frankly wankish talk about 'quantifying risk' but the reality is that this is just one big boy's game. It's not even a casino, so much as organised extortion and robbery.

This fiasco is what you get when you left scientifically and mathematically illiterate idiots farm everyone else. They get away with it because their mentors - the rich billionaires with their adolescent libertarian ideologies - can afford to buy the narratives that define what's happening.

What people need to learn is that most of the starchy self-absorbed 'authoritative' people in suits are talking crap - utter, utter nonsense, far beyond the silliest fringes of the New Age or the most eccentric political and social beliefs.

Intellectually, they're flat earthers and extremist mullahs rolled into one. They have their degrees and their policy institutes and their funded programs, but they do not understand anything at all about real, non-ideological physically-grounded economics.

They're not only evil and stupid, they're also fantastically clueless and insulated from reality. This might sound shrill, but consider the historical record here - how much intellectual honesty do you need to realise that if you lend to people who can't afford to pay you back, and then sell on the loans, the results are guaranteed to be worthless?

Even this very simple level of insight seems so far outside of their imaginative scope that they can't even admit that it could be relevant to their computer models.

And yet they own almost everything, and want to own even more.

How much longer are we going to continue to put up with this plague of fantasists, chancers, apologists and self-inflating so-called experts?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Aug 16th, 2007 at 08:18:20 PM EST
[ Parent ]
actually I think the most common derivatives are pretty well understood by the quants that create them.  Maybe even most of the traders that play them get most of it.  The really kinky stuff is just fluff that doesn't trade in large volumes.

The trouble is, traders are paid to make big money.  If they risk big and win, a huge paycheck follows.  If they risk big and lose, they just look for another job.  The risk/reward is asymmetric and pushes you to take on more risk than is prudent.  Optimists tend to get paid better than pessimists.

Couple that with group think reinforcing the momentum in the market and you have a recipe for ugly snap backs.  Seen it more than once.

And don't kid yourself.  You can't con an honest man easily.  The people losing homes knew they couldn't afford them for the most part.  As for the flippers -- f--k em.  let them eat the losses.

by HiD on Fri Aug 17th, 2007 at 05:19:31 AM EST
[ Parent ]
 Optimists tend to get paid better than pessimists

I wish!

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Aug 17th, 2007 at 05:23:39 AM EST
[ Parent ]
idealists don't get paid at all ;).  Especially if they keep pointing out the emperor has no pants.  I'm very glad to be out of that mess.
by HiD on Fri Aug 17th, 2007 at 05:35:58 AM EST
[ Parent ]
You're glossing over the fact that:

  1. There's a huge and mendacious PR industry supporting the optimists in their ever-more-unlikely optimism.

  2. If the risks were genuinely understood, why are central banks in a panic?

  3. The rating agencies were effectively being paid to lie to make the optimism look plausible.

  4. How corrupt and/or stupid do the markets as a whole have to be to keep repeating this cycle?

  5. What exactly is the social benefit of any of this nonsense?
by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Aug 17th, 2007 at 05:29:00 AM EST
[ Parent ]
I don't see any central bank panic.  They've put in a bit of liquidity to stabilize short term credit markets.  The sums are tiny.  Less than we are pissing down a rathole in Iraq in a month.

the panic is in the corporate press types who see their white shoed buds heading for a major whacking.  Cramer's croc tears for the people losing their houses is cover for a bailout for  billionaire hedge fund managers who for the most part have the bulk of their money in their own funds.

Markets are stupid.  We've had boom/bust cycles for centuries as greed gets out of hand from time to time.  Without the pain to keep the bozo's honest (at least a little), speculation gets crazy.  How can any sane person pay the value of a house for a tulip bulb?  Or $5K for a frigging beanie babie?  Yet people do it.  Over and over.

Social benefit?  What makes you think most people give a rats ass about social benefit?  They care about THEIR benefit.  Hence the Republican/Tory parties.

by HiD on Fri Aug 17th, 2007 at 05:41:39 AM EST
[ Parent ]
The sums are tiny.  Less than we are pissing down a rathole in Iraq in a month.

Yes but people don't realize this.

If the central bank lent 500 billions USD worldwide for one week and saved a 10% interest spike to the private banks involved (all numbers are way above what happened) that makes it to less than one billion USD of "giveaway", that is less than four days of Iraq war cost (10 billions USD per month IIRC).

It's not a reason to do it, but that's not big money.

by Laurent GUERBY on Fri Aug 17th, 2007 at 06:30:39 AM EST
[ Parent ]
I think we're getting close to a total of $200-$300 billion of liquidity injection from various central banks over the last week or so.

I'd say that's more than 'a bit.'

The Iraq war isn't really comparable, because that's treated as a straight outlay - effectively it's just public spending by one government.

But what's happening with the ECB and other national banks is that they're using their own reserves to try to solve a problem that was created in the US by the US money markets, and which should have remained local to the US.

The Fed meanwhile is hemming and hawing and throwing in some token liquidity to make it look as if it's doing something. But Bernanke has done almost exactly nothing so far - possibly because he knows he doesn't have to as long as Europe, Japan and the rest will provide the US with more cheap cash for a little longer.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Aug 17th, 2007 at 07:40:45 AM EST
[ Parent ]

we're getting close to a total of $200-$300 billion of liquidity injection from various central banks over the last week or so.
I'd say that's more than 'a bit.'

That's loans to European banks, usually secured. The only real subsidy is that these funds were lent at 4% rather than the then prevailing 4.7% caused by the drying liquidity. So the actual subsidy would 0.7% of the above amount, if the money were repaid only in a year.


But Bernanke has done almost exactly nothing so far - possibly because he knows he doesn't have to as long as Europe, Japan and the rest will provide the US with more cheap cash for a little longer.

Not quite either: while the ECB has provide straightforward loans against deposits of treasuries to banks, the Fed has apparently lent against mortgaged-backed paper, i.e. the toxic underlying assets - if mortagages are the problem, then these amounts are much more likely to become actual subsidies - in any case, it makes the Fed one of the potential losers of the mortgage defaults.

Meanwhile, what the ECB has done is allow the European Banks to have enough liquidity to reduce their exposure to US "toxic sludge" without being forced to distress sales, i.e. without giving up a lot of the potential residual value. That allows European banks to eat their losses, but nothing more (panic would have forced them to take much larger hits). everybody is being hit by the underlying mess, but the scope of these losses is dwarfed by the potnetial losses if the whole pyramid unwinds brutally.

So the ECB has done its job, I'd say. And it would seem that they still intend to raise their main rate to 4.25% from the current 4% at the next meeting, thus showing that they intend to continur their tightening policies, even after that targetted intervention.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 08:22:31 AM EST
[ Parent ]
AFAIK central bank made a few days maturity (collaterized) loans to private banks, then bank repaid. In the end (after my conservative week estimate) there is no more money outstanding now than before intervention. The amount short-term loaned each time decreased quickly.

The private banks saved : (amount outstanding) * (number of days to maturity / 365) * (rate in spike mode - rate in normal mode).

Here: 500e9 * 7 / 365 * (x+10%-x) ) ~= 1e9.

We can say this is a subvention from central banks to private banks.

by Laurent GUERBY on Fri Aug 17th, 2007 at 08:24:04 AM EST
[ Parent ]
The Iraq war isn't really comparable, because that's treated as a straight outlay - effectively it's just public spending by one government.

i thought it was an investment in our security from terror!

so cornfused...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Fri Aug 17th, 2007 at 09:35:09 AM EST
[ Parent ]
I see my latest comment echoes what was discussed in this subthread. That's what happens when one arrives late to a big party of a thread.

Can the last politician to go out the revolving door please turn the lights off?
by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 04:11:03 AM EST
[ Parent ]
If the risks were genuinely understood, why are central banks in a panic?

I think they are panicking because the realisation is dawning. It reminds me of the realisation - post Piper Alpha - of the Lloyds' reinsurance spiral.

How corrupt and/or stupid do the markets as a whole have to be to keep repeating this cycle?

It's not really a matter of markets being corrupt or stupid so much as them being markets. They do what they do. Garbage in gives rise to garbage out.

