Amazingly the Senate voted down a measure today to the Financial Reform Bill which would have required home buyers to put down at least 5% when taking out a home loan. That's right just 5% down, not 20% that used to be the norm and is what is required in Canada. Again, the Democrats voted down 5%.
The Senator who tried to get this passed was told by the party in power and community and housing advocacy groups that the 5% requirement was too draconian. Wow , as Ronald Reagan once said in another context, "There they go again". I know he may not be the best guy to quote, but this travesty just cries out for a great quote from someone.
So it looks like when things get better, lenders will start making bad loans again. I believe they already are; I saw a recent ad for home loans with only 3 1/2% down.
Will we never learn?
As I wrote in my last post, if bad loans weren't allowed to be made all of this other financial reform stuff won't really matter all that much. However,the Democrats have chosen to go the other way. Allow bad loans and just try to "cushion " the fall out to the economy when they fail. I think there is joke there somewhere about "turning the ladder, instead of unscrewing the light bulb".
Eric
Wednesday, May 12, 2010
Thursday, April 29, 2010
BAD LOANS
I have been following the financial reform bill and the debate via the media as best I can. The shape of the bill appears to be quite comprehensive, with one very fundamentally large exception. The bill appears to focus on absorbing the losses resulting from another financial panic or meltdown so the whole economy is not imperiled to the same degree. Things like "too big to fail", enhanced capital requirements, lower leverage limits, regulation of derivatives, executive compensation, and even the bank tax, are all well and good (perhaps), but they don't address the issue of actually preventing a future crisis.
In fact the one thing that's not covered is the prevention of making bad loans, or least an attempt to so. If the loans were good loans, no amount of leverage, securitization, derivatives, out sized compensation, or other opaque complexities or side bets, would have been a problem.
Why hasn't the emphasis been, as far as reasonably possible, to prevent lenders from making bad loans.
There is a lot of talk about a Consumer Protection Agency when what we really need is a Lender's Protection Agency. I know the optics don't look very good, but that's what's really needed. We need to protect lenders from making bad loans.
You say that sounds silly, well it's not so silly and here is why. I'll start with a story about a piece I saw on 60 Minutes. They interviewed a subprime lender in California (he seemed like a pretty smart guy) and asked how could he make loans to people who not only put no money down, but didn't even go through a credit check (income , job, assets etc-NINJA loans.) These were also known as liars loans. He said that he knew that he should have required all of the basic underwriting stuff , but that if he did so, his customers would just go down the street to another lender who won't require it, and in a few months he would be out of business. He was caught in a trap, even if one of his own doing, and he couldn't stop unless his competitors did as well. The only way to have put a stop to this insanity would be for the government to stop everyone from making these bad loans. That's what they do in Canada; no home loans without putting 20% down and customary credit underwriting.
Not so long ago our banks were "required" under banking regulations to use "safe and sound lending practices" to properly underwrite loans. Clearly the so called NINJA loans won't qualify. Implementing such a rule again would protect the banks from themselves and as a result protect all of us. I don't know when that all went away , but at the very least we should bring it back and apply it to all lenders of any kind. These shaky, some say shady, loans not only hurt the borrowers but in the end hurt the lenders as well; as we have so painfully seen.
So let's add a Lender's Protection Provision to the financial reform bill to protect lenders against making bad loans. Of course, you can't eliminate all bad loans, but we could go a long way in that direction and then we wouldn't have to worry so much about all that other stuff everybody talks about, but was not the root cause of the financial crisis. The root cause was BAD LOANS.
I'll discuss why lenders were allowed to make these bad loans in a subsequent post.
Eric
In fact the one thing that's not covered is the prevention of making bad loans, or least an attempt to so. If the loans were good loans, no amount of leverage, securitization, derivatives, out sized compensation, or other opaque complexities or side bets, would have been a problem.
Why hasn't the emphasis been, as far as reasonably possible, to prevent lenders from making bad loans.
There is a lot of talk about a Consumer Protection Agency when what we really need is a Lender's Protection Agency. I know the optics don't look very good, but that's what's really needed. We need to protect lenders from making bad loans.
