NationStates Jolt Archive

http://www.businessspectator.com.au/bs.nsf/Article/Joye-$pd20090226-PM69X?OpenDocument&src=sph

I just stumbled across this excellent, if a little long, article about the mortgage system in the US, how it is different from that in other countries and why it is particularly vulnerable to fucking itself up.

The basic idea is that compared to other countries, securitisation makes up a huge chunk of the market. That's not because of greedy people in Wall Street though, but because of the lack of truly national vanilla banks in the US. There are 8,400 banks in the States (1,000 of which are already projected to be toast within the next 3-5 years, by the way), there are maybe a dozen in Australia. The author argues that the reasons for that are largely due to the government's "emergency" regulations and, primarily, institutions designed to deal with crises such as the Great Depression staying around and distorting the structure of home lending over time.

What do you think? And does this offer any particular insight into how a mortgage rescue and a system reset might look like?

A bit long and over my head.

If you want what most people consider to be a "vanilla bank" you have to look at credit unions in the US.

Most credit unions were completely untouched by the crisis, because they're never involved in securities.

Leonstein, a lot of people on this forum may understand the conversation better if they get some background. Right now, they probably think it's all the evil Republicans fault.

http://vimeo.com/3261363

The best explanation.

A bit long and over my head.
Well, here's the gist of it:
The government-created, yet purportedly private GSE duopoly, which acted as a surrogate for a nationally integrated deposit-taking system, stunted the need for the geographically dispersed and intrinsically fragile US banking industry to naturally consolidate and insulate itself from failure over the course of the 20th century. These structural flaws in the US credit creation system were exacerbated in the early 2000s, when the highly-leveraged GSEs, on the conflicted imprimatur of both government and shareholders, entered the much riskier nonprime segments of the US mortgage market, which ended up accounting for most of their losses. Once again, the traditional private lending sector was pushed further down the credit curve with a consequent explosion in