Variations on this theme will continue and for as long as we have a deficit-based system we will see cycles of Schumpeterian creative financial destruction.

What exactly is the social benefit of any of this nonsense?
 

That depends upon how you define "Society" and whether or not you believe in the "trickle down" of the wealth siphoned off by the intermediaries running the system.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Aug 17th, 2007 at 05:44:10 AM EST
[ Parent ]
They were not panicking. The ECB was reported by the anglo-saxon press to be panicking because that's what their conventional wisdom tells them a Franco-German bank would do.

Can the last politician to go out the revolving door please turn the lights off?
by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 04:12:49 AM EST
[ Parent ]
What exactly is the social benefit of any of this nonsense?  

Money flows upward from poor to rich.  That is the whole point and purpose.  That is what it is for.  It may not be quite right to call it a benefit . . .

The Fates are kind.

by Gaianne on Fri Aug 17th, 2007 at 07:20:41 AM EST
[ Parent ]
What exactly is the social benefit of any of this nonsense?

hahahaha....

why it's those extra porsches and cartier watches....there's a reason they're called 'fundamentals' you know.

the feds just lowered the discount rate....

to combat the credit crunch...no need to worry about that, says sky news...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Fri Aug 17th, 2007 at 09:14:59 AM EST
[ Parent ]
With the problem being there is 1 decent quant for every 1000 brokers and traders.

Ask a broker about Black-Scholes; it will be refered to more likely than not as a "black box".

If the brokers don't get it certainly the client isn't likely to but, as the broker says to the client who's taken a liquidity bath, "well I made money and my brokerage house did too (on fees and commissions); sorry you didn't but two out of three ain't bad!"

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Fri Aug 17th, 2007 at 05:39:29 AM EST
[ Parent ]
I won't argue this point.  Most of those folks are loyal to this year's bonus and that's about it.

But don't conflate broker with trader.  Brokers have no skin in the game or even their company's skin.  Trader's are carrying the risk and hedge fund people are usually required to keep much of their huge paychecks inside their own fund.

by HiD on Fri Aug 17th, 2007 at 05:50:15 AM EST
[ Parent ]

Yes, it is a BIT "shrill", even for you. Hey Colman, shouldn't this guy be asked to play the ball and not these chaps ? :-)

Maybe it's because I'm a Londoner - that I moved to Nice.
by Ted Welch (tedwelch-at-mac-dot-com) on Fri Aug 17th, 2007 at 06:36:50 AM EST
[ Parent ]
"These chaps" are the ball.

Really, Ted.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Aug 17th, 2007 at 07:53:50 AM EST
[ Parent ]
No, they're the opposing side - old chap :-) To be serious - I don't think it's ever a good idea to treat anyone as a mere thing, like a ball - that's what is used, in military training, to enable people to kill and torture others: "After all, they're not really people - like us."

But I do think it's a good idea to be very honest with each other, which might even mean saying that an argument is bloody stupid - if one really thinks it is. Though calling members of OUR team "flat earthers and extremist mullahs rolled into one... evil and stupid ... fantastically clueless", would be a bit "shrill" :-)

"Do not fear the enemies who hate you, fear the friends who flatter you." Nietzsche


Maybe it's because I'm a Londoner - that I moved to Nice.

by Ted Welch (tedwelch-at-mac-dot-com) on Fri Aug 17th, 2007 at 10:35:19 AM EST
[ Parent ]
I'm being shrill because this is not a numbers game. This is not about what appears on a spreadsheet at the end of the trading period.

This is about real people losing real jobs and real homes and real health care. It's about a real eco-system being stripped bare with real physical effects. It's about real semi-permanent damage to seas and rivers and water tables that's going to take generations to correct itself - if it ever does.

It's about the biggest resource pillage in history, with very real and very literal strip-mining of energy, metals, top-soil, human labour, and other essential life-support elements, with no thought at all to managing extraction over a reasonable time-frame.

All of this is happening so these spivs and enablers can pontificate in their plummy pinstripe tones about how wonderful the markets are - while competing with each other about who has the biggest yacht and the biggest holiday home.

If there's something defensible going on here, it's really not easy to see what it might be.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Aug 17th, 2007 at 11:10:43 AM EST
[ Parent ]

"If there's something defensible going on here, it's really not easy to see what it might be."

Of course I think the situation is terrible too, but talking about people as "evil" and "mullahs" is the kind of thing I expect in one of Bush's speeches rather than here. I don't think your generalised harangues make it much easier to see what is going on -- or what to do about it - kill all those you deem to be "evil" ? But I'm sure writing them makes you feel better :-)

Maybe it's because I'm a Londoner - that I moved to Nice.

by Ted Welch (tedwelch-at-mac-dot-com) on Fri Aug 17th, 2007 at 05:48:41 PM EST
[ Parent ]
I'm not talking about killing anyone.

But I don't apologise for lumping Free Market dogma in with the other religious follies of the day. They're indistinguishable as far as I can tell - with the difference that Market Fundamentalists are far more dangerous than other fundies because they have real power, rather than simply aspiring to it.

As for the ethics - what other words would you suggest for a system which has killed millions, ruined entire countries and done trillions of dollars of damage to a life support system that we all rely on?

Not terribly nice? A bit misguided? Possibly not the best of all possible worlds?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Aug 17th, 2007 at 09:42:09 PM EST
[ Parent ]
Well, while you're condemning "religious follies" I'd suggest you avoid the use of "evil".

Maybe it's because I'm a Londoner - that I moved to Nice.
by Ted Welch (tedwelch-at-mac-dot-com) on Mon Aug 20th, 2007 at 04:03:23 PM EST
[ Parent ]
They may be the opposing side, but they're not in this forum discussing with us.

Les absents ont toujours tort.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Aug 17th, 2007 at 12:43:26 PM EST
[ Parent ]

Ah, progress - now they are "the other side", so actually human, but, as they're not in OUR team - everything is permitted ?

Maybe it's because I'm a Londoner - that I moved to Nice.
by Ted Welch (tedwelch-at-mac-dot-com) on Fri Aug 17th, 2007 at 05:30:02 PM EST
[ Parent ]
as it is the tinhgs that I have outlined:

  • the ideology of greed;
  • the idea that only financial valuations give worth to anything
  • the notion that wage inflation is bad but not asset price inflation
  • the shockingly lax monetary policy of the past decade
  • the cheerleading by politicians of finance as the new engine of growth and wealth creation
  • the unraveling of existing regulations (like Glass-Steagall)


In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 01:20:21 AM EST
[ Parent ]
I know that, it was just a case in point.

you are the media you consume.

by MillMan (millguy at gmail) on Fri Aug 17th, 2007 at 01:09:21 PM EST
[ Parent ]
It seems the great depression worked. Laissez Faire capitalism wasn't allowed close to power for about 40 years.

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Fri Aug 17th, 2007 at 05:39:03 AM EST
[ Parent ]
Those are (unfortunately) the lines I was thinking along.
by afew (afew(a in a circle)eurotrib_dot_com) on Fri Aug 17th, 2007 at 07:55:40 AM EST
[ Parent ]
all you can do is offer people an antidote, or better, a preventative education in the basic facts of existence in the 'privileged first world'.

i.e. the class division between the 'haves' and the 'have-nots' is as with us as ever, it's only the rungs to climb from the lower to the upper have changed.

the poorer classes are always constrained to build monuments to the folly of the richer....before the pyramids, now the house of cards that is the 'money business'.

collapsing mines, bridges, mountains, glaciers, markets....

theme of the moment...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Fri Aug 17th, 2007 at 09:06:32 AM EST
[ Parent ]
I'm going to take a contrary position in spite of the fact that traffic has picked up on my essay "the coming crash" which I wrote in 2005.

The percentage of defaults in the housing market is not that great so blaming everything on the subprime market is an oversimplification. So is the slow down in the sale of homes.

What is really going on is that hedge funds borrowed money with little in the way of liquid assets to back it up. This is exactly what happened in 1929 when the margin rate was 10%.

Hedge funds have been bragging over the past few years about how highly leveraged they were. This is, of course, a sign of risky behavior, not something to boast about.

