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March 24, 2009

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what to say -- these are not good people. but... i do think they're ultimately rational people in the sense that money comes first, and they'll end up doing things that they think will make them money.

so, while it's utterly despicable and blackmailish, it's hard to believe the threats are very credible. if they think they can make money, they'll help. if they don't, they won't.

i don't think patriotism has ever -- or will ever -- motivate these people (or lack thereof). it's all money -- that's their world.

I've got,
Ninety thousand pounds in my pyjamas,
I've got forty thousand French francs in my fridge,

I've got lots of lovely lire,
Now the Deutschmark's getting dearer,
And my dollar bills would buy the Brooklyn Bridge.

There is nothing quite as wonderful money,
There is nothing quite as beautiful as cash,
Some people say it's folly,
But I'd rather have the lolly,
With money you can ma-ake a splash.

There is nothing quite as wonderful as money
(money money money)
There is nothing like a newly minted pound
(money money, money)

Everyone must hanker for the butchness of a banker
It's accountancy that makes the world go 'round
(round round round)

You can keep your Marxist ways
For it's only just a phase
For it's money makes the world go round
(money money money money money money money
money money)

I believe you are fortunate that Obama seems able to keep his eye on the larger goal steering the ship of state through the storms rather than dealing with the sins already committed, and apparently being committed. And important that there are others who will remember and at appropriate time mete out punishment.

I have no idea whether the Geithner plan will work, but isn't it a great advantage if it can be carried out without needing to get congress to produce new legislation?

At the same time I think it would be salutary if Geithner discovered that there was one bank that failed the stress test, and was nationalized- excellent object lesson for the rest of the Wall Street gang, and provide practice for Treasury/Fed, a test run so they are up the learning curve if they have to nationalize all the deadbeats.
I think an ear

Is there any reason why these Wall Street ghouls shouldn't be facing charges of treason? I mean, are there seriously no laws with language that would cover holding the country and the government hostage?

Bankers are in it for the money, big shocker. In their defense, however, "patriotism" is an even more deplorable motivation than greed. I know if somebody told me that I should put my own financial interests aside out of "patriotism', I'd tell them where to go.

A few objective points, though:

1. 'Patriotism' is an even more meaningless concept in an industry as international as banking and finance.
2. Various institutions have been resisting taking the government dollar before the whole AIG bonus thing blew up: bonuses are one of several reasons for fearing the government's dollars - the major one being the fear that politicians will interfere with deals after the fact, a danger that the furor over AIG seems to have proved real. Don't expect the media to consider this angle though.
3. The stress-test is probably useless anyway, apparently, but one thing it certainly does is give a government that's now proved itself untrustworthy a good look at your internal operations.

"...considered seeking capital from hedge funds and private-equity funds so they could return federal bailout money, thereby escaping federal restrictions."

Awesome. If they can get private money to stay afloat I'm all in favour of it. Although one wonders where this capital was hiding while they've all been crying pauper back when bailouts were free. What, there's suddenly no crisis of lending now?

Byrningman "2. Various institutions have been resisting taking the government dollar before the whole AIG bonus thing blew up"

I'd ask for a cite on that but y'know what? Good. Taking a bailout is not meant to be a preferred option.

You don't get to screw people over, send a lynch mob after them, arrange for them to be in fear of their lives, AND still have them be your friends and allies.

Not even if they deserved it, which most of them don't.

I'm beginning to wonder if Obama is all there, if he really thought it would go down any other way.

I'm not in the slightest surprised that the bankers' principal concern is their compensation. Money, and the power that it buys, are the only values Wall Street recognizes.

If they can dodge this bullet, they will have learned nothing. We'll then just have to wait for the next batch of "innovative products" that Wall Street cooks up to fleece us.

Obama the "pragmatist" is turning Obama the reformer into a joke. Is anyone surprised we haven't heard much about "stress tests" these days?

Unless there's another huge shoe Obama has yet to drop, we're being sold out to Wall Street, again.

Both the stress tests and the attempts to get credit flowing again are essential parts of our attempt to solve the enormous economic problems we now face, problems that these very firms are largely responsible for.

I realize it's conventional wisdom and very fashionable at the moment, but is the bolded bit really true? Because you (and others) are hanging a great deal of outrage on this claim.

It seems to me that the plausible causes of the current economic climate are:

1. A housing bubble. Folks who work on Wall Street aren't responsible for that. We are. We paid too much for our homes, and we speculated too much, we took on too much risk. (The "predatory lending" claim is good at deflecting blame from ourselves -- i.e., it's good scapegoating -- but there is a complete absence of credible figures or, even, incredible evidentiary support. It's nothing but a white-toast bun. Where's the beef?)

2. A supply shock, in the form of a massive increase in the cost of oil. Folks who work on Wall Street aren't responsible for this at all.

3. Significant manufacturers -- particularly, the big three -- with an unsustainable long term model. Again, folks who work on Wall Street aren't responsible for this.

4. Speculation by Wall Street investors. Yes, here is where some folks on Wall Street made bad, terrible, maybe even criminal bets. But these bad bets didn't cause the downturn; they magnified the downturn. Without at least #1 -- which fed them -- they wouldn't have gone sour as the did. Without #1 and #2, we probably wouldn't have the current severe recession (it'd be milder).

The blame for the current economic crisis lies with us as much as -- if not more than -- some rapacious other who lives far away.

It's difficult to accept, but there it is.

The housing bubble was created by Wall Street. It was the result of absurdly easy credit, and the whole point of extending such credit was to create more paper that could be leveraged 30-to-1 and bet against in "credit default swaps."

The oil bubble was also created by Wall Street - too much money in control of the top 1% and not enough productive uses for that money meant that a lot of it was invested in commodities. Do you really think that legitimate supply-and-demand changed that much over a six month period? It was all speculation.

If punishment is not meted out now when the bankers are despised by the public and dependent on government life support, it will never be meted out. Even if the short-term results are worse, the only way that Main Street will ever recover is if the political power of Wall Street is decisively crushed.

Obama's Laugh???

What most people are not discerning is, is that Pres. Obama is somehow aiding us in facing this "shadow" or darkness of greed in our society. He is not trying to Hide it or Cover it up! Ironically, he is being blamed for not trying to Fix it in a hurry, so it will not be Exposed..... But to truly fix it, we must face it, identify it and generate enough public consensus so that it can be changed. That is how change is made. That is why I see Pres. Obama as really a true change agent. True and lasting change can only come from the people, demanding change. That is why Obama can laugh, he knows that the fat cats' days of unchecked greed and speculation are numbered!

Now GOP's new buzz word is "unsustainable", however, what was really "unsustainable" as the recent events so adequately portray is that George Bush's Iraq War, tax cuts to the wealthy, jobs going over seas, tax breaks to companies that shipped jobs over seas, deregulation of banks and insurance companies, and more (which I will leave to the experts to flush out), is the really true Unsustainable and break down and collapse of our economic system, fabric of society (bridges, roads, jobs, education), you name it, he failed in all aspects of this society. There are "tent" cities popping up all over United States because families can no longer sustain to live in a house because they no longer have a job!

This new buzz word "unsustainable" is a hoax, disingenous and hypocritical. Remember, they want Pres. Obama to Fail!

And lastly, let's be Clear, George W. Bush's first year in office was spent more at the Ranch then in Washington. Where was the Party of No's outrage then? May be if George had spent more time in D.C. working, they would have been more alert about the signs leading to 9/11, just a thought.....

We paid too much for our homes, and we speculated too much, we took on too much risk.

it takes two to make a bad mortgage.

Joe Homeowner should've known he couldn't pay that mortgage, in the long run. but Ollie The Originator should've known it was a bad load to write in the first place. nobody walks into a bank and forces a banker to write a bad load at gunpoint.

the bubble couldn't last forever; someone was going to get caught holding that note. which is why Ollie The Originator sold those mortgages as quickly as he could make them: to make sure he wasn't holding the note when the music stopped.

Von, the financial system is certainly culpable in multiple ways in the housing bubble, as Josh G notes. The truly astonishing thing would have been if cheap easy money had *not* led to a wave of home buying, with said wave driving up prices, because ordinary consumers were somehow more prudent than the Fed and the financial system. But that's what you're implying when you say it's the fault of home buyers and not lenders, that home buyers could reasonably have been expected to be more prudential than the institutions providing credit.