You say that sounds silly, well it's not so silly and here is why. I'll start with a story about a piece I saw on 60 Minutes. They interviewed a subprime lender in California (he seemed like a pretty smart guy) and asked how could he make loans to people who not only put no money down, but didn't even go through a credit check (income , job, assets etc-NINJA loans.) These were also known as liars loans. He said that he knew that he should have required all of the basic underwriting stuff , but that if he did so, his customers would just go down the street to another lender who won't require it, and in a few months he would be out of business. He was caught in a trap, even if one of his own doing, and he couldn't stop unless his competitors did as well. The only way to have put a stop to this insanity would be for the government to stop everyone from making these bad loans. That's what they do in Canada; no home loans without putting 20% down and customary credit underwriting.
Not so long ago our banks were "required" under banking regulations to use "safe and sound lending practices" to properly underwrite loans. Clearly the so called NINJA loans won't qualify. Implementing such a rule again would protect the banks from themselves and as a result protect all of us. I don't know when that all went away , but at the very least we should bring it back and apply it to all lenders of any kind. These shaky, some say shady, loans not only hurt the borrowers but in the end hurt the lenders as well; as we have so painfully seen.
So let's add a Lender's Protection Provision to the financial reform bill to protect lenders against making bad loans. Of course, you can't eliminate all bad loans, but we could go a long way in that direction and then we wouldn't have to worry so much about all that other stuff everybody talks about, but was not the root cause of the financial crisis. The root cause was BAD LOANS.
I'll discuss why lenders were allowed to make these bad loans in a subsequent post.
Eric
Tuesday, April 27, 2010
The Wall St. Full Employment Act
It seems to me that one of the consequences of the financial reform efforts (unintended, I assume) is the benefits which may redound to Wall St. As I see what could happen, these efforts could be called The Wall St. Full Employment Act.
Let's start with getting our definitions straight. Wall St. refers to investment banks; firms like Goldman Sachs, Morgan Stanley, Merrill Lynch( now owned by Bank of America), Lehman Bros. (gone) and Bear Stearns (now owned by JP Morgan Chase). They all are (or were) headquartered in the Wall St area of New York City; ergo the name.
Big Banks are large commercial financial institutions that used to just basically take deposits and makes loans. They don't even primarily reside in Wall St, but rather are headquartered in Charlotte, San Francisco, Minneapolis, Pittsburgh and Mid-Town Manhattan.
As a result of the financial crisis, investment banks also became commercial banks because it entitled them to many of the government benefits employed to fight the financial panic. It was the smart thing to do, and it was allowed since the repeal of Glass Steagall.
Commercial banks, also as a result of that repeal, have been allowed, for some time, to act as investment banks.
If Glass Steagall is repealed, they will have to choose sides. The true investment banks will just drop their bank charters. They really don't care much about taking deposits and making loans. Have you ever seen a Morgan Stanley branch bank or a Goldman ATM? Me neither.
For the commercial banks, it's not so easy. If they are forced to leave investment banking, the field will be wide open for Wall St. to capture all of that business (very profitable albeit risky) the commercial banks will be required to abandon.
Talk about unintended consequences. In one fell swoop, Wall St. will have eliminated it's strongest competition. They will have to scramble to handle all of the new business.
By the way, I'm not sure allowing the Banks to do just non-proprietary investment banking will solve this problem in the long run.
All in all, getting rid of Glass Steagall may be bad for Banks, but great for Wall St.
Eric
Let's start with getting our definitions straight. Wall St. refers to investment banks; firms like Goldman Sachs, Morgan Stanley, Merrill Lynch( now owned by Bank of America), Lehman Bros. (gone) and Bear Stearns (now owned by JP Morgan Chase). They all are (or were) headquartered in the Wall St area of New York City; ergo the name.
Big Banks are large commercial financial institutions that used to just basically take deposits and makes loans. They don't even primarily reside in Wall St, but rather are headquartered in Charlotte, San Francisco, Minneapolis, Pittsburgh and Mid-Town Manhattan.
As a result of the financial crisis, investment banks also became commercial banks because it entitled them to many of the government benefits employed to fight the financial panic. It was the smart thing to do, and it was allowed since the repeal of Glass Steagall.
Commercial banks, also as a result of that repeal, have been allowed, for some time, to act as investment banks.
If Glass Steagall is repealed, they will have to choose sides. The true investment banks will just drop their bank charters. They really don't care much about taking deposits and making loans. Have you ever seen a Morgan Stanley branch bank or a Goldman ATM? Me neither.