I will be very surprised it this non-productive behavior spills over into the real economy. Profitable firms that need to finance new operations will find the capital. Takeover deals and debt-financed stock buybacks won't.

The real danger is the same one that caused the stagflation in the 1970's - a guns and butter deficit spending policy. The debt must be paid. There are only two ways: raise taxes or devalue the currency. Last time it was inflation and I'm guessing that is what will happen this time as well.

Many low risk, fixed income, securities are now selling at a discount. Buyers are betting that inflation will cause the real value of these instruments to drop and are demanding the discount to compensate.

Can societies deliberately bring about economic disaster? Well one only has to look at Germany in the 1920's to see how even an advanced society can do it with the right mix of incompetents at the top.

I think the US is already in a recession. The signs are everywhere. Just yesterday Macy's, a middle scale department store chain, reported an earnings drop. This was preceded by similar news from Walmart. Walmart even went so far as to admit that their customers were running out of money before the end of the month.

One thing is sure that if all those who were dead wrong last week are now explaining what is really going on they are still clueless.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Thu Aug 16th, 2007 at 04:17:00 PM EST
I hope you're right ;-)

You can't be me, I'm taken
by Sven Triloqvist on Thu Aug 16th, 2007 at 04:24:20 PM EST
[ Parent ]

The percentage of defaults in the housing market is not that great so blaming everything on the subprime market is an oversimplification. So is the slow down in the sale of homes.

The percentage of defaults is not great _yet. Buyers with negative equity have never been so numerous (40% of 2006 borrowers), and that's a population highly unlikely to fully repay their loans.

The subprime boosted the market, helped boost prices and fuelled the price spiral which created the "wealth effect" for many and underpinned consumption for many with otherwise stagnant incomes.


Profitable firms that need to finance new operations will find the capital.

Well, it's not clear today that they will. Not at the conditions they expected. and many firms that are in marginal situations will find it a lot more difficult.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 01:24:10 AM EST
[ Parent ]

Borrowers hit as refinancing options vanish

As world stock markets reel from the collapse in the subprime lending market and Countrywide, the biggest US mortgage lender, struggles to stay afloat, borrowers such as Cynthia and Joe Esperaza are grappling with problems of their own.

The Esperazas have two children and live in Santa Clarita in California's San Fernando Valley. They took out a Countrywide loan three years ago after having been sent promotional literature by a local mortgage broker.

The Esperazas were given a teaser rate of 1 per cent for the first two months of the mortgage. But then, they say, the rate rose in stages - from 2.8 per cent at first, all the way to 8 per cent currently. Eventually it will hit 9.95 per cent.

As a result, the Esperazas say, they cannot keep up. They are paying each month only part of the interest that they owe - not the principal - and that means their debt is continuing to grow. In the mortgage industry this is known as negative amortisation or "neg am". For the Esperazas, it means that having borrowed $326,000 three years ago, they now owe $344,000.

(... In California, where Countrywide is based, foreclosures have soared 800 per cent as borrowers fall behind in their payments.

(...)Their loan was fixed at 5.9 per cent for the first two years. After the two-year teaser period lapsed, the rate rose to 8.9 per cent. It will increase by an additional percentage point every six months until it reaches 12.4 per cent.

"They didn't tell us this was going to happen," says the father of the family. His wife adds that she was told she would be able to refinance the loan before the end of the two-year introductory period.



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 02:19:13 AM EST
[ Parent ]
Stupid is as stupid does.

Can these people really pretend that a 1% rate was a reality?  Or even 5.9%?  They were counting on cheap money as far as the eye can see and closed their eyes to the risk.  It's a sin that brokers preyed on their hopes but they are partially culpable for not having the sense to understand variable means variable.  Not variable only if it moves in my direction and someone will show up to bail me out in a year or so.  Just what did the notice that the max could be 12.4% mean to them?  

Their real problem is the house probably isn't worth $344k.  Time to call the bank and work out a better deal or hand them the keys and face reality.  They've lost their down payment but probably gotten cheap rent as their interest payments were tax deductible.

by HiD on Fri Aug 17th, 2007 at 05:26:53 AM EST
[ Parent ]
No, they were probably told that they could refi continuously and keep switching to low rates. If you're smart you can get a bargain mortgage that way.

Which is exactly what a mortgage broker said to me three years ago.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Aug 17th, 2007 at 05:31:47 AM EST
[ Parent ]
You have to have enough sense to realize that the day will come when they take the ice cream  for a nickel away.  If you cannot afford the high end of a variable loan, or the price of a fixed loan to buy the house, you can't really afford the house.  And most of these people know that in their guts.  They just take the chance anyway.
by HiD on Fri Aug 17th, 2007 at 05:43:42 AM EST
[ Parent ]
You might want to try sharing this insight with the Fed and the speculators and banks who bought the funny-money CDOs.
by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Aug 17th, 2007 at 05:42:13 PM EST
[ Parent ]
they knew.  they just hoped they get away with it a little longer.  Only had to make it to Jan to get the bonus check.
by HiD on Fri Aug 17th, 2007 at 08:31:25 PM EST
[ Parent ]
There is great benefit in having the aqbility to recognize when one has reached his limit of understanding and has the practical sense to realize that danger lies beyond. "I'm not a smart man, Jenny..."

I can swear there ain't no heaven but I pray there ain't no hell. _ Blood Sweat & Tears
by Gringo (stargazing camel at aoldotcom) on Fri Aug 17th, 2007 at 11:25:58 AM EST
[ Parent ]
These are the same people who send birthday cards to characters in soaps.

I don't think the ignorant have an exclusive franchise on gullibility.

You can't be me, I'm taken

by Sven Triloqvist on Fri Aug 17th, 2007 at 05:11:04 PM EST
[ Parent ]
There was an interesting chart on John Mauldin's site a couple weeks ago. He pointed out that we are just in the beginning wave of this housing situation. See: The Mortgage Pig in the Python

But it will take longer than you might think for that negative influence to decrease. Let's take a look at the following table. This shows the amount of adjustable rate mortgages that reset each month for the first half of this year and will reset for the next 18 months. Note that these reset numbers are a driving factor in the increasing rise in foreclosures. Pay attention to the numbers I highlight in red [sorry, no red-ed] for January through June of 2008. The largest portion of mortgage resets is not until next year.

(in dollars, billions)
Jan 2007 $22
Feb           25
Mar           35
Apr           37
May           36
Jun            42
July           43
Aug           52
Sep           58
Oct           55
Nov           52
Dec           58
Jan 2008   80
Feb           88
Mar        110
Apr           92
May          76
Jun           75
Jul             50
Aug           35
Sept          26
Oct            20
Nov           15
Dec           17

We have just seen $197 billion of mortgage resets so far this year. That is less than we will see in two months (February and March) of next year. The first six months of next year will see more than the total for 2007 or $521 billion. This suggests to me that the number of foreclosures is due to rise dramatically from the already high current levels, putting more homes into a weak housing environment.

These homes that are going to see reset prices are for the most part not going to be able to be rolled over into a traditional 30 year mortgage because there is not going to be enough equity to get a traditional mortgage. While the total increase in payments is an estimated $42 billion, which is not all that large in the grand scheme of things, to the individuals who are paying the increase it is a large increase in their housing costs. My estimate is that this is about one-half of 1% of total consumer spending. Along with inflationary rises in food and energy, this is going to continue to put pressure on consumer spending.

One theory says that the tumble never went far enough last time, that the stock market went from bubble to froth, and still needs to go to its norm. Not that I want to see anyone in misery, myself included, but it would be much better for this to happen during these days of the Bush malAdministration. He still has over 500 days to screw things up. It would be best if he is completely discredited by a completely shaken economy, than him stirring up trouble with what little credit he has.

Never underestimate their intelligence, always underestimate their knowledge.

Frank Delaney ~ Ireland

by siegestate (siegestate or beyondwarispeace.com) on Fri Aug 17th, 2007 at 08:41:52 AM EST
[ Parent ]
What is interesting is that the dollar has rebounded somewhat against the euro in this recent market decline. Any theories?