The price of oil, both up and down, has been moving significantly because of speculation, not changes in underlying demand.

The "unsustainable model" of manufacturers also had a lot to do with a long period of easy credit, which fueled high levels of debt. More importantly, it was sustained by the near-total breakdown of shareholder capitalism as a system, where the fundamentals of most companies stopped having any meaningful relationship to their share prices. Again, that comes back to Wall Street, or to the highest reaches of corporate culture: that's why performance and economic fundamentals stopped mattering, and why there was no one left (not long-term shareholders, not investment advisors, not corporate boards) to push back on the disconnect between manufacturers and their foundational markets.

Glad you concede that "bad bets" by Wall Street have something to do with it. I think it goes a bit beyond "magnify the downturn". When speculative bubbles pop, the damage is sometimes limited just to the speculators and their immediate partners. Sometimes it affects several sectors of the economy enough to produce ripple effects. But the situation we're in now is as dire as it is because the entire global financial system has been at risk of sudden, total catastrophic collapse. The "bad bets" you're talking about are what have made this crisis far more complex and dangerous than an ordinary speculative bubble or an ordinary business-cycle downturn. To just say, "Oh, sure, that made things a little worse" is to pretty much miss the entire point of the current situation.

WTF... why would i misspell "loan" as "load" twice ?

Joe Homeowner should've known he couldn't pay that mortgage, in the long run. but Ollie The Originator should've known it was a bad load to write in the first place. nobody walks into a bank and forces a banker to write a bad load at gunpoint.

Yes: by definition, bubbles require at least two actors (a buyer and seller) to act irrationally. It didn't appear irrational to either at the time, however, because both come to regard the housing market as a futures market. Prices had gone up, they would continue to go up.

Of course, neither Howie the Homebuyer or Ollie the Originator are on Wall Street. They're your neighbors, they're middle class, and they are legion. Which is why it's incredibly fashionable to write things like folks at certain Wall Street Firms "are largely responsible for" the current economic mess. Because it's easier to blame someone else.

Josh G.,

The housing bubble was created by Wall Street. It was the result of absurdly easy credit, and the whole point of extending such credit was to create more paper that could be leveraged 30-to-1 and bet against in "credit default swaps."

The "absurdly easy credit" that you say is responsible for the housing bubble was caused by the Federal Reserve, if anyone, and supported by politicians on both sides of the aisle.

The oil bubble was also created by Wall Street - too much money in control of the top 1% and not enough productive uses for that money meant that a lot of it was invested in commodities. Do you really think that legitimate supply-and-demand changed that much over a six month period? It was all speculation.

Speculation in a futures market! Egads, no! (The really interesting part of your comment is your claim that there were "not enough productive uses for that money" that ended up in commodities. If true, it means that we're facing a depression.)

If punishment is not meted out now when the bankers are despised by the public and dependent on government life support, it will never be meted out. Even if the short-term results are worse, the only way that Main Street will ever recover is if the political power of Wall Street is decisively crushed.

Yes. Crush Wall Street. And The City, while you're at it. (London is probably more powerful than New York.)

"A supply shock, in the form of a massive increase in the cost of oil. Folks who work on Wall Street aren't responsible for this at all."

My impression was that the Bush govt did nothing to counter the upward price. eg the strategic oil reserve. I assumed this was to benefit the oil industry.

Timothy, you're blaming everything on easy credit which is primarily the Fed's fault (tie for second: Congress and the White House).

Regarding oil "speculation": Oil cannot be transported around the world without a futures market. The futures market is the market for oil. Those futures markets react to news regarding future supply. There was a lot of bad news from a number of fronts regarding the supply of oil, and lot of which was legitimate. (Katrina, the Iraq war, the invasion of Lebanon, etc.?) The futures markets reacted. The result was a short, but very severe, supply shock.

Shane: re "2. Various institutions have been resisting taking the government dollar before the whole AIG bonus thing blew up"

I read, don't know whether it is true that Paulsen was demanding all big banks take the initial TARP to remove the stigma:otherwise it might look as if there were banks in trouble.

Nice little attempt at exculpation there, von in your 07:42 comment - unfortunately, "Wall Street's" hands aren't quite so clean as you try to make out.

1. A housing bubble. Folks who work on Wall Street aren't responsible for that.

Partly right: "Wall Street" wasn't directly responsible; but they certainly (as Joel G. points out in the following comment)WERE for using "creative financing" to leverage the debt from said bubble into trillions of dollars of hot-air
"securities" whose collapse in value is the root cause of our current problems. Of course, "Wall Street" did also manage to rake off billions and billions of dollars in fees, etc. from trading all this ephemera: but since the "bubble" was "our" fault, I guess it's all OK with you. And btw, do you really disbelieve that there has been any "predatory lending"?? REALLY??

2. A supply shock, in the form of a massive increase in the cost of oil.

Yes - a massive increase fueled (obviously) by market speculation which has recently collapsed into a massive drop. But what does this even have to do with the current financial crisis?

3. Significant manufacturers -- particularly, the big three -- with an unsustainable long term model.

True enough: but what then would you imagine to be a "sustainable" model - close every factory in the US and ship the jobs off to low-wage havens? Malaysia? Bangladesh? And what, if anything has "Wall Street" done to arrest the decline in the American manufacturing sector?

4. Speculation by Wall Street investors. Yes, here is where some folks on Wall Street made bad, terrible, maybe even criminal bets. But these bad bets didn't cause the downturn; they magnified the downturn.

OK, here I'll agree 100%. Except that the downturn has been "magnified" into the most serious international financial crisis in a generation. And the agents of that magnification aren't some abstracted "rapacious other" - but the players in a industry (finance) whose mismanagement and irresponsibility have come back to bite ALL of us: not just "Wall Streeters".

Dang! I find myself agreeing with von? It must have been something I ate.

Or maybe it's because he has a point. The bottom line is that it's all nice and easy to blame an unregulated derivatives market for everything. But the bottom line is that the housing bubble caused this mess, and we're all responsible. Not just wall street. All of us. Add to that the negative savings rate of our population, and you have a toxic bubble ready to burst.

It's easy to blame wall street and get really angry at the physics nerds who made dumb inapplicable math models, but I know plenty of people who were ecstatic about their ARMs and their 0% credit cards five years ago. I told them they were playing with fire, and they said they'd just refinance! They should have known better. We all should have known better. There is no free lunch, and now we all get to eat the sh*tpile.

I think Toles summarizes it well:

Toles

"the fact that they are making these threats not over some large issue of principle, but over their bonuses -- that's just breathtaking."

Hm, I think this is a serious misreading of what ought to count as a principled objection. For Wall Street the ability to be paid bonuses is a principle of how labor relations work. The objection of Wall Street to a punitive bonus tax is about as principled as the reaction of auto workers or teachers would be to the claim that the current crisis necessitates to abolition of collective bargaining and seniority. Calling that a 'shameful lack of patriotism' would misunderstanding where auto workers and teachers are coming from, and so it this interpretation of Wall Street.

There are lots of things that can and ought to be fixed with Wall Street, but abolishing bonuses is way way overbroad, as overbroad as abolishing auto or teachers unions. Trying to do this indicates an outsider's lack of understanding of the industry.

Johnny Canuck, Bush could have drained the strategic oil reserve dry and still not had a significant impact on prices. We would then be left with no strategic reserve.
Bush made the right call on that one, even though it was unpopular.

Of course, neither Howie the Homebuyer or Ollie the Originator are on Wall Street. They're your neighbors, they're middle class, and they are legion.

the people working the desks at the local branches are local, certainly. but lending policies and mortgage products aren't designed on the fly by the people at the desk in the supermarket branch. and things like "liar loans" and "subprime lending" weren't driven by Main St; that came from Main St's desire to profit from Wall St's hunger for more and more loans to bundle, slice and leverage.

there's a flow. but what's driving the flow isn't the pressure of homeowners forcing money into the system; it's the vacuum of Wall St sucking money through the lenders.

Look: I don't think that Wall Street is exclusively responsible. I think that the Fed has a lot of blame, not just for the easy money part but also for failing to use their regulatory powers. Etc.