For the commercial banks, it's not so easy. If they are forced to leave investment banking, the field will be wide open for Wall St. to capture all of that business (very profitable albeit risky) the commercial banks will be required to abandon.
Talk about unintended consequences. In one fell swoop, Wall St. will have eliminated it's strongest competition. They will have to scramble to handle all of the new business.
By the way, I'm not sure allowing the Banks to do just non-proprietary investment banking will solve this problem in the long run.
All in all, getting rid of Glass Steagall may be bad for Banks, but great for Wall St.
Eric
Tuesday, April 13, 2010
Time Out --Part II
In David Brook's op-ed "Relax, We'll Be Fine" in the Tuesday, April 6,2010 New York Times, he picks up on the optimism for America's future of my post "Time Out" . Here are a few choice quotes:
"despite all the problems, America's future is bright."
"Over the next 40 years... the US population will surge by an additional 100 million people...The population will be enterprising and relatively young. In 2060, only a quarter will be over 60, compared with China at 31 percent and 41 percent in Japan."
"The demographic growth is driven partly by fertility. The American fertility rate is 50 percent higher than Russia, Germany or Japan, and much higher than China."
"In addition , the US remains a magnet for immigrants. Global attitudes about immigration are diverging , and the US is among the best at assimilating them (while China is exceptionally poor). As a result, half of the word's skilled immigrants come to the U.S."
" between 1990 and 2005, immigrants started a quarter of the new venture- backed public companies"
"the US leads the world in scientific and technological development. The US now accounts for a third of the world's research and development spending ... The average American worker is nearly 10 times more productive than the average Chinese worker, a gap that will close but not go away in our lifetimes."
There is a lot more to his column and I urge you to find it. I particularly liked his conclusion that " In sum , the US is on the verge of a demographic, economic and social revival, built on its historical strengths".
It's also very interesting to note, in light of some of the anti-immigration hysteria, how critical immigration is to our future economic success.
Eric
"despite all the problems, America's future is bright."
"Over the next 40 years... the US population will surge by an additional 100 million people...The population will be enterprising and relatively young. In 2060, only a quarter will be over 60, compared with China at 31 percent and 41 percent in Japan."
"The demographic growth is driven partly by fertility. The American fertility rate is 50 percent higher than Russia, Germany or Japan, and much higher than China."
"In addition , the US remains a magnet for immigrants. Global attitudes about immigration are diverging , and the US is among the best at assimilating them (while China is exceptionally poor). As a result, half of the word's skilled immigrants come to the U.S."
" between 1990 and 2005, immigrants started a quarter of the new venture- backed public companies"
"the US leads the world in scientific and technological development. The US now accounts for a third of the world's research and development spending ... The average American worker is nearly 10 times more productive than the average Chinese worker, a gap that will close but not go away in our lifetimes."
There is a lot more to his column and I urge you to find it. I particularly liked his conclusion that " In sum , the US is on the verge of a demographic, economic and social revival, built on its historical strengths".
It's also very interesting to note, in light of some of the anti-immigration hysteria, how critical immigration is to our future economic success.
Eric
Tuesday, April 6, 2010
O Canada-Why Not?
I have been following the efforts in the Congress to enact financial reform. I agree with strengthening regulations regarding increased capital requirements and less leverage.
I definitely agree that the so called "shadow banking" sector must be included in the regulatory scheme.
Frankly, I think credit default swaps should be banned, unless you also hold the underlying asset(the so called naked swaps) or treated as insurance, with reserves set aside like any other insurance. But I'm sure there are decent arguments on the other side of that one.
I'm not sure why we need a separate Consumer Protection Agency other than to make sure bankers do what they should always do which is to make loans based on "safe and sound" underwriting principles.
Of course it's just silly to levy a tax on banks which can only cost consumers and create additional moral hazard ( whatever that really is). I really don't get why you tax banks for TARP losses arising from making loans to car companies and an insurance holding company. They better pass that tax quick before GM,Chrysler and AIG pay back the money they got, maybe even with a profit to the taxpayer.
However, what we really need is a ban, as exists in Canada, on subprime lending of the kind that got us into this mess in the first place.
Why is it that no one talks about eradicating the root cause of the financial meltdown-- abusive subprime loans. How in the world did the government allow subprime lending, especially the kind made with no money down and no proof of income, assets or even a job. The so called "no docs" loans that were made to anyone with a pulse.