Hey, Grandma Moses started late!
by LEP on Thu Aug 16th, 2007 at 04:45:43 PM EST
Most hedge funds with shit in the fan hold their accounting in US$. So they are liquidating foreign (non US) assets that still show a profit while they can, to recoup their losses in the consolidated balance sheet. To do this, they are selling whatever currency they previously held (euros or emerging markets), buy US$ instead (thus the price hike), and buy short-term treasuries to get a minimal safe yield on the cash (thus the crash of market rates for treasuries, below the fed target rate).

There is also many small players (corporations, institutions) in emerging markets who do not trust their own domestic currency to perform well in the crisis ahead, and they buy $ in these times. Always did, still do (although some may be buying euros now, it is still not the majority).

Pierre

by Pierre on Thu Aug 16th, 2007 at 05:13:31 PM EST
[ Parent ]
Thanks for the explanation - I was wondering about that too.

What a bizarre solution though. Let's see how well that works out for them.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Aug 16th, 2007 at 08:26:39 PM EST
[ Parent ]
The similar effect is on the oil price:
At the beginning of August traders speculating in oil futures had bet the price of a barrel of light sweet crude, delivered in September, up to almost $80, sparking a renewed outburst of worry that the fabled day of the $100 barrel of crude might soon arrive. Two weeks later, the price of that September barrel of crude has dropped to around $72. In the interim, stock markets around the world went on a wild ride.
The first explanation offered by analysts is that traders are worried that the credit crunch afflicting financial markets might spread into the general economy. Slower economic growth would mean less demand for oil, thus depressing prices. But on Monday, the Wall Street Journal's Matt Chambers suggested another explanation: Hedge fund operators are selling off their oil futures holdings, as part of a generalized effort to reduce their overall risk exposure. With so much going wrong elsewhere in their portfolios, it's time to sell risky assets and raise cash. It's the new, "risk averse" Wall Street, pledging, once again, to mend its carefree ways.
by das monde on Sat Aug 18th, 2007 at 11:10:53 AM EST
[ Parent ]
What is most interesting is the following. Remember the dollar drop just a few weeks ago? The explanation for that was... problems in the US subprime mortgage market!

Here you have it: one month those problems in the US subprime mortgage market cause dollar to drop, while Dow Jones shoots over the record 14000 points. A month later, the cause is the same, the effects are reversed... Amazing!

by das monde on Sat Aug 18th, 2007 at 11:12:25 AM EST
[ Parent ]
The first $ move was the eurozone banks bringing back what they had managed to sell of their ABS before the freeze...

You can sum it up by saying that the subprime crisis has "increased the volatility" of the currencies

Pierre

by Pierre on Sat Aug 18th, 2007 at 06:28:41 PM EST
[ Parent ]
Maybe because most of the new injection of money into the markets has been carried out by the ECB and not by the Fedearl Reserve (with the BoE doing _nothing).

I think it is interesting that unlike in previous global financial crises (such as 1997) which originated outside the US and saw the Fed take the decisive action, this crisis has originated in the US, both in the private sector (the refinancing bubble) and within the Fed (Greenspan's bubbly monetary policy), and resolved by the European Central Bank.

It was interesting 2 weeks abo to read the FT and the IHT on the plane and see that the facts reported were that the ECB intervention was sizeable, timely (and well-paced over time) and effective, but the analysis and the presentation of the facts was full of innuendo about panic, overreaction, and paying more attention to the Fed's actions than they maybe deserved.

Can the last politician to go out the revolving door please turn the lights off?

by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 04:05:14 AM EST
[ Parent ]

Indeed, many of the instruments at the heart of the current credit storm barely existed before this decade - which means that computers can only model these markets based on the benign conditions of the past few years.

Another big problem is that computer models do not always take account of the way that their own behaviour is affecting markets.

Actually, this is true only for the credit derivatives. The equity (stock) derivatives are "almost" safe I can say (well, they will shake if the whole economy goes down, but they will not trigger another crisis of their own). And t hat's the vision of a pessimistic outsider who decided a few years ago to move inside the matrix and check the small cogs.

They did trigger the 1987 crisis, which was the first crisis after the mass-marketing of stock options. It was clearly caused by the primitiveness of the Black-Scholes model, the lack of a real shock in the historical data to calibrate the model, and indeed the very first program trade automata, which clearly did not mind for their own impact on the market.

State-of-the art equity trade automata now make 1-st, 2-nd and n-th order estimates of the impact of their moves on the market, and they won't make another 1987 crash. (besides, they have better safety limiters now)

I think the reason 1987 went on so well, in spite of being the most spectacular one-day drop in decades, is that it really was decoupled from the real economy. It really was the result of programs valuing deals with the wrong model and trading in unchecked volume, in a death spiral. When humans pulled the plug, the market came back to normal.

B&S has been at least amended (and completely superseded for many options). And history now has a nasty stress-test through which all new equity models must pass.

Credit derivatives, on the other hand, have never been tested for a systemic crash. 1929 was believed to be too old and irrelevant. The "dissemination of risk" thing can actually work for on punctual default.

Remember Enron ? losses where close to 20 B$ with a duration in months - I'm talking AAA bonds and credit lines only, not the equity. This is something unheard before:
-in France, we already had Credit Lyonnais which came up on the same order of magnitude but the state bailed it out and the duration of the liability was more like 10 years).
- even LTCM only lost a few B$ over a couple of years, after the initial 120B$ short-term refinancing panic, which is why banks agreed to bail it out themselves once they figured out there was not so much risk in refinancing .

Well, Enron did not trigger any domino effect, although it would have if it did happen in the time of LTCM. Why ? precisely because it's lenders had offloaded the risk to larger markets.

Today it won't work, because the risk is systemic, not a one-off: banks have been trading their respective risks with each other, thinking "I'm smartly dumping my shit over my neighbor", when they should have thought forward "Hey, but we're all throwing the same kind of shit around". So basically they hold portfolios full of crap that is no better than what they sold away.

Subprime, alt-A will suffer two-digit losses on 600B$ of AAA bonds. Then consumers will choke, corp profit too, and a greater amount of AAA bonds, CDOs, CDS backed by commercial real estate and corporate junk bonds will be wiped out. Some emerging countries will go into civil war and default on a smaller amount of sovereign debt (but still pretty big).

We are talking of a shock of the magnitude of a sudden default by a major sovereign borrower (the size of France or Germany), in the tune 1000+ B€ of AAA grade. Calyon (french peasants turned investment bankers) just reckoned 150B$ of global losses, goldman sachs now 300B$ (they minimize, they may be sued), it will turn out to be bigger after ARM-october, 50B$ in loans to reset. And that's just subprime.

Recall that total US$ M3 is probably about 13 000 B$. Of which 30% is "classic" money. So we really are about to see some +15% of "wall street money" (chimp money) burn in flames. Guess there will be fewer banks on the Street in two years.

Pierre

by Pierre on Thu Aug 16th, 2007 at 05:40:09 PM EST
now cover an incredible range of products. Many of them are straightforward and useful.

The problem is that a number of them have been built on the assumption that counterparty risk and/or liquidity risk could be, to a large extent, ignored - i.e. they are valuable so long as people thing they are but not if everybody actually needs to cash them in - because the whole house of cards folds, then.

That's what we're seeing now. With nobody willing to take one new risks on these, the existing ones suddenly cannot find buyers, and thus have no apparent value - the value will appear only if and when they are actually called on, and the counterparty pays, or not, the requisite amount. but in the meantime, they are a huge black hole. But a lot of finance was built using as foundations these products, so there are whole edifices that suddenly don't know what they are standing on.

Fun stuff. Good time to be a litigation lawyer, I expect.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 02:24:17 AM EST
[ Parent ]
When you say "litigation" I take it you mean third parties and "mismanagement"? Surely the inside circle know what they are buying?
by Number 6 on Mon Aug 20th, 2007 at 06:23:05 AM EST
[ Parent ]
Have any of you heard that term used in business lately?
Business like politics are closely related by the amount of horse manure slung back and forth.