But I think that Wall Street has a lot more responsibility for the housing bubble than von seems to. Securitizing the loans created a huge market for mortgages. The fact that everyone seemed to think that securitizing them and slicing them up into tranches was a good way of dealing with their riskiness meant that the same people who constituted the huge market for mortgages also stopped caring about the quality of those mortgages in the way they ordinarily might have.

When you have an apparently bottomless market for mortgages and quality is not an issue, it's not a big surprise that a lot of people issued some pretty dreadful rewards, and made out like bandits for doing so. Supply and demand.

By the way, let's be clear: I am not excusing certain actors on Wall Street for dreadful, even criminal calls. I don't have any warm fuzzy feelings for the folks at AIG. But any explanation of the current economic crisis that doesn't include John Q. Public as first among the "guilty" is gravely incomplete.

And I use the term "guilty" loosely: No one intends a bubble, much less a crash. Even most of the "bad" speculators on Wall Street didn't have an evil intent. They didn't know they were being idiots. They certainly didn't want to lose their jobs (and many of them have.) They looked at a system that was sustaining and profitable for nearly a decade and kept making the same bad bets.

Even most of the "bad" speculators on Wall Street didn't have an evil intent.

I don't think they were sitting around twirling their moustaches, if that's what you mean, but they were completely indifferent to the perils of their actions, and that's evil enough for me.

They didn't know they were being idiots.

They weren't being idiots, though. They were being rational profit-maximizers, at least in the short term; and those who jumped ship early did exactly what (their version of) capitalism commanded them to.

I don't think they were sitting around twirling their moustaches, if that's what you mean, but they were completely indifferent to the perils of their actions, and that's evil enough for me.

You realize that a lot of these folks now have no jobs, right?

They didn't know they were being idiots.

I refuse to believe in stupidity on such a vast scale that it threatens the economy, but for a decade never caused any personal inconvenience to the perpetrators. What are the odds of that?

And I use the term "guilty" loosely: No one intends a bubble, much less a crash. Even most of the "bad" speculators on Wall Street didn't have an evil intent. They didn't know they were being idiots.

This is called "gross negligence". I wouldn't try it as a criminal defense.

This happened the classic way that bubbles and schemes work. The people on Wall Street weren't stupid. If you talked to them a few years ago, most of them would have told you that something was going to happen and this couldn't last. But then everybody figures that they could unload their investments, take their gains, and get out of the markets before the crap hits the fan. Of course, by definition everyone can't do that, and it looks like almost nobody did.

Bubbles, like cons, mostly work not because the participants think that the game is legitimate but because they think they're the ones screwing everyone else.

But I think that Wall Street has a lot more responsibility for the housing bubble than von seems to. Securitizing the loans created a huge market for mortgages. The fact that everyone seemed to think that securitizing them and slicing them up into tranches was a good way of dealing with their riskiness meant that the same people who constituted the huge market for mortgages also stopped caring about the quality of those mortgages in the way they ordinarily might have.

We'll have to agree to disagree. Wall Street deserves blame for derivatives, but companies like Freddie Mac and Fannie Mae, easy money from the Fed, and loose oversight in Congress surely deserve more of the blame for the lack of quality in mortgages.

When you have an apparently bottomless market for mortgages and quality is not an issue, it's not a big surprise that a lot of people issued some pretty dreadful rewards, and made out like bandits for doing so. Supply and demand.

On this one, you had me up to the "made out like bandits" bit. I don't know who on Wall Street is making out like a "bandit" in the sense that they are profiting from another's loss. These people may still be making more money than you or I have or will see in our lifetimes, but they are making significantly less than they have or would have and an unbelievable amount of thier wealth (assets) has evaporated.

Von: I don't know, but at the time, I undestood the Obama campaign that simply not adding to the strategic oil reserve, or a modest 10% reduction, during the speculative oil bubble, might have broken it.

"There are lots of things that can and ought to be fixed with Wall Street, but abolishing bonuses is way way overbroad"

It's actually quite a bit worse than "abolishing" bonuses, since that implies a prospective action which they could adjust their own behavior to cope with, maybe go into another line of work, or retire, or insist on being paid a regular weekly paycheck. What's happening is that they have already performed the work for which it was agreed in advance that they would get the bonuses, and now the agreed upon compensation for the work they've already performed is being retroactively gutted.

They've been told, in effect, that they'd be fools to ever again think they could count on getting paid for their labor, and that they can't even rely on being allowed to keep what they were paid in years past. Under the circumstances, the sensible thing for them to do isn't just find another line of work, it's to flee the country before the government thinks to go after their pay from further back.

Yes: by definition, bubbles require at least two actors (a buyer and seller) to act irrationally. It didn't appear irrational to either at the time, however, because both come to regard the housing market as a futures market. Prices had gone up, they would continue to go up.

Of course, neither Howie the Homebuyer or Ollie the Originator are on Wall Street. They're your neighbors, they're middle class, and they are legion. Which is why it's incredibly fashionable to write things like folks at certain Wall Street Firms "are largely responsible for" the current economic mess. Because it's easier to blame someone else.

Posted by: von

At the risk of repeating common knowledge for the nth time, that is simply, factually, not true. Actually, rather than repeat ad nauseum the facts, let me ask you this: What makes you think prospective home owners know better than banks what they can afford to pay on a mortgage?

That's an honest question. My personal experience is that I over-rated my ability to pay on a mortgage, the bank over-ruled me(this was 1997-1998) . . . and they were right. For all the usual depressing reasons dealing with large numbers of random actors.

The "absurdly easy credit" that you say is responsible for the housing bubble was caused by the Federal Reserve

Is "easy credit" the same as "low interest rates"? The Fed can cause the latter, but that doesn't make it inevitable that Countrywide and Wells Fargo will lend hundreds of thousands of dollars to people with no jobs or assets.

Under the circumstances, the sensible thing for them to do isn't just find another line of work, it's to flee the country before the government thinks to go after their pay from further back.

"the circumstances" being the effects of a bill that hasn't been to the Senate yet and that the President is signaling that he's not terribly interested in signing ?

@Hilzoy,

Those tranches could actually be good things: the idea is that they could open up decent lines of credit to folks who are marginally below the qualifying line, thus opening up an avenue for equity building for lower class citizens.

It's important to distinguish between (1) bundling credit and (2) Ratings arbitrage and predatory ARM lending. (1) is not necessarily bad, and could go a ways to allow for growth in savings/equity in poorer households. (2) should be criminalized, and a lot of it is already illegal.

@ScentOfViolets,

The problem is that banks did not only take advantage of asymmetric information. They also took advantage of consumer greed. I know plenty of well off people who bought into no downpayment ARMS. I told them that they were crazy, but they all said they'd sell or refinance by the 5 year adjustment. We now see how that worked out. Von is right, the public is not guilt free in this debacle.

Andrew Sullivan is making the same point as von and I this morning. Enough with the outrage at Wall Street fat cats. It's time for some introspection on all of our behavior.

Aren't there some labor unions at these banks that we could be talking about?

The only difference that makes is that they can take their time about it. The very fact that a law like this could be proposed, and taken seriously, destroys the confidence that is necessary for people to plan for the future.

Something very nasty is on the table that never was before. Don't begin to think that doesn't change things.

A great deal of our nation's prosperity has rested on the fact that, while we might have stupid policies, and a pathetic savings rate, we were at least the sort of nation where you could be confident certain things wouldn't happen. We're not, anymore.

Expect capital and skilled workers to start moving out.

It's time for some introspection on all of our behavior.

how much introspection is required on our part to prevent the next global insurance giant from overleveraging itself into a position where it could quite possibly bring down the world economy ?

Cleek,

I agree with you that the ratings arbitrage at AIG should never been allowed to happen. That was a huge failure of our regulatory system. But it couldn't have happened in the first place without the surplus of consumer greed. That's all I'm saying.

The problem is that banks did not only take advantage of asymmetric information. They also took advantage of consumer greed. I know plenty of well off people who bought into no downpayment ARMS. I told them that they were crazy, but they all said they'd sell or refinance by the 5 year adjustment. We now see how that worked out. Von is right, the public is not guilt free in this debacle.

Posted by: br

It's usually considered bad form to agree with the premise and then turn around and deny it in your argument. Once again, how were these people supposed to know that what they were doing was unsupportable? They were loaned the money, after all. So unless you can make the case that there was outright fraud on the part of the buyer, rather than a deliberate failure of due diligence on the part of the lender, you simply haven't got a leg to stand on.