As Paul Krugman pointed out it is against the law in Canada to make home loans with less than 20% down. Even with low interest rates and too big to fail banks, Canada didn't have much of a housing bubble problem. The reason was no subprime lending. The same was true of NYC where co-op boards certainly didn't allow subprime financing.
Why can't we just do that in the US? I really don't understand why no one talks about that. Everything else deals with how best to absorb the consequences of future problems. I think we also should do something to actually help prevent future problems. Securitization didn't cause the loans to go bad. Even credit default swaps didn't create those scandalously poorly underwritten loans. What's the old computer cliche "Garbage In , Garbage Out". The subprime loans were mostly garbage and no Volker Rule or other regulatory reform would change that.
All the other catastrophic problems followed from having made crappy loans in the first place. What am I missing here? All the other reforms do not address eliminating this root cause of the meltdown. Who is against eliminating subprime lending and why?
Eric
I definitely agree that the so called "shadow banking" sector must be included in the regulatory scheme.
Frankly, I think credit default swaps should be banned, unless you also hold the underlying asset(the so called naked swaps) or treated as insurance, with reserves set aside like any other insurance. But I'm sure there are decent arguments on the other side of that one.
I'm not sure why we need a separate Consumer Protection Agency other than to make sure bankers do what they should always do which is to make loans based on "safe and sound" underwriting principles.
Of course it's just silly to levy a tax on banks which can only cost consumers and create additional moral hazard ( whatever that really is). I really don't get why you tax banks for TARP losses arising from making loans to car companies and an insurance holding company. They better pass that tax quick before GM,Chrysler and AIG pay back the money they got, maybe even with a profit to the taxpayer.
However, what we really need is a ban, as exists in Canada, on subprime lending of the kind that got us into this mess in the first place.
Why is it that no one talks about eradicating the root cause of the financial meltdown-- abusive subprime loans. How in the world did the government allow subprime lending, especially the kind made with no money down and no proof of income, assets or even a job. The so called "no docs" loans that were made to anyone with a pulse.
As Paul Krugman pointed out it is against the law in Canada to make home loans with less than 20% down. Even with low interest rates and too big to fail banks, Canada didn't have much of a housing bubble problem. The reason was no subprime lending. The same was true of NYC where co-op boards certainly didn't allow subprime financing.
Why can't we just do that in the US? I really don't understand why no one talks about that. Everything else deals with how best to absorb the consequences of future problems. I think we also should do something to actually help prevent future problems. Securitization didn't cause the loans to go bad. Even credit default swaps didn't create those scandalously poorly underwritten loans. What's the old computer cliche "Garbage In , Garbage Out". The subprime loans were mostly garbage and no Volker Rule or other regulatory reform would change that.
All the other catastrophic problems followed from having made crappy loans in the first place. What am I missing here? All the other reforms do not address eliminating this root cause of the meltdown. Who is against eliminating subprime lending and why?
Eric
Friday, April 2, 2010
Pol Taxes
I have read and heard various numbers that anywhere from 35% to 60% of eligible taxpayers pay NO Federal Income Tax. When I discussed this with one of my more progressive friends and queried why the Republicans weren't making a big deal out of this, he said something that "blew my mind" ( sorry for the '60s jargon). The Republicans don't want to bring this issue up because so many of their constituents ( i.e. Tea Party type people) are among those who pay no,or very little, Federal Income Tax.
They think they are overburdened with Federal Income Taxes, but in reality they are not . If it were brought to their attention that they don't really pay very much Federal Income Taxes, Republicans might lose a lot of their most active and vocal base. The top 5% percent pay 60% of the Federal Income Taxes, but I'm guessing that a whole lot of those folks at Tea Party rallies are not in that top 5%.
Now let's be clear about this. I'm only talking about Federal Income Taxes; not Social Security Taxes ( which hopefully people will get back at least the money they paid) or Medicare Taxes ( which most people will use in the future to pay medical costs).
Of those who pay Federal Income Taxes, the top 10% of income earners pay over 72% of the taxes and the bottom 50% pay less than 3% of taxes paid.
Both parties really don't want people to hear too much about these figures. You almost never see articles or prominent stories about this in the mainstream or fringe media.