When the widget factory goes to China so do the widget makers, the skills of the widget makers, he income of the widget makers and the community of the widget makers.  How is that "sustainable"?

by Lasthorseman on Thu Aug 16th, 2007 at 06:22:34 PM EST
sustains the new Chinese widget makers just fine.  They get to move off of dirt farms into unsafe factories.    Just like our great grandparents did from 1830-->1960.
by HiD on Fri Aug 17th, 2007 at 05:33:56 AM EST
[ Parent ]
That is the flaw in the globalization model. There is no legal or social responsibility on the part of companies or governments that shift jobs overseas to the people who had those jobs. Why can't there be plans for workers who are to lose their jobs by companies but before these jobs are shifted?
by BJ Lange (langebj@gmail.com) on Fri Aug 17th, 2007 at 09:21:54 AM EST
[ Parent ]
because then all the savings evaporate and the whole process is about making the widget 50% cheaper. Gotta have cheap crap at Walmart.

The argument in favor of protectionism is based on the assumption that people in Country X have more value than those over the horizon.  Considering how many of my countrymen think/vote I'm not sure I much care if they lose their jobs any more.

by HiD on Fri Aug 17th, 2007 at 02:07:52 PM EST
[ Parent ]
It is one of the flaws in supply side economics that needs correction.
by BJ Lange (langebj@gmail.com) on Fri Aug 17th, 2007 at 02:18:56 PM EST
[ Parent ]
I'm not sure I care either given how irresponsible so many of my fellow countrymen have been.  The waste and whining continues to reach ever-more-obscene levels.  "I need the three-billion-inch plasma television, and a bailout from Fannie and the Fed because my mortgage rate just jumped three points!"  Enough already.

The "We're more important than tham because we're your fellow countrymen!" argument is certainly the one I've heard from many interest groups, but I think many of us are fine with protectionism as a temporary means to pushing other countries towards tougher standards on workers' rights and environmental quality.  I have no problem with the idea of someone beating me in competition for a job.  However, I have a major problem with allowing China to turn Beijing into some sort of post-apocalyptic version of Baltimore in the interest of keeping its competitive advantage, to say nothing of the more boring issues like currency manipulation.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Fri Aug 17th, 2007 at 08:46:34 PM EST
[ Parent ]
 The dirty secret of bankers

is in fact

Money as Debt

All asset price bubbles are caused by money created as debt by the banking system using the "fractional reserve" Central Banking system, and where the minimum possible capital is deployed to back bank created "Debt Money" pursuant to the BIS "Basel Accords".

Sooner, rather than later, this system will be supplanted by a sustainable alternative.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Aug 16th, 2007 at 07:04:52 PM EST
your alternative is a moneyed elite lending only based on existing capital.  Good work if you are a Rothschild or a Saudi Prince, but kinda rough on anyone who'd like to have a house before they've saved 30 years to buy it.
by HiD on Fri Aug 17th, 2007 at 05:30:20 AM EST
[ Parent ]
Firstly, who said "lending" at interest is the answer to anything?

Secondly, you can forget the "monied elite" - they have pretty much chump change - have you never heard of pension funds?

Long term investor demand for "Infrastructure funds", REIT's, "Income Trusts", "sukuks", etc etc show the cosmic appetite out there for long term asset-based returns.

We've hardly even scratched the surface. Replacement of deficit-based but asset-backed credit with "asset-based" investment is, I think, a huge opportunity.

That's how Macquarie Bank et al make all their money. They borrow to buy productive assets, bundle them in legal vehicles and sell 'em off to investors.

The financing costs are lower because they are essentially converting Debt to modestly yielding Equity (and therefore have no capital repayment to make).

That's the future IMHO.

And before you jump in, yes, credit is still needed for "working capital", but that can easily come about from a mutual guarantee of bilateral "trade" credit, with a bank as service provider.

All credit derivatives are doing is allowing banks to offload to investor/risk takers the only value they DO provide which is a guarantee of the borrower's credit.

The fact is that Banks as credit intermediaries are obsolete.

If I'm wrong in saying that, tell me in what respect?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Aug 17th, 2007 at 11:05:51 AM EST
[ Parent ]
Every time I ask you how your system finances a simple home purchase I get back dead air.  When you can clarify that one I'll spend more time debating you.

My biggest problem is your distrust of fractional banking.  it's kinda gold buggy which to me is medieval thinking.  Without the ability to borrow against future earnings, most people are trapped in rental housing paying out to said pension funds, aristocracy etc.

That's how Macquarie Bank et al make all their money. They borrow to buy productive assets, bundle them in legal vehicles and sell 'em off to investors.

The financing costs are lower because they are essentially converting Debt to modestly yielding Equity (and therefore have no capital repayment to make).

essentially no different than securitizing loans.  Like everything I've seen of Islamic finance, it's just relabeling to make mullahs happy.

by HiD on Fri Aug 17th, 2007 at 02:03:13 PM EST
[ Parent ]
like me!

I would like an answer to your question too. There must be something I'm missing altogether.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 02:27:54 PM EST
[ Parent ]
simple questions.

And I have a great belief that if there was a better mousetrap we'd be using it.

by HiD on Fri Aug 17th, 2007 at 08:24:55 PM EST
[ Parent ]
This IS a better mousetrap.

And we have ALREADY started using it: I merely observe what is going on and develop it.

The Hilton group used a >£1bn "capital partnership" LLP to finance development of 10 hotels about five years ago.

The entire Canadian capital market operates in a similar way, by packaging up GROSS revenues of Companies into trusts and selling off units in these "income trusts" to pension investors.

It's just that trusts suck as an enterprise model, although lawyers love them.

LLP's are six years old, and are are only now becoming familiar in the UK.

These "Open" Corporates literally change the game.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Aug 17th, 2007 at 08:37:01 PM EST
[ Parent ]
long term large scale investment.   Not that different than REITs or any other capital/bond hybrid.  I don't see any magic bullet here.  The funds still came from somewhere and they have to be repaid or ownership doesn't change hands.
by HiD on Fri Aug 17th, 2007 at 09:19:39 PM EST
[ Parent ]
Right. I vill say zees only once...

An LLP (UK style) is an entity, like a Company, with an independent legal existence and the protection of limited liability.

Unlike the prescriptive Company "Mem & Arts" an LLP agreement is a consensual legal agreement that says anything the members mutually agree, and there isn't even a requirement that it be in writing (not that I recommend that).

Unlike the US LLP (and the UK LP) there is not a General Partner (with unlimited liability) and Limited Partners. Despite the name, an LLP is NOT legally a partnership, but IS a corporate body.

A Land Partnership is an application of the LLP.

The freehold of land is transferred to a "Trustee" or "Custodian" Member. (exactly analogous to the way that custodians like Northern Trust "own" shares while institutions trade the beneficial interest in them)

The other Members of a "Land Partnership" are:
(a) the Occupier (capital user);
(b) the Investor (capital provider);
(c) (optional) the Developer/ Manager.

The Investor either introduces money - or "money's worth" in (say) land, buildings, sweat equity, goods, services, whatever.

The Occupier pays:

(a) an amount in respect of depreciation and maintenance of the building; and

(b) an agreed level of "Capital Rental" which is shared proportionally between the investors in the same proportion as their holdings of "Equity Shares".

The key point is that there is no obligation to repay capital, as there is in a loan. Why should the capital be repaid, when land does not depreciate?

Since - as with shares in a Company - there is no obligation to repay investors then this is not a loan, but it IS "Equity" - just not as we know it.

WATCH MY LIPS.

THIS IS NOT A LOAN.

The LLP agreement creates what is a new form of indefinite tenure (replacing conventional leases) - an "evergreen" contractual tenure if you will, whereby for as long as he pays the rent, the Occupier has the right to occupy the property.

Anything the Occupier pays in excess of rent due automatically becomes an investment.

This is not "securitisation". If you "securitise" a loan made by a bank it is still a loan - except now it's called a bond.

That is why the "equitisation" in this model has NOTHING in common with so-called Islamic banking where the relationship with the borrower may (usually isn't) be "Islamically sound" but the money is created out of fresh air as usual. ie it is "deficit-based"

Which is why I refer to investment through LLP's - in the same way as I do to investment in "conventional" company "Equity" or units in unit trusts - as "asset-based" finance.