I'd also be interested in what you think was the asymmetrical information in these transactions. I hope I'm not being overly cynical here, wherein your argument morphs from 'greedy homeowners' to 'buyer beware'.

@ScentOfViolets,

I have a PhD. I am talking about dot commers, bankers, and academics who were willing to play the dice. They knew very well they couldn't afford the ARM refinancing, but banked on (1) the market only increasing and (2) moving before 5 years. A friend of my father's is a banker who sold his house in Walnut Creek which doubled in value and then paid cash for a retirement home in Florida. He won the bet. Another friend of mine couldn't get out of his Cambridge condo before the interest adjustment and lost a huge sum of money and is back to renting. But all of these people knew they were gambling.

These are not poor clerks at Subway. These are professionals knowledgeably living way beyond their means. And knowing that it could all collapse if they mistimed a sale.

@ScentOfViolets,

By asymmetrical information, I meant that the banks almost always know mortgage law better than the buyers. So if there is ever a debacle with ARM adjustments, the banks know how it will go down better than the buyers. But the people I knew in this housing mess knew that they were gambling.

ItaliEx at your service.

You have a PhD, eh? Well, I've just about finished mine in math, so my PhD trumps your PhD any day of the week. You don't want to go there, comprehende? Now:

@ScentOfViolets,

I have a PhD. I am talking about dot commers, bankers, and academics who were willing to play the dice. They knew very well they couldn't afford the ARM refinancing, but banked on (1) the market only increasing and (2) moving before 5 years.

You're telling me then that the lending institutions didn't do their due diligence chores? Or that these dot-commers(I was one) were fraudulently misrepresenting their income? Or both? If there's fraud on the part of the buyer to conceal their cash flow problems, I'd agree with you. But even if what you say about the people you know is, er, not an exaggeration, there is simply no indication that widespread fraud had much to do with the bust.

Try again, please.

Under the circumstances, the sensible thing for them to do isn't just find another line of work, it's to flee the country before the government thinks to go after their pay from further back.

Bye. Seriously, if these people want to go Galt, I'll help them pack. If Wall Streeters are seriously trying to convince the public how vital they are to the success of this country, propagating one of the worst financial crises in world history is a tough way to make your case.

"The cemeteries are full of irreplaceable men." -- Clemenceau

By asymmetrical information, I meant that the banks almost always know mortgage law better than the buyers. So if there is ever a debacle with ARM adjustments, the banks know how it will go down better than the buyers. But the people I knew in this housing mess knew that they were gambling.

Posted by: br

If that's what you think the asymmetrical information was, then how does that explain anything, given that this has always been the case? You certainly didn't see this happening in 1995, or 1986, or 1977, etc. I'd suggest, the same way many other people have, that the pertinent asymmetrical information might have something to do with the changes that occured in the late 90's and onward.

Surely you as a PhD would agree ;-)

"Those tranches could actually be good things: the idea is that they could open up decent lines of credit to folks who are marginally below the qualifying line, thus opening up an avenue for equity building for lower class citizens."

That's the sort of thinking that got us into trouble: Maybe those folks were below the qualifying line for a good reason? And the equity building in fact was debt building?

If we wanted to expand home ownership, maybe we should have looked into ways to make starter homes cheaper, instead of ways to allow poor people to get deeper into debt.

At the risk of repeating common knowledge for the nth time, that is simply, factually, not true. Actually, rather than repeat ad nauseum the facts, let me ask you this: What makes you think prospective home owners know better than banks what they can afford to pay on a mortgage?

You're not repeating the "facts" that shall govern each, every, and all. You're drawing a general conclusion from your own, individual experience. There's a difference.

But, in answer to your question: Because prospective home owners know their income, circumstances, and future prospects better than any banker could. I'll grant you that bankers usually have greater general expertise. Prospective home buyers, however, have specific expertise and, more importantly, can educate themselves to some degree regarding the bank's general expertise. A bank, OTOH, has to rely onthe homebuyer to be honest, accurate, and complete.

Both sides have a knowledge problem, but the buyer's knowledge problem is easier to cure.

You have a PhD, eh? Well, I've just about finished mine in math, so my PhD trumps your PhD any day of the week.

Erm, since you don't actually have a PhD yet, doesn't this mean that you lose?

I know if somebody told me that I should put my own financial interests aside out of "patriotism', I'd tell them where to go.

And so we come to the heart of the problem.

For 'patriotism' please feel free to substitute 'a decent respect and concern for how my actions affect other people'. Still feel the same way?

The blame for the current economic crisis lies with us as much as -- if not more than -- some rapacious other who lives far away.

No, by God, it does not.

And belay the 'us'. I'll thank you to bloody well speak for yourself.

Josh G: The housing bubble was created by Wall Street. It was the result of absurdly easy credit, and the whole point of extending such credit was to create more paper that could be leveraged 30-to-1 and bet against in "credit default swaps."

Wrong, the Fed sets the price of money.

Shane: Awesome. If they can get private money to stay afloat I'm all in favour of it. Although one wonders where this capital was hiding while they've all been crying pauper back when bailouts were free.

Wrong on two counts. First, many institutions have been forced to take bailout money against their management's wishes. Secondly, the bailouts are not remotely 'free', since precisely the topic of this thread are the strings that come with them.

Cleek: Joe Homeowner should've known he couldn't pay that mortgage, in the long run. but Ollie The Originator should've known it was a bad load to write in the first place. nobody walks into a bank and forces a banker to write a bad load at gunpoint.

There is no equivalency in a dubious mortgage agreement. Even if the bank thinks the client is overextending themselves, ultimately that's the client's problem. Is the creditor's job to sell money or to raise the debtor's family for him?


It's blindingly obvious that many financiers ran their companies into the ground, no arguments there. But it's also prefectly true, as Von and others have pointed out, that bankers are not and never have been responsible for the price of money (set by the Fed), people voluntarily miring themselves in excess debt, the price of oil, Americans' refusal to save money in a way that would ultimately raise the productivity of American industry.

I know if somebody told me that I should put my own financial interests aside out of "patriotism', I'd tell them where to go.

"I regret that I have but one life to give to my country. But my money, I'm outta here."

And I'll make a WAG. If the innovators who developed our present derivative system decide to leave the country most of us won't notice. And capital that will only invest in risk-free vehicles that pay 15%+ interest is irrelevant to the non-financial U.S. society anyway. Hasta la vista, baby.

Even if the bank thinks the client is overextending themselves, ultimately that's the client's problem.

clearly, it's not the only client's problem. we wouldn't be having this discussion if it were.

you sell me something you know i can't afford, it's both our problems. but the one with the control in the transaction is you, not me. i can't force you to sell me a bad mortgage. that's your choice. and if you build a business around aggressively pushing and selling iffy mortgages, it's really your problem.

If the bankers were using fraud to magnify their short-term bonuses, and setting up the entire financial system to fall apart, why the HELL should they get their bonuses for doing their jobs, when it's now become obvious they DIDN'T do their jobs?

Hell, the companies should be suing these "masters of the universe" for breach of contract!

Instead of trying to blame poor people, or Fannie and Freddie, who didn't start this mess, why not blame the people who, y'know, started it, encouraged it, leveraged it, and crashed the economy? I don't give a crap about the "sanctity" of their contracts any more than these spleenweasel CEOs and Wall Street investors care about the "sanctity" of, say, union elections, workers' contracts, or the well-being of other people.

They want to take their ball and go home, because the mean nasty government might make them face some consequences for their actions? Fine, let them go back to their million dollar mansions and suites, and console themselves with the stacks of money they've already skimmed off everybody's retirement plans. We'll all be better off. Any idiot can run a company badly, but it takes very clever idiots to wreck the entire economy. Idiots we'd be better off without.

Oh, and as for blaming our "negative savings rate" and the average worker, even leaving aside information asymmetries, there's a reason we have a negative savings rate. Because wage growth has been flat for at least a decade. And blame for that also lies at the feet of the people who've obsessively fought unions, offshored decent jobs, and gutted the economy.

Who, amazingly enough, happen to overlap a lot with the "free market" crowd, the CEO crowd, and the "master of the universe" investment banker crowd.

So if you want to blame homeowners for their situation, why not look at who caused that situation in the first place.

I mean, besides it being easier to blame poor people.