The Democrats, of course, believe the rich are under taxed and the middle class is overburdened, and facts like this are very inconvenient. Why is it , according to the Democrats apparently ,that only people making less than $250,000 come from hard working, tax paying, families? Are the rest just free loaders? The numbers don't bear that out; but those higher earners don't have as many votes.
The Republicans want to keep as many people as they can "riled up" about how they are overtaxed, so they can get elected. Whipping up the top 5% just won't bring out much of a crowd. Therefore it helps the Republicans to perpetuate the illusion that we are all overburdened with Federal Income Taxes.
Neither party care much about the facts.
Eric
They think they are overburdened with Federal Income Taxes, but in reality they are not . If it were brought to their attention that they don't really pay very much Federal Income Taxes, Republicans might lose a lot of their most active and vocal base. The top 5% percent pay 60% of the Federal Income Taxes, but I'm guessing that a whole lot of those folks at Tea Party rallies are not in that top 5%.
Now let's be clear about this. I'm only talking about Federal Income Taxes; not Social Security Taxes ( which hopefully people will get back at least the money they paid) or Medicare Taxes ( which most people will use in the future to pay medical costs).
Of those who pay Federal Income Taxes, the top 10% of income earners pay over 72% of the taxes and the bottom 50% pay less than 3% of taxes paid.
Both parties really don't want people to hear too much about these figures. You almost never see articles or prominent stories about this in the mainstream or fringe media.
The Democrats, of course, believe the rich are under taxed and the middle class is overburdened, and facts like this are very inconvenient. Why is it , according to the Democrats apparently ,that only people making less than $250,000 come from hard working, tax paying, families? Are the rest just free loaders? The numbers don't bear that out; but those higher earners don't have as many votes.
The Republicans want to keep as many people as they can "riled up" about how they are overtaxed, so they can get elected. Whipping up the top 5% just won't bring out much of a crowd. Therefore it helps the Republicans to perpetuate the illusion that we are all overburdened with Federal Income Taxes.
Neither party care much about the facts.
Eric
Monday, March 29, 2010
Market Shrink
The root cause of of the Great Recession, and indeed most all such phenomena, is human nature. I know , what a shock. And as humans maybe we need professional help. By "we" I mean the "market" because the market is just made up of humans after all.
When things went wrong from the excesses of subprime lending made by non traditional lenders to people who never should have gotten the loans in the first place, people/markets panicked. The panic, which itself may have been irrational, however lead to real problems, which had rational negatives consequences. If just the subprime market went down,the economy could have rather easily absorbed the losses. The subprime mortgage market was only a small fraction of all home mortgages, and even they didn't all go into default, at least at first.
Of course the unregulated credit default swap market really fed the hysteria. The rumor mill went wild with headlines abut CDS exposure which approached the value of all of the world's markets combined! The best example is Lehman Brothers who was rumored to have $800 Billion Dollars of CDS exposure. The reality, which came out in bankruptcy proceedings where the trades were all sorted out ( by net outing the trades and ignoring the massive multiple counting of the same single trade), turned out that Lehman's real exposure was $2 Billion Dollars--- oops, but too late. Yes $2 Billion is still a lot of exposure, but maybe its problems could have been dealt with better and bankruptcy avoided.
Why do people/markets panic? Where are "the cooler heads" who should have "prevailed?" What is it about human nature that we are prone to excesses and irrational behavior? People might respond by saying look the market was right and the economy did in fact collapse. But was that just a cascading self-fulfilling prophesy? What would have happened had people/ markets not panicked? We'll never know, as we dig ourselves out of the mess we're in.
Because of the panic, market prices sank, which lead to a perceived reduction in wealth, which lead to a reduction in buying, which lead to a fear of reduction in business profits, which lead to jobs cuts, which lead to further reduction in buying etc, etc. That's what happens when companies cut back, stop hiring ,lay off workers, cut back on travel and investments and so on and so on -- people who have lost their jobs stop shopping and traveling and so on and so on-- you get the picture.
Lately there have been basically 4 types of workers out there. (1) Those who have lost their jobs;(2) Those who are worried they will lose their jobs;( 3) Those who may have jobs they won't lose, but are worried about the success of their companies and therefore their jobs; and (4) Those who are so well off they have no real worries. None of this leads to a great economic recovery because everyone is cutting back on their spending, including #4 above . For example, a friend of mine related to me a comment made by a billionaire friend's wife --- She said "I've cut back on my spending by half because it just feels so unseemly in these hard economic times to keep on spending like I was." Wow are we in trouble.