Investors may sell to other investors this new class of proportional shares - which may carry a proportional share in a market rental, or alternatively (in a community partnership, where other tax-like mechanisms could also be introduced in relation to the land) a reasonable index-linked return.

This is therefore essentially a simple new form of residential REIT (it is tax transparent) but with a simpler management structure without the conflicts of conventional REIT's.

Re fractional reserve banking, my view is anything but medieval. It's right up to date.

Credit intermediaries are simply unnecessary. They are obsolete, like all other intermediaries in the Internet age.

On the one hand, a bank may manage the bilateral creation of "trade" credit, and also provisions into and operation of a default fund, mutually owned within a "Guarantee Society".

On the other hand, a bank may appraise "peer to peer" "Land Partnership" investments in property, introduce investors to investments, and risk capital by making markets in these quasi REIT units.

In neither case need a bank put its capital at risk by creating credit based upon it. In neither case is the bank acting as an intermediary between "depositor" and "borrower", but instead as a service provider.

The model is "sustainable" because the developer does not borrow, buy, build and bugger off, but acts as a consultant/service provider with an interest in the outcome, and without having to borrow or risk any capital.

It is therefore more "profitable" for all concerned to develop "sustainably" and energy efficiently, because this lowers the cost of ownership over time and hence increases the net rental return.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Aug 17th, 2007 at 08:25:37 PM EST
[ Parent ]
  1.  this is just a lease with an option to buy.  And worse for the landlord/owner/investor he/she has to stand still and allow the tenant/purchaser to buy fractional ownership making the investment as illiquid as all hell.  Is there a pre agreed price or % of equity that each dollar "invested" over and above the lease payment garners?  How does this vary with time?  As the investor, why would I give you the same % for X dollars in year 50 as I would have in year 1?

  2. While the developer hasn't borrowed money, the Investor or capital provider  has had to pony up old funds to build or purchase the building.  Assuming we cannot use fractional reserve methodology to borrow, these must be existing funds and therefore much more limited.  Everyone will have to wait their turn as with a building society.   A long slow painful process.  Welcome to 1450.  Shylock provided a service.  He let society grow at a faster rate than a system where it's just as profitable to put your money in a mattress or buy beer today instead of next week as to save it with interest accruing.

  3. While you claim this is more profitable for all concerned, all I see is words and no reasoning why returns are higher and costs lower.  Assuming the capital provider demands the same return on his old money as before, just where are the savings/added profits?  Who holds the "default fund" insurance premia?  How is this different than bank profits or perhaps the building society share returns?

  4.  What real value does a developer provide by hanging around after a house is built to provide "consulting"?  Just what does he do?  Recommend when to repaint?  

  5. What if the investor needs his funds back for his kid's college education in 7 years but the occupier has no interest in buying him out?  Does he have to discount his shares in the project to sell them to another investor?  you've wiped out the simplicity of straightforward time deposits with the bank taking the timing risk.  Matching people with exactly the same time horizons would be difficult.  This is where I see an aristocracy taking over.  The XYZ estate builds up capital and we all have to dance to their tune buying with 60 year leases and no fee simple rights.  blech.

Overall what I see is illiquid, complicated structures that would be difficult to get away from if life changes (divorce/move/death).  I for one, prefer the simple clarity of I borrowed $200K, have payments of $x/month for 360 months then it's mine with the right to sell and pay off the loan at any point.  I don't want a "developer" or "investor" involved in my day to day decisions as to how I manage my house.
by HiD on Fri Aug 17th, 2007 at 09:08:07 PM EST
[ Parent ]
1. Not quite. The investor never has ownership of anything - merely the rights to a stream of "Capital Rental" payments which are set at the outset and rise (or fall) with an agreed measure of inflation. These payments have nothing whatever to do with location.

Neither does the "Occupier" have any "ownership" - he has a right of occupation (whatever that means). There could easily be many different "Occupiers" eg fishing rights, farming rights, and so on.

So for the sake of argument if it costs £100,000 to buy the land and build the property, then we go to the market and see what investors are looking for in returns from what would become a UK "Property Pool" as more properties joined the scheme. This rate will be based upon what an investor thinks is an acceptable rate of return on a rock solid (property based) and index-linked return.

Maybe 3 or 4% would be acceptable for an index-linked return that would be instantly accessible. It could even run down to 2% or less (UK government index linked gilts were issued at 2% and were sold down to 0.4% at one time, dunno what they are trading at now).

The location of the property is entirely irrelevant, since this is a pool of the Capital invested IN the land. The location value of the land - which changes over time - and how this fits in with the financing of local communities, is a separate subject. I see "Community Partnerships" in due course replacing/becoming local government.

2. Good point. Except that it would be quite in order for a land owner to agree to transfer his land into trust in return for an agreed valuation based upon (say) 20% of the property rentals flowing from the developed property.

Equally, the soon-to-be Occupier might put in sweat equity (eg digging foundations - which used to be mandatory in Norway if you wanted funding from the State housing bank) - and a builder, plus all the other service providers involved, would be given the option of exchanging their "costs" for an "equity share". Anything more than their costs (ie a profit margin) they would be expected to invest, so they have an interest in doing a good job.

In other words, it is only necessary to obtain pre-existing "money" insofar as you need to pay "external" costs. The land investor is key: and here it is possible to imagine that the community which grants the right to build residential property could become an "investor" too, to a significant degree, sharing the gains with the land owner.

3. In this model, "default" relates to the inability to pay rent, and that would of course result in repossession (if equity has been exhausted), and a new Occupier. There is no default otherwise, and an Occupier can take a payment holiday anytime he wishes, provided he has an investment in the property Pool to his name (ie paid rentals ahead of time).

There can be no credit default because this is not credit. If you want your money out, simply find a buyer for your generic UK property pool units. Plenty of investment institutions making markets there, I would think.

  1. What is a "developer" anyway, but someone who brings together all the elements of creating a property? There will be a need for service providers "developer/managers", bringing occupiers together with properties, and (for instance in blocks of flats) whatever the occupiers collectively agree. possibly they would have a role in providing community energy services.

  2. The Occupier doesn't care who the Investor is and the Investor doesn't care who the Occupier is. Investment need not be location specific. Investors would be in and out of "property pools" (and I see no need for more than one per country, through a "partnership of partnerships" "Open Corporate" structure).

Time horizons do not come into it. You are essentially buying "spot" money when you buy units of a property rental pool. But the rate of return is index-linked and nothing whatever to do with arbitrary decisions by central banks in relation to credit/debt money which costs NOTHING to create.

If you want to invest longer term then do so, in something else.

Equally the right of occupation has no time element. It's merely a question of whether or not you want to live there, and whether or not you can afford the Capital rental involved (and any community land related charges).

In fact I see a Community land related charge (a location rental) as being a potentially powerful tool in redressing the balance over time between the haves and have nots.

But that's another story.

Land Partnerships would be just as simple as now - otherwise they will not work, for sure.

Do you call the existing system of buying and selling property simple?

In this model, property is never bought and sold again, although occupiers, investors and maybe managers change over time.

Management issues would be colectively decided insofar as they need to be (eg condo's and cooperatives) with managers only if necessary.

Investors have no say in matters that concern occupiers, only in terms of matters that concern them (eg the "value" of new investment in money or money's worth)

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Aug 18th, 2007 at 04:18:56 AM EST
[ Parent ]
this is far too complicated.  And yes, the current system I've always used is much simpler.  See a house, buy a house.  It's yours once you pony up the cash.  Don't have enough?  Get a mortgage and make payments until you own it.  I don't need to meet with a committee to make decisions of any nature.  The only time my banker gets involved is to make sure I pay my taxes and keep the place insured.  If I were the investor in your scenario, I'd be damn involved in making sure the occupier didn't strip the building to the studs and wander away.  Just like any other landlord.