Bottom line: American taxpayers are getting hosed. All so that we protect shareholders and Wall Street bonuses. Robbery. What Stiglitz said.

http://www.cnbc.com/id/29848741

Oh, and if there is any upside to be had, hedge funds and other similar investment groups get a huge piece almost risk free.

Obama has seriously disappointed.

But, in answer to your question: Because prospective home owners know their income, circumstances, and future prospects better than any banker could.

You've just repeated your original formulation back at me in slightly different words. Why do they know their income, circumstances, and future prospects better than any banker could? Surely you wouldn't apply this argument to insurance agencies, would you? And for the same obvious reasons?

Why can't I pay $10 a year for full auto insurance coverage, including provisions for lifetime disabilities and multimillion dollar disbursements to any parties I may inadvertently injure? After all, I know I'm a very good driver. I know my own abilities and personal situation far better than any insurer, right?

If you disagree, how do you reconcile the two positions?

P.S.- given where I'm at in the program, the only way not to get one is to either be in a terrible car accident or to get drunk and ralph all over the committee at my defense(and perhaps in the latter case not even then. I know of at least one student who vomited in front of one of the committee before actually doing the formal defense, and she somehow persevered.) I know my personal situation pretty well after all ;-) And, as I said, if anyone wants to pull some sort of rank like mentioning they have a PhD, well, my guns are bigger than yours. End of story.

"My impression was that the Bush govt did nothing to counter the upward price. eg the strategic oil reserve."

Your impression is wrong. The strategic oil reserves couldn't have broken more than a very few dollars off the price of oil, and that is even if we completely tapped them and then 2 months later the price of oil would have been right back up. Our strategic oil reserves aren't nearly enough to seriously tinker with the price of oil.

More generally, I think this is a problem over an empty threat. If bankers really can find private financing so they can save their bonuses, we should be freaking thrilled. We certainly shouldn't *want* to bail them out. But they can't. So they won't be getting their bonuses. This is whining, not policy. Getting too worked up over it doesn't seem productive.

The really hard question is what to we do with ridiculous numbers of silly mortgages, what do we do with ridiculous securities that were designed as if housing prices could only go up, and how do we get banks back to loaning to good businesses (I shared the anecdote of a close friend who desperately needs to expand his business, but his bank has frozen 95% of the business credit lines indiscriminately because they are running scared).

Also we need to find a way to get hundreds of thousands of lower and middle class construction workers who have been building the housing bubble into something else more useful. And we need to get tens of thousands of upper class New Yorkers out of wasteful financial company jobs and into something useful.

(Which is NOT to say that construction jobs or financial jobs are ALL wasteful. Merely that both sectors until recently have had way too much employment. The housing bubble made both sectors look much more attractive than anything else).

If some of these institutions really can get away with avoiding government funding, that is great! The rest of them can't, so all they have is impotent whining.

"You've just repeated your original formulation back at me in slightly different words. Why do they know their income, circumstances, and future prospects better than any banker could? Surely you wouldn't apply this argument to insurance agencies, would you? And for the same obvious reasons?

Why can't I pay $10 a year for full auto insurance coverage, including provisions for lifetime disabilities and multimillion dollar disbursements to any parties I may inadvertently injure? After all, I know I'm a very good driver. I know my own abilities and personal situation far better than any insurer, right?

If you disagree, how do you reconcile the two positions?"

Because the likelyhood of you knowing your job and cash flow is much more under your control than getting hit by an accident.

Dependent and independent variables. You'd expect a math PhD to understand the difference...

These weren't bad bets by Wall Streeters--they were the best kind of bets, the kind through which you make tens of millions of dollars with no chance of losing. They knew they were too big to fail. That's the bottom line. They knew they had the government behind them the whole way, and they still know it.

It will be very easy to see going forward whether or not the deep problems in our political and economic systems have been dealt with. If they have been, there won't be any more big bonuses on Wall Street. These people are bankers, and banking is not an excessively profitable business. If they're making boatloads of money, it's because they're taking advantage of the crucial role that their institutions play in the economy to make wildly risky bets. They'll have PhDs lined up 10-deep to say that the bets aren't that risky, but they'll be wrong. The huge profits that Wall Streeters have been making can't be made without huge risk. If they want to take those risks and make that money, they can't work for banks any more.

Needless to say, the article in the post does not give one the idea that Wall Street will transform itself willingly. But such a transformation is absolutely necessary for the survival of our country. Literally. If the people who run the big banks cannot or will not recognize this (or if they just don't care), and if our political leadership is so beholden to financiers that they will not force such a transformation, then the USA is, to use a currently popular word, doomed.


Even if the bank thinks the client is overextending themselves, ultimately that's the client's problem.

clearly, it's not the only client's problem. we wouldn't be having this discussion if it were.

And this is precisely the sort of asymmetrical knowledge that was the problem. For over a hundred years at least, right up to the turn of the century, people were able to count on the self-interest of the banks to act as a check on how much of a mortgage they were able to afford. Banks tended to loan too little, not too much, and people could safely reason that they were not biting off more than they could chew - surely the bank wouldn't deliberately lose money by giving them a loan they couldn't afford. Bankers just aren't that sort of people, so the thinking went, they would never give a loan to someone if they thought there was anywhere near a good chance that they might lose money on the deal.

And this was good thinking(I know at least one person who repeated that chestnut to me in 2005 to justify their mortgage) - up until a few years ago. This was also where the asymmetry kicked in. Very few of those people knew that the lending institutions were no longer holding on to that paper and were instead selling it off to parties unknown. Of course, for the same old, same old reasons - to make money.

But the buyers didn't know that. To them, just has it had been for their parents, their grandparents, and their great-grandparents, an indication of an affordable loan was the fact that the bank was making it at all. And if by some chance they were skeptical, they were told about 'financial innovations' that made risk more manageable, etc, by someone apparently much more competent in this field than they were. And who were only repeating what they saw on the 'news'. Very few were told that they were getting a too-good-to-be-true loan because the bank would no longer be responsible for any losses. And again, this is from direct experience. I don't think mine is much different from anyone elses.

Because the likelyhood of you knowing your job and cash flow is much more under your control than getting hit by an accident.

Dependent and independent variables. You'd expect a math PhD to understand the difference...

Posted by: Sebastian

And you know this because . . . ? btw, I would recommend, Sebastion, that you don't use terms like dependent and independent variables if you don't know what they mean. Which is clearly the case here, since you haven't explained what those variables are in this instance, and why.

That isn't an asymmetrical knowledge problem, that is an incentive problem. By making it possible to easily trade away mortgages (and yes we are looking at you as well FannieMae) we split the incentives. If you have to hold it yourself, the incentives are to be careful about the default risk. If you don't, you can forget about the default risk and hope that the buyer won't care too much either.

Interestingly we made mortgages easier to trade for the purpose of decreasing bank defaults. The problem we were fixing at the time was that since mortgages were local, a local downturn in the housing market would kill the local bank. By allowing trading from say a California bank to a Florida bank and vis versa they could hedge against that problem. When California prices went down, Florida ones didn't necessarily go down, so the bank survived.

This was a good thing.

The problem is that eventually all this trading helped harmonize the housing markets. (And harmonize is almost exactly the right word. If you think of resonatating tones and harmonic feedback you are getting it). So eventually you aren't really hedging anymore. So you've lost the value of the hedge AND additionally you have lost the local risk information that used to be inherent to banks holding their own loans AND you've lost the ability to have as much local knowledge even if you tried to pull back because the property values have become much more harmonized/coordinated across various locations.

And that is what we call unintended consequences. Ugh.

The overcompensated greedy ex of the Big Three are respnsible for the failures of the auto companies. Their determination to blame the unions is a symptom of their pathology.

It's a pathology that we all need to look at good and hard because it is a pretty common pathology. In fact, it is American conservatism.

Way back when, from those god-awful Pilgrims, our culture got infected with the notion that material prosperity equated with virtue. God's favor made manifest by prosperity in this world etc indicated who was among the elect. Ever since then it has been a subconscious article of faith with many Americans that the poor are depraved and degraded people who bring their poverty on themselves and the wealthy are wealthy because they are smarter annd more productive than everyone else.
And some poor people ARE depraved and degraded and responsible for their condition and some wealthy people are wealthy because of being smart and productive.