Sure we had gone to excess. We were over leveraged and living on borrowed funds more than we should have. Yes we needed to modify our behavior, but come on, why a full fledged nervous breakdown? How did so much of these values just vanish? Maybe they weren't there in the first place?
Experts thought it could never happen, but the problem is the experts were thinking rationally. What happened ,at least at first, wasn't rational. Sadly however it became all to real.
You have to ask yourself , are we crazy now or were we crazy before and have just realized how crazy we were?
What we really need is a Chief Shrink, or Czar in current parlance, who can talk us down from our panic before the panic turns into a real live rationally based crisis.
I read somewhere about a developing science of analyzing ,and of course benefiting from, this sort of market mass psychosis. The problem is that people and markets don't always act rationally, and the trick is not to think in a rational way but rather in an emotionally based way.
At the time of the subprime loan panic, the default rate for commercial mortgages (CMBS) was .4% (that's right point 4% not 4%) and stayed that way for many months. There was no rational reason to panic just because less credit worthy borrowers who may have been "tricked" or certainly enticed into taking out loans they couldn't afford to repay began to default on their mortgages. Nevertheless the market value of CMBS securities plunged because residential(RMBS) subprime loans began to default. Of course once the value of the securities plunged and the recession began those commercial loans are now increasingly going into default. But what came first?
I remember listening to a story at the time the CMBS default rate was .4% but the subprime crisis was in full stride. This story was recounted by the chief economist for Wachovia. He told me about a Swiss debt trader who approached his boss about an opportunity to buy mortgage back securities at an attractively discounted price. His boss said absolutely not. The trader persisted and said that the pool of securities in question had no subprime loans of any type in them. The boss emphatically said no again. When the trader again pointed out that not only were there no subprime mortgages but that there were no residential mortgages at all in the pool, the boss asked whether the word "mortgage" was in the name of the securities. When the trader replied that yes these were commercial mortgages, the boss ended the conversation by saying if you bring me any investment again with the word "mortgage " in its name you are fired!
Of course, the boss turned out to be right because once everyone stopped buying anything with the word "mortgage" its name the whole market value for those securities crashed. Eventually this lead to the crash of the whole market which lead to the slow down in business activities which lead to the lay offs of millions of workers which lead to a real recession which in turn lead to the impending crash of the commercial real estate market with the result that CMBS default rate is now predicted to go to 8.5% by June.
Either that boss in Switzerland was very very smart or understood what can happens in a panic or was just lucky in avoiding the consequences of the crash he helped create. In any event how do you "calm" the markets before the panic takes over? Maybe we need a shrink to tell us "just because something bad happens that the world isn't falling apart and if we only refrain from panicking everything will be just fine". Since rationality and logic didn't seem to work--- remember those commercial properties were just fine - full of busy workers who received pay checks which they used to buy things and travel and the like - until a group of home buyers with less than stellar credit began defaulting on their crazy mortgages they were "tricked " into getting, that the government should never allowed to be made in the first place. As the guy from Saturday Night Live would say --- What's Up with That?
Who knows maybe a Psychiatrist-in-Chief or a Shrink Czar is what we really need.
Eric
When things went wrong from the excesses of subprime lending made by non traditional lenders to people who never should have gotten the loans in the first place, people/markets panicked. The panic, which itself may have been irrational, however lead to real problems, which had rational negatives consequences. If just the subprime market went down,the economy could have rather easily absorbed the losses. The subprime mortgage market was only a small fraction of all home mortgages, and even they didn't all go into default, at least at first.
Of course the unregulated credit default swap market really fed the hysteria. The rumor mill went wild with headlines abut CDS exposure which approached the value of all of the world's markets combined! The best example is Lehman Brothers who was rumored to have $800 Billion Dollars of CDS exposure. The reality, which came out in bankruptcy proceedings where the trades were all sorted out ( by net outing the trades and ignoring the massive multiple counting of the same single trade), turned out that Lehman's real exposure was $2 Billion Dollars--- oops, but too late. Yes $2 Billion is still a lot of exposure, but maybe its problems could have been dealt with better and bankruptcy avoided.
Why do people/markets panic? Where are "the cooler heads" who should have "prevailed?" What is it about human nature that we are prone to excesses and irrational behavior? People might respond by saying look the market was right and the economy did in fact collapse. But was that just a cascading self-fulfilling prophesy? What would have happened had people/ markets not panicked? We'll never know, as we dig ourselves out of the mess we're in.
Because of the panic, market prices sank, which lead to a perceived reduction in wealth, which lead to a reduction in buying, which lead to a fear of reduction in business profits, which lead to jobs cuts, which lead to further reduction in buying etc, etc. That's what happens when companies cut back, stop hiring ,lay off workers, cut back on travel and investments and so on and so on -- people who have lost their jobs stop shopping and traveling and so on and so on-- you get the picture.
Lately there have been basically 4 types of workers out there. (1) Those who have lost their jobs;(2) Those who are worried they will lose their jobs;( 3) Those who may have jobs they won't lose, but are worried about the success of their companies and therefore their jobs; and (4) Those who are so well off they have no real worries. None of this leads to a great economic recovery because everyone is cutting back on their spending, including #4 above . For example, a friend of mine related to me a comment made by a billionaire friend's wife --- She said "I've cut back on my spending by half because it just feels so unseemly in these hard economic times to keep on spending like I was." Wow are we in trouble.
Sure we had gone to excess. We were over leveraged and living on borrowed funds more than we should have. Yes we needed to modify our behavior, but come on, why a full fledged nervous breakdown? How did so much of these values just vanish? Maybe they weren't there in the first place?
Experts thought it could never happen, but the problem is the experts were thinking rationally. What happened ,at least at first, wasn't rational. Sadly however it became all to real.
You have to ask yourself , are we crazy now or were we crazy before and have just realized how crazy we were?
What we really need is a Chief Shrink, or Czar in current parlance, who can talk us down from our panic before the panic turns into a real live rationally based crisis.
I read somewhere about a developing science of analyzing ,and of course benefiting from, this sort of market mass psychosis. The problem is that people and markets don't always act rationally, and the trick is not to think in a rational way but rather in an emotionally based way.
At the time of the subprime loan panic, the default rate for commercial mortgages (CMBS) was .4% (that's right point 4% not 4%) and stayed that way for many months. There was no rational reason to panic just because less credit worthy borrowers who may have been "tricked" or certainly enticed into taking out loans they couldn't afford to repay began to default on their mortgages. Nevertheless the market value of CMBS securities plunged because residential(RMBS) subprime loans began to default. Of course once the value of the securities plunged and the recession began those commercial loans are now increasingly going into default. But what came first?
I remember listening to a story at the time the CMBS default rate was .4% but the subprime crisis was in full stride. This story was recounted by the chief economist for Wachovia. He told me about a Swiss debt trader who approached his boss about an opportunity to buy mortgage back securities at an attractively discounted price. His boss said absolutely not. The trader persisted and said that the pool of securities in question had no subprime loans of any type in them. The boss emphatically said no again. When the trader again pointed out that not only were there no subprime mortgages but that there were no residential mortgages at all in the pool, the boss asked whether the word "mortgage" was in the name of the securities. When the trader replied that yes these were commercial mortgages, the boss ended the conversation by saying if you bring me any investment again with the word "mortgage " in its name you are fired!
Of course, the boss turned out to be right because once everyone stopped buying anything with the word "mortgage" its name the whole market value for those securities crashed. Eventually this lead to the crash of the whole market which lead to the slow down in business activities which lead to the lay offs of millions of workers which lead to a real recession which in turn lead to the impending crash of the commercial real estate market with the result that CMBS default rate is now predicted to go to 8.5% by June.
Either that boss in Switzerland was very very smart or understood what can happens in a panic or was just lucky in avoiding the consequences of the crash he helped create. In any event how do you "calm" the markets before the panic takes over? Maybe we need a shrink to tell us "just because something bad happens that the world isn't falling apart and if we only refrain from panicking everything will be just fine". Since rationality and logic didn't seem to work--- remember those commercial properties were just fine - full of busy workers who received pay checks which they used to buy things and travel and the like - until a group of home buyers with less than stellar credit began defaulting on their crazy mortgages they were "tricked " into getting, that the government should never allowed to be made in the first place. As the guy from Saturday Night Live would say --- What's Up with That?
Who knows maybe a Psychiatrist-in-Chief or a Shrink Czar is what we really need.
Eric
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