Banks provide a service.  You seem to believe with more information people can do without the packaging and management of differing time horizons.  I say that is damn near impossible for ordinary folks as opposed to the large corporations and pension funds you use in your examples.  Sure, giant pools of capital can take very long views and be patient.  But most ordinary folks cant.  Their savings make up a large chunk of the money in the system.  

you make many blithe assumptions that people can easily find buyers to take them out of an investment that they've changed their mind about.  Pretty easy with simple instruments but a right to a stream of cash from a building lease with the lessor having the right to buy in on some complicated formula?   Again, good luck finding a market for this.  Looks like a Rube Goldberg mousetrap to me.

by HiD on Tue Aug 21st, 2007 at 05:22:15 AM EST
[ Parent ]
Chris, maybe you could say this twice by making it a diary?

Can the last politician to go out the revolving door please turn the lights off?
by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 03:52:54 AM EST
[ Parent ]
Every time I ask you how your system finances a simple home purchase I get back dead air.  When you can clarify that one I'll spend more time debating you.

I agree that I can only make sense of Chris' model to finance investments in productive capital. But, then again, under Chris' model all homes are put into trust and residents pay rent (though if they overpay they can own a fraction of the house).

Sometimes I speculate on a model where all real estate is community-owned and occupancy rights are leased, with the income replacing property taxes. But I don't think that is culturally acceptable.

Can the last politician to go out the revolving door please turn the lights off?

by Carrie (migeru at eurotrib dot com) on Tue Aug 28th, 2007 at 03:51:06 AM EST
[ Parent ]
that of strict regulation of the financial world (real regulation, not the busybody but pretend kind like we have right now)

have there been any diaries describing the kinds of "real regulation" that would have been able to overcome the greed and chicanery of bankers to prevent LTCM and the current crisis?

Truth unfolds in time through a communal process.

by marco on Thu Aug 16th, 2007 at 07:12:09 PM EST
Private banks are allowed by the state to create money through loans in exchange of strict regulations in the way they do loan money.

Amongst the simplest of bank regulation is for example to require the bank to put "real" money aside proportional to loans they make to certain kind of counterparty. Regulator could decide that loans to hedge funds and counterparty that have no public reporting/regulation requirements would face a higher "put aside" rate than loans to other kind of counterparties (like consumers, non financial businesses, etc...).

by Laurent GUERBY on Fri Aug 17th, 2007 at 06:57:31 AM EST
[ Parent ]
As usual here it's back to the basics, I recommend Dean Baker:

http://www.eurotrib.com/story/2007/8/11/125421/242#30

The computer and math stuff is just MSM diversion of the real issue at hand (1): the USA housing bubble, the 4 to 8 trillions USD of "paper" wealth that has to go down to zero one way or another in the coming monthes/years/decades.

There are three models for creating money through housing loans:

  • Model 1: the bank knows the client and the local housing market, makes the loan and keep it on its book until it is repaid. Bank gets a fee on the loan. Regulator look at bank housing loan risks, this is not rocket science.

  • Model 2: the bank aggregates some loans, most collected by housing professionals, supposed of uniform quality, and sells those aggregated loans to institutions and investors who usually buy only the top quality tranches. Bank no longer has loan on book. Housing professional takes a fee, bank take a fee and third party investors holds the potato. Note: the investor here has no real way to know the quality of the loan aggregate, it must rely on the two previous agents in the chain. In case of blow up bank are not affected, only the investor are (and public has to hope it's not their state or pension fund money).

  • Model 3: hedge fund buy some of the aggregated loans (high quality but lower too compared to most institutions). But then the bank come back in the picture by loaning money to hedge funds to leverage them: hedge fund has 1 million in investor money, the bank loans 9 millions to the hedge fund (so when the hedge fund assets go up one percent, instead of gaining 10 000 USD if it had only the million, it will go up 100 000 USD thanks to the bank loan allowing to buy 10 times more of it). So bank has now hedge fun loans in its book.

Hedge funds can have multiple banks, banks do loan money to each other on a regular basis have no idea what other bank hedge fund loan portfolio looks like. So it's likely that in the wake of recent events, banks stopped loaning money to each other afraid of a bank blow up and the central banks stepped in for a few days.

In the end of model 3, bank still have housing loans risk on their book, but of the worst kind since compared to model 1 they sonce don't know the share of the 4-8 trillions "boom" money they have.

The state grant the right to private banks to create money through loans in counterparty for regulations in the way they do it.

Very simple regulations can prevent banks to loan money to opaque counterparties but the main legacy of the Greenspan era is not really low rates, but the idea that the state should not regulate those bank loans at all.

Forget about the rate, it's all about the regulation.

(1) I do not work in the housing credit derivatives sector, but from what I know there's no model in housing credit going really above a multiplication, and there's no historical data whatsoever to calibrate anything since there never was a liquid market for those assets now or in the relevant past (and nobody knows the underlying loan portfolio anyway). So when MSM says "mark to model" valuation it's really just "mark to what I want".

by Laurent GUERBY on Fri Aug 17th, 2007 at 06:21:14 AM EST
Excellent summary. The whole mechanism started reasonably, with banks lending to hedge funds using strong collateral, conservatively valued, but as prices kept on going up, and liquidity everywhere put pressure on everybody to find more remunerative deals (i.e. riskier), these prudent behaviors gave way to more aggressive stuff. The basic argument went: "if  (house prices)(other underlying asset prices) go down by 30%, a big crash, we're back to where we were last year, so let's use the valuation from 2 years ago to be very safe. Except that 2 years ago, we were already significantly overvalued...

As Laurent points out, the first step of the crisis is banks stopping to lend to hedge funds and to suspect banks. That in itself, as I argued in this diary, is sufficient to crimp lots of markets in a major way given the predominant role funds of all sorts have been playing all over the place. They are suddenly all gone from being buyers and sellers to just being sellers (or at best, holders). That is unbalancing a lot of markets. Private equity deals for big quoted corporations is just the most visible one, but it's not the only one.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Aug 17th, 2007 at 07:07:09 AM EST
[ Parent ]
there's no model in housing credit going really above a multiplication, and there's no historical data whatsoever to calibrate anything since there never was a liquid market for those assets now or in the relevant past (and nobody knows the underlying loan portfolio anyway). So when MSM says "mark to model" valuation it's really just "mark to what I want".

Actually, the models are much more complicated than a multiplication, but I remain to be convinced that they actually fit the observational data so much better than a multiplication, indeed.

The calibration data is indirect when the product is new and was not traded in the past: you can calibrate to historical default statistics for instance (picking the time window that suits you best, like the phony past decade in housing).

Also, remember that you are only required, by law, to calibrate the model "to the market": that is, you calibrate the empirical constants in your model to replicate the risk perception that is "displayed" in the market at time T (for instance, the credit spread are supposed to embody the market's expectations of future default, and if they were low, it means you really could sell any crap to the crowds). This does represents the fair market value at which you could sell the asset at time T.

What regulation does not demand, is that you check the depth of the market (the volumes traded daily vs. what's in the book of a typical market player, and your books in particular). If the volumes are low in comparison, it means the prices could not hold very long if you had to liquidate. Forex to US$ is probably the deepest. Treasuries are very deep (except from the p.o.v. of the Chinese). Equity is pretty deep too. "classic" equity or treasury derivatives are almost as liquid as equity.

The CDO, CDS markets were never very deep to start with, and now they are down to zero. The spreads have shot up. In most models, it means the value is close to zero. In that, the models are not so wrong, actually !

It's just that bankers become reluctant to face the results the moment is displeases them. So it's also a stress-testing problem: regulators have been lax in the model-testing standards for credit derivatives, and no thorough risk assessment was ever made on these portfolios (risk assessment is mandatory and now pretty comprehensive on equity derivatives).

Pierre

by Pierre on Fri Aug 17th, 2007 at 07:45:21 AM EST
[ Parent ]
Yes I agree you can complicate and on your conclusion on the fit :).

For calibration there are three big problems on the current brand of housing derivatives:

  • this is a first in history: huge amount of household ARM outstanding and variants. Never been done before.
  • there was widespread fraud in entering household financial parameters when those loans were made, again a first in history.
  • there's already an historical high of houses (new and existing) for sale and we have an unprecendent amount coming in when the ARM will reset and people will default, no one knows what will happen to this huge oversupply  of house, never seen before.