However lots and lots of smart productive people never get (and possibly don't seek) material wealth--health care providers like me, for example! And, as evidenced by our current economic troubles, lots of very wealthy people do not deserve the compensation they get because they were neither smart nor productive.

This Social Darwinism,the secular version of the belief in the "elect", inherited from those mean spirited Calvinists who it is our misfortune to have as cultural ancestors, has plagued our politics throughout our hisotry. Basically, this is the philosophy of American conservatism: serve the rich because they deserve it since they are by virtue of being rich inherently better than evereyone else and by serving them you will serve everyone else and if it doesn't work then it must be the fault of everyone else but certainly not the repsonsiblity of the weatlhy. They rationalize it as belief in small government, belief in personal responsiblity, support for intitiative and so on, but what it boils down to is "You're on your own, Jack! Everyone for themselves and may the best man win! " The US as Titanic.

According to this philosophy it is sensible to pay humongous bonuses to the exs who run companies into the ground while blaming the lack of profit on "overpaid" unionized employees. According to this philosophy it is more important to keep the rich of Wall Street rich than to save the economy of the whole country. According to this philosophy taxing the rich is punishing them unfairly for their virtuous behavior, etc. etc etc. but shifting the tax burden on to the middle and lower classes is acceptable. According to this philosophy it is sensible to run up huge expenses financinng the military industrial complex while cutting taxes for the rich, and blame thhe resulting deficit on undeserving welfare recipients . It is OK with Republicans to funnel tax dollars into subsidies for timber companies or agribusinesses but not to programs for the homeless of the mentally ill.And so on.


Because of this stupid, anti-Christian, anti-democratic Medieval philosophy everything the government does to serve the common good is socialist or, if not socialist, then a statist attack on personal intitative.

I'm glad the our oligarchs are exposing themselves so unambiguously. I'm in favor of waving the pitchforks in the air. I'm even in favor of metaphorically stabbing a few butts. But mostly I'm in favor of changing the Overton window in this country so that the government's legitmate role in promoting the prosperity of all citizens is no longer derailed and mired in all this crap about how bad it is to use government power to serve anyone except those that don't need it.

Well, I've just about finished mine in math, so my PhD trumps your PhD any day of the week

Uh, there are people who comment here that have serious math credentials (I don't include myself in this category), including at least one math Ph.D whose work I can't begin to understand. But I only got about halfway through an MS before I called it quits.

There is no equivalency in a dubious mortgage agreement. Even if the bank thinks the client is overextending themselves, ultimately that's the client's problem. Is the creditor's job to sell money or to raise the debtor's family for him?

It's the creditor's job to look after his own money by ensuring that he lends it only to people with a reasonable chance of repaying their loans. The home loan originators manifestly failed to do that. They deliberately avoided the established process for vetting prospective borrowers by moving to no documentation "liar loans". They were vigorously encouraged to do so by the companies that were securitizing loans, who actually paid "bonuses" (i.e. bribes) to originators for getting buyers into non-traditional loans. It's ludicrous to pretend that this was somehow a process of wily borrowers taking advantage of foolish lenders.

@russell: And belay the 'us'. I'll thank you to bloody well speak for yourself.

Hear, hear! I'm tired of being told that "we're all at fault" or "everyone is responsible" or "we all benefited". I was interested in buying a home starting in about 2003, but I decided to stay away. At first it was just because I was shocked at how high prices were, but it didn't take me long to recognize that there was a massive bubble. I avoided taking out a dumb loan to buy overpriced property, and I told everyone who wanted to talk about Real Estate that I thought there was a bubble and why. I fail to see why I should be lumped in with people who took out (or sold) liar loans in the belief that the market would keep expanding forever.

I fail to see why I should be lumped in with people who took out (or sold) liar loans in the belief that the market would keep expanding forever.

Because if we're all at fault, the no one is to blame, so there's no need to go looking for the perpetrators. And there's no reason to change anything.

Of course, if we're all really at fault, then maybe the system that we set up needs to be changed, but that's socialist or something so nevermind.

I'm sorry, but the issue with bonuses is *not* that somehow out of vengeance we want financial managers to be paid far less.

It's that the bonuses aren't bonuses. If you have a bonus-based system of compensation with low base salaries and high potential compensation through bonuses earned for high performance, the entire point of that system is that it has a downside, that it imposes costs for failure, that the people who take high risks are the first to feel it if the risks were unwarranted. Part of the public outrage here is that the bonus system clearly doesn't function like that in reality, either at the specific level of compensation or at the general level of visiting consequences most directly upon those who incurred the greatest risks.

Von notes that there are people out of work in the financial sector, and that many have seen personal wealth wiped out. But that's a general condition throughout the economy at the moment. I suppose that the rank-and-file of the financial industry may be experiencing a slighly worse version of it, but not at all proportionate to the risks they chose to incur on behalf of their own businesses or on their own personal behalf. Moreover, the people most responsible for making those decisions at the top of many of these organizations are, I suspect, largely insulated from even those consequences, unless they happen to have stepped over the line into criminal misconduct. E.g., the decision-makers who took the absolutely biggest risks are not experiencing the absolutely biggest consequences.

When risk and consequence are this badly misaligned, that's a general problem, and it's not John Q. Public that is "first on the list" of the causes for that misalignment. I've kept my retirement money out of any stocks for some years because risk makes me queasy, but there was a brief period in October where everything I've saved was in peril of being wiped out because of extraordinary risks being taken by a unit of AIG. People in my community who are losing their jobs because upper middle-class homeowners in California and Nevada were heedless in buying homes with the easy money the Fed kept floating didn't take any extraordinary risks, but they're now in extraordinary peril.

The bonuses are a synecdoche for a series of wrenching disconnects between risk and consequence, and I'm sorry, the buck for that disjuncture stops at Wall Street's desk, at the Fed's offices, in Congress, not at John Q. Public's front door.

Obama's unconflicted support for the Paulson bailout during the campaign was a major red flag. It was clear to those who were paying attention that he was and is basically an establishment whore. But seeing the supposed "change" candidate groveling back to Wall Street like a Republican to Rush Limbaugh, under cover of a barrage of Bush-league spin, is depressing.

"It's that the bonuses aren't bonuses"

No, they were retention bonuses; These are the people who were hired to pick up the pieces after the folks who created the mess had left, and in order to convince them to stick around for a job everybody knew was dead end in a deteriorating job market, it was agreed that they'd be paid at the end of the job, if they stuck it out.

Uh, there are people who comment here that have serious math credentials (I don't include myself in this category), including at least one math Ph.D whose work I can't begin to understand.

I think it's a good general principle that you need more than just a PhD to pull rank around here. Like maybe a named professorship, or something.

On a related note, has anyone ever seen Hilzoy and SuperUser at the same time? I'm starting to wonder....

They deliberately avoided the established process for vetting prospective borrowers by moving to no documentation "liar loans".

It was more than that. A number of lenders would black out income information on no-doc loan documents. They didn't want this information even when it was handed to them, because accurate information might screw up the underwriting.

There's a big difference between hitting a pedestrian because you're in pea-soup fog and hitting a pedestrian because you put a blindfold over your eyes. We're way into the latter category here.


Why you need to throw a banker against the wall once in a while:

Banks sold fraudulent loans to Wall Street. Wall Street made them into products which supposedly reduced the risk but did not. AIG-FP insured them without being able to pay the insurance. Bond rating agencies rated them AAA using horribly simplistic models, in order to satisfy the market for AAA ratings.

Many of these companies have failed, taking their shareholders wealth with them. However, the actual people at these companies have (many of them) gained ridiculously large incomes which they still have.

That's why you have to throw a Wall Street financier against the wall once in a while, to show them you mean business.

Since a human life is valued at about $5 million to $10 million (that is what we are willing to spend to save a life), correspondingly this massive fraud means that some hangings are in order.

On a related note, has anyone ever seen Hilzoy and SuperUser at the same time? I'm starting to wonder....

Most of us know that hilzoy's real name is Hildegarde Zoincks Superuser.

But the bottom line is that the housing bubble caused this mess, and we're all responsible. Not just wall street. All of us.

Speak for yourself. I rent.


And yes, I think everyone involved should be punished according to their responsibility.

The irresponsible no-doc homeowner who ended up costing the bank $100,000 should get one lash of the whip.

The irresponsible loan officer who ended up costing the bank's shareholders $10 mil should get 100 lashes.

The irresponsible Wall Street guy who ended up costing various parties $1 billion should get 10,000 lashes of the whip.

Since the latter is a death sentence, we'll save labor by just hanging him instead.

No, they were retention bonuses; These are the people who were hired to pick up the pieces after the folks who created the mess had left, and in order to convince them to stick around for a job everybody knew was dead end in a deteriorating job market, it was agreed that they'd be paid at the end of the job, if they stuck it out.

For some, that is true. But not all. Not even close to all. Nice spin though.

And if the job market is dead, where is the incentive to leave? In other words, to where would they be going?

Brett, you know what a salary is? It's a retention bonus. I'm getting paid a retention bonus right now. It's my paycheck.

Now if you think that the people at the London unit of AIG needed a specific large additional salary to guarantee that they wouldn't walk, you fail in two ways. 1) In understanding labor markets. You think that most of the people at that unit (or AIG in general) have a surplus of employment options at the moment? That they would go on the job market in a seriously depressed industry carrying a recent career record that is an intense liability because they weren't paid large bonuses above their base salaries? How much of a risk of a mass walkout of key personnel do you think AIG (or other financial firms) are taking if they cut compensation levels while trying to keep their businesses solvent? My guess is, about the same risks of a mass walkout of scholars working on the poetry of the Italian Renaissance if there's a salary freeze at many universities this spring.

Which points to 2): overstating the specific value of those employees. Not only do universities not have to worry about mass departures if part of what they do in the current emergency is adjust raises downward or even freeze salaries temporarily, they don't have to worry because they have plenty of replacements waiting in line should that somehow occur. Given conditions in the financial sector at the moment, I think AIG could find replacements for personnel who find that they're being inadequately compensated--and the argument that somehow only the people who caused this mess understand it well enough to fix it strikes me as a total myth.

Bonuses in general in the financial sector were structured as incentives for performance. If they're incentives for performance, then they're also exposure to risk. That's the fundamental objective of structuring compensation in that manner. But it stopped working a while ago, mirroring the way that risk and consequence stopped being properly linked in the economy as a whole.

I eagerly await David Neiwert's comment on the type of reaction expressed by TheWesson... ;)

problems that these very firms are largely responsible for.

I realize it's conventional wisdom and very fashionable at the moment, but is the bolded bit really true? Because you (and others) are hanging a great deal of outrage on this claim.

It seems to me that the plausible causes of the current economic climate are:

1. A housing bubble. Folks who work on Wall Street aren't responsible for that. We are. We paid too much for our homes, and we speculated too much, we took on too much risk.

So Lehman's failure was not its own fault? Bear Stearns? Merrill? The near collapse of Citi? The economic problems were not caused by people who "paid too much for their homes." They were caused by the house of cards erected by Wall Street on those purchases.

In a sensible system when people can't meet their mortgage payments the lender(s) take a loss, and that's that. But once you erect a paper-mache structure of MBS and CDS and who knows what, without anyone bothering to check the value of the underlying mortgage, you have the makings of a disaster. And once lots of people start making gobs of money trading these things the incentive to ask about how good thse loans are is pretty small, and in fact there's pressure to make more loans, to build the tower higher.

Yes, some, maybe many, homebuyers acted unwisely. But it took the genius of Wall Street to take these bad decisions and turn them from a set of individual, but limited, problems into a gigantic mess.

What Bernard said.

I had similar thoughts in response to Von, but Bernard said it better.

Way up thread, Brett Bellmore:

"You don't get to screw people over, send a lynch mob after them, arrange for them to be in fear for their lives, and still have them be your friends and allies."

When did the rules change?

I didn't receive the memo.

Big, fat, black mythical welfare mothers buying the thick-cut pork chops at the grocery. Even scrawny, skinny, white welfare mothers voted for Ronald Reagan on the way to the grocery to buy the thick-cut pork chops, in case the big, fat, black welfare mothers might get there first.

Air traffic controllers. Tax collectors

Various feminazis, parasites, traitors ....... Frank Luntz drew up the list for Newt Gingrich, Dick Armey and the rest of the usual suspects.

For good measure, let's mention the entire federal workforce during the Gingrich/Clinton government shutdown ...

.... then go read Wikipedia's little write-up
on Timothy McVeigh with excerpts from his anti-tax, pro-gun, government-hate spewings, which sould like they were lifted directly from the Gingrich Revolution's talking points ...

Way before al Qaeda, Federal buildings were evacuated regularly after McVeigh because of threats by red-blooded, cold-blooded killer Americans. Way before al Qaeda, the wife's car got the once-over by the Federal police, just to go to work to be an evil government scientist, for cripes sake.

Well, what would this list be without every utterance by Grover Norquist?

I forgive you, Brett.

You probably didn't get the memo either about how America demonizes its internal enemies.

Way before al Qaeda, cold blooded Americans were lynching and beheading other Americans of different ethnic backgrounds - be it African, Italian, Irish or other.

hey, we've got red-blooded, empty-headed patriots urging armed revolution right here, right now.

You realize that a lot of these folks now have no jobs, right?

You realize that a lot of these folks saw more money in a year than I will see all of this decade, right?

That isn't an asymmetrical knowledge problem, that is an incentive problem. By making it possible to easily trade away mortgages (and yes we are looking at you as well FannieMae) we split the incentives.

No, Sebastian, it is, as I have already explained, an asymmetrical information problem because the people taking out mortgages weren't aware that banks were routinely trading away mortgages instead of holding on to them as they had in the past. They were thus unaware that this old reliable signal - that banks making you a loan meant ipso facto that they thought you had an pretty good chance of paying back the loan - was no longer working. Iow, they didn't know that banks didn't have skin in the game any more. Nor did the lending institutions advertise this fact. The people who were suspicious of these good deals that their parents and grandparents never got were fobbed off with elaborate explanations about new ways of managing risk. Scientifically formulated, of course ;-) Somehow, they were never told bluntly that the lender could care less whether or not the loans were performing because they had no intention of holding on to them.

To my mind, that is a very significant bit of information to withhold. Would it have made a difference in people's buying patterns? I don't know. But I do know several people after the fact claiming that if they had known, they wouldn't have behaved the way they did.

Uh, there are people who comment here that have serious math credentials (I don't include myself in this category), including at least one math Ph.D whose work I can't begin to understand. But I only got about halfway through an MS before I called it quits.

Posted by: Slartibartfast

It's really not that difficult if you just keep slogging :-) I'm more than twice as old as the average PhD candidate, and if I can do it in my state of advanced decrepitude, anyone can.

Kidding aside, I just want to make it clear that I really don't hold with waving around a PhD(or indeed any other certification) like it gives the owner some special generalized authority. I only went off about mine because someone else tried to make that presumption. If somebody wants to say that their opinion about kidney stones carries more weight than the average because they're a doctor, that's fine. If somebody wants to claim their opinion about CDO's, the Geitner plan, etc carries more weight than average because they're a doctor, well, that's where I emphatically disagree, shall we say.

It's really not that difficult if you just keep slogging :-)

I beg to differ (:

There is no equivalency in a dubious mortgage agreement. Even if the bank thinks the client is overextending themselves, ultimately that's the client's problem.

Again, the asymmetry at work here is that the client assumes that the bank will let him know if he is - certainly that's been the case up until fairly recently. You're saying that even if the bank thinks the client is overextending themselves, and even if the client is basing their evaluation on practices the bank is no longer following, and even if the bank knows this, and even if the bank doesn't give a straight answer if the client asks flat-out what the mechanics are . . . that's still the client's problem.

Me, I'd say this flies perilously close to the wind, verging on outright fraud.

No, Sebastian, it is, as I have already explained, an asymmetrical information problem because the people taking out mortgages weren't aware that banks were routinely trading away mortgages instead of holding on to them as they had in the past.

It's also an asymmetrical information problem on the other side of the trade. One effect of securitization is to obfuscate the quality of the underlying loans. By the time you get to some highly engineered financial product like a CDO, the final buyer has no way of independently verifying the quality of the underlying mortgages. The whole situation is practically begging the mortgage originators to engage in fraud.

"because the people taking out mortgages weren't aware that banks were routinely trading away mortgages instead of holding on to them as they had in the past."