Square meter per capita are very high in the USA, there is plenty of room to pack without anyone buying a house. A foreclosed house not sold for 10-20 years will become a ruin and loose all value, it will sell at raw land cost minus cost to destroy the hasardous ruin (and lower the value of the neighbourhood).

First in history means zero relevant observations, there is no magic model here.

by Laurent GUERBY on Fri Aug 17th, 2007 at 08:11:56 AM EST
[ Parent ]
I agree there are lots of first here. But even not taking these bad news into account, the MtM valuation models already conclude that, given the present illiquidity, the market expectation for future default is close to 100% loss. The models probably do not accurately predict whether it is going to be 85% or 98%, and it is again, just an indicator of player's new sentiment, not an Oracle for the future (it is even getting likely that they are over-pessimistic now, and super-senior tranches of CDO won't lose more than 30-50% even for the worst vintage of subprime MBS - of course, that's all talking US$ over 20 years when the dust settles, when the US$ will have devalued by 80%...).

What is really out the window, is the probability models that were used to predict the risk of such a market turnover (the 25-sigma probability, which was actually a +30%/year probability as common sense could have told 2 years ago). These models were based on the coincidental fact that optimistic market spreads ex ante from about 2000, did in fact match the exceptionnally low default rates observed ex post in 2005. When actually these low default rates were only due to the refi credit bubble.

Most senior bankers involved knew, but they chose to pretend not, so they could cash in and pack in time. And guess what ? most won't be liable to prosecution: regulations don't require bankers to hedge systemic risk (it's written in the law, I have it on my desk: "Règlement N°95-02 du 21/7/1995 relatif à la surveillance prudentielle des risques de marché", thick booklet). The systemic risk is explicitly of the responsibility of the market authorities and central banks (talk about bail out).

Because these authorities are highly politicized, whatever the claims of the contrary, it seems governments have chosen ratings agencies as a better scapegoat...

Pierre

by Pierre on Fri Aug 17th, 2007 at 08:39:14 AM EST
[ Parent ]
These may be firsts, but that shouldn't excuse the fact that what has happened in simple terms is that the market has taken bad debts, with limited to zero prospects of becoming good debts, and tried to turn them into credit.

The issue isn't that the models are wrong, it's that the process should never have happened in the first place.

No one should be trying to model crap like this. It's madness even trying to get a sensible market value out of 'assets' that by any sane standard are either worthless, or close to worthless.

But as you say, it has happened for political reasons. This is one big political scam, and should be acknowledged as such.

It's been as much about social engineering, giving a sputtering economy the illusion of bouyancy so that approval ratings remain high among the peasants, and the have-mores can maintain their culture of entitlement, as about the specifics of risk modelling.

As the ARMs reset and the US starts to see an astonishing new wave of homeless bankrupts, it needs to be remembered that this was as much a political feint as a financial pyramid.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Aug 17th, 2007 at 05:40:45 PM EST
[ Parent ]
Yes indeed. The establishment (fed+white house) was happy with the housing bubble because it kept the masses happy like under prozac: they had the house-ATM instead of the pay raise, and with proper media spin and indoctrination, you could let them believe it was just as sustainable. I'm still puzzled: the greenspans and the bernanke knew it wasn't sustainable, and eventually the thing would crash the US economy (and probably the world economy). We can only assume that they believe in confidence that there will be more damage at the bottom of the ladder than at the top. A few investment banks are expandable, in the process of manufacturing two generations of subservient debt-ridden slaves. That is, If they can tame the civil unrest ... and the protectionist/populist stance of the dems, which has the potential to send another shockwave all the way to China and back like a boomerang !

Pierre
by Pierre on Fri Aug 17th, 2007 at 05:49:43 PM EST
[ Parent ]
Well, well, well. The Fed has just cut its discount rate by 1/2 point. That shot of amphetamine gave a nice boost to the markets (Dow up 180) but the dollar fell .50 cents against the euro.
The ghost of uncle Alan is still watching!

Hey, Grandma Moses started late!
by LEP on Fri Aug 17th, 2007 at 10:45:57 AM EST
They all knew it was a bubble from the beginning.  Wall Street has been engaged in a colossal Ponzi scheme driven by the housing market for a good chunk of the last decade.  (Read back:  This bubble began long before 2003 in many areas of the US.)  But they were able to convince themselves that it would work; or that they would at least get out before everybody else.

Nope.  And now the Fed is beginning to signal that it will bend right over for these half-wit MBAs in Lower Manhattan -- just as the rest of us, who aren't completely brainless, begin to get excited about the prospect of the return of an affordable housing market.  And the ECB doesn't appear to be much better.  But I hope I'm wrong on both.

It doesn't really matter, anyway.  A lot of foolish people made a lot of foolish bets with other foolish people's money.  Now it's falling apart, and they're screwed.  Welcome to the big leagues, Jim Cramer:  The Medicaid line start over there (pointing), and, yes, I'd like fries with that.

And, while I wait for the market to hit bottom, I have my cigs and booze and fantastic teevee coverage.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Fri Aug 17th, 2007 at 05:52:18 PM EST
This is a much more complex presentation than it needs to be.  I'm applying Occam's razor and reducing this crisis to one thing:

ARMs.  Adjustable rate mortgages.  

That's what sub-prime borrowers got.  US lenders -- that is, the inviduals with families, bills, and maybe more than a touch of greed who MAKE their money lending money, and have long since been paid for having done what they did -- had zero incentive to explain what an ARM might mean if interest rates went up.  "If."  As in, they were so low that that there was only one direction they could go.

Now interest rates have once again risen, taking ARMs with them.  Suddenly, folks who barely cleared the hurdle  to start with can't clear it any more.  

= default. Defaults.  Many defaults.  And bad news for anyone not knowing any better than to buy that sort of paper.  But remember: those who did already got paid for doing it, just like those who arranged the deals to begin with already got paid for doing it.

This is not rocket science.  But it might better be rocket science.  Therein, it's just a matter of extremely predictable physics: inertia, momentum, gravitation, thrusts, and trajectories.  Very difficult to infuse much BS into basic constant variables.

In this econ meltdown, I cannot fathom how so many folks seem to be scratching their heads or something else and wondering "How did this happen?"

-----

The best argument against democracy is a five minute conversation with the average voter.
W. Churchill

by US expat Ukraine on Fri Aug 17th, 2007 at 10:31:08 PM EST
The ARMSs are definitely at the heart of this. But more than just ARMs was general speculation and how these mortgages played into it. Quite a number of these ARMs were sold in bait-and-switch schemes so many people were not fully aware of the implications of these mortgages. The most notorious mortgage company in the bait-and-switch scheme was Ameriquest which just settled a multi-state federal court lawsuit for about $350 million. During this time, Bush appointed their CEO to be Ambassador to the Netherlands.
by BJ Lange (langebj@gmail.com) on Fri Aug 17th, 2007 at 11:02:13 PM EST
[ Parent ]
Jebus.

That makes perfect sense in the worst way.

-----

The best argument against democracy is a five minute conversation with the average voter.
W. Churchill

by US expat Ukraine on Sat Aug 18th, 2007 at 02:11:32 AM EST
[ Parent ]
Writing about US economics and not ...
... about the housing bubble, would be like writing about Energy policy and ignoring Transport.

The Housing Boom and the government deficit are the two legs that the economy is standing on, and given that money spent overseas and tax cuts used to accumulate wealth do not give the best bang for the buck in terms of domestic stimulus, it seems highly likely that the housing boom is the primary growth driver.

And that is the scariest type of bubble ... when people are treating capital gains as if they were income by using them to leverage debt, and that debt finance is the support for the economic growth that allows the bubble to proceed.

If a bubble bursts when there are also other independent sources of economic growth, then there is much less damage done to the wider economy when the bubble bursts.

SupportTheTroopsEndTheWar.com and Energize America

by BruceMcF on Sat Aug 19, 2006 at 02:58:11 PM EDT



I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Sun Aug 19th, 2007 at 01:27:42 AM EST


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