Speak for yourself, my bank was quite upfront about not intending to hold onto the loan.

I don't blame the bank that let me refinance my house after the divorce, or the second bank that gave me a home equity loan. It was largely the fault of my ex, who came into our marriage deeply in debt, and a year later left it debt free, necessitating the refinancing. And to some extent it was my fault, I knew I should have sold the place, even though I built it myself on the land I grew up on, and moved into a trailer park, instead of taking on a mortgage that I could barely pay in good times.

Am I to fault the mortgage company for giving me an outside chance of holding onto the place, rather than myself for taking that chance, or my ex for making it necessary?

But I do wonder, to what extent the vast increase in divorce has contributed to the crisis: Two income families with reasonable debt levels suddenly becoming one income guys crushed by the burden is common enough it's got to have some impact.

Interestingly we made mortgages easier to trade for the purpose of decreasing bank defaults. The problem we were fixing at the time was that since mortgages were local, a local downturn in the housing market would kill the local bank. By allowing trading from say a California bank to a Florida bank and vis versa they could hedge against that problem. When California prices went down, Florida ones didn't necessarily go down, so the bank survived.

This was a good thing.

Agreed.

The problem is that eventually all this trading helped harmonize the housing markets.

I don't think so. It's not clear to me why the trading of mortgages ought to increase the correlation among housing prices in different areas. These depend, in general, on local economic conditions, the desirability of the area, etc. Those won't change.

To me the problem is that instead of a mortgage being a single bet it became the basis of lots of bets. The securitiziation increased risk two ways.

First, it permitted huge amounts of leverage to come into play while obscuring underlying value. If you misjudge the quality of the underlying asset, and leverage to the hilt, you have problems. This is true even if the underlying assets are perfectly sensible mortgages, which do, after all, default sometimes.

Second, the CDS market enabled huge bets by non-lenders on the mortgages. It's one thing if a bank, or group of investors, loses $100,000 when a mortgage goes bad. It's another when there are 100 bets on the mortgage, so the loss is $10,000,000. And it gets worse when some of the losers can't pay. Then some of the winners are in trouble too, because having useless insurance is exactly like overestimating the quality of the mortgage.

Anyway, I have a BA in math, so I must be right ;-)

I'm sorry, but the issue with bonuses is *not* that somehow out of vengeance we want financial managers to be paid far less.

It's that the bonuses aren't bonuses. If you have a bonus-based system of compensation with low base salaries and high potential compensation through bonuses earned for high performance, the entire point of that system is that it has a downside, that it imposes costs for failure, that the people who take high risks are the first to feel it if the risks were unwarranted. Part of the public outrage here is that the bonus system clearly doesn't function like that in reality, either at the specific level of compensation or at the general level of visiting consequences most directly upon those who incurred the greatest risks.

To elaborate, the public feels outraged because they've been sold a con for the best part of thirty (or more) years. The average working stiff, you tell him he's being downsized, or that his benefits are being cut, he won't like it. But he'll go along with it because he believes in the system. Similarly, the average working stiff doesn't particularly care for the outrageous compensation of certain people in his company or maybe someone he's read about in the paper. But he thinks that maybe they really do have some super-duper skills that ordinary folks like him just don't have. After all, Kurt Warner has something like completion percentage of something like 65 or 66%. And that's a career completion percentage. Since he knows he's never going to be able to match something like that, maybe the big boys really do deserve those bonuses. And so he'll go along with it. Because he believes in the system.

But when the average working stiff sees someone fumble spectacularly and still get rewarded, spectacularly rewarded, just as if he had been doing his job well, while people like him have to eat the costs of those multi-billion dollar mistakes . . . that's when he stops believing in the system.

That's what people are upset about, as Wonkie also mentions up above. They've gone from thinking that the system, while a little hard-nosed, is basically the right way to do things, to thinking the system is set up to reward a small set of completely undeserving mooks. People who are not better than they are in some sense, but worse.

Sebastian: That isn't an asymmetrical knowledge problem, that is an incentive problem. By making it possible to easily trade away mortgages (and yes we are looking at you as well FannieMae) we split the incentives.
ScentOfViolets: No, Sebastian, it is, as I have already explained, an asymmetrical information problem because the people taking out mortgages weren't aware that banks were routinely trading away mortgages instead of holding on to them as they had in the past. They were thus unaware that this old reliable signal - that banks making you a loan meant ipso facto that they thought you had an pretty good chance of paying back the loan - was no longer working.

*raises hand*

I don't have a PhD, so maybe I'm not the brightest kid in class here, but I fail to see where these are in contradiction.

It strikes me as logically sound that a problem can arise both from perverse incentives that reward nonexistent lending standards, as well as from the asymmetric information problem that inhibits the ability of consumers who are not real estate or financial experts to make informed borrowing decisions.

But, in answer to your question: Because prospective home owners know their income, circumstances, and future prospects better than any banker could.

First of all, bankers don't (and really shouldn't) make these decisions: simple mathematical models decide. For example, a loan may be given if the weighted sum of a prospective borrower's credit score, annual income for the last five years, and verified assets are above some threshold. The question of how skilled bankers are at assessing borrowers is irrelevant: what matters is how good bankers' models are at assessing borrowers.

For the average person, I think typical banker models are far better at predicting prospective borrower's ability to repay. For starters, the models don't suffer from cognitive biases that beset human beings when evaluating themselves. Most people are convinced they're above average drivers and the human tendency to engage in self-deception is particularly strong when it comes to social signifiers like owning a home ("Of course I qualify for this loan because I'm a good person and homeownership is restricted to good people").

Beyond that however, most people are innumerate. They are scared of math. They are extremely uncomfortable thinking about numbers and they lack the skills and experience needed to do so correctly. Banks don't have this problem. There's a reason that lots of ARM mortgages were sold with super low teaser rates: many people decide whether they can afford a mortgage by figuring out if they can cover the first month's mortgage cost every month. That is a really dumb algorithm, but if you're functionally innumerate, it is probably the best you can do.

I'll grant you that bankers usually have greater general expertise. Prospective home buyers, however, have specific expertise and, more importantly, can educate themselves to some degree regarding the bank's general expertise.

I really don't see how we can expect significant numbers of prospective homeowners to develop the mathematical fluency needed so that they can realistically assess mortgage vendor claims on their own. People won't attend math classes for a year in order to get their own mortgage. Now, if you want to suggest that no one should be able to sign up for a home mortgage without retaining their own attorney/CPA who has a legal obligation to explain to them what their mortgage will actually cost, I can sign onto that idea, but I don't think that's what you're saying.

von, you once mentioned that your father is an econ prof and your brother has a math (or econ?) phd from MIT, right? Might I suggest that this level of mathematical fluency is extraordinarily uncommon? The average person is befuddled by fractions, let alone the complexities of risk analysis involving variable interest rate loans with negative amortization. Heck, the average person doesn't quite understand that credit card debt will grow dramatically if you only make the minimum payment.

A bank, OTOH, has to rely onthe homebuyer to be honest, accurate, and complete.

This is completely wrong. A bank can rely on credit scores. It can demand to see tax returns for the last few years. It can require that when prospective borrowers list assets that they own, they must also provide paperwork proving that they really own those assets. Now, some borrowers will go to great lengths to deceive the banks, but we have a word for that: fraud. And while that was a problem, a much bigger problem was the use of stated income stated asset loans where the bank simply refused to verify anything.

"because the people taking out mortgages weren't aware that banks were routinely trading away mortgages instead of holding on to them as they had in the past."

Speak for yourself, my bank was quite upfront about not intending to hold onto the loan.

Brett, let me say that you have some rather unusual experiences. No, I am not speaking just for myself. Not only does this seem to be a national phenomenon in general, I also know a few people, smart people, going-places people, who were not told that. Who, being the smart, going-places type of people that they were, actually asked the bank what was going on.

Do you agree that the lending institutions should have made this fact known to their prospective clients?

Or do you step back yet another pace and claim that it's up to the customer to find that out, not on the bank to supply requisite information . . . even if asked (albeit in an indirect way)?

Further, your sentiments above seem to be at variance with an earlier post of yours:

That's the sort of thinking that got us into trouble: Maybe those folks were below the qualifying line for a good reason? And the equity building in fact was debt building?

So how do you square the two statements? They seem contradictory to me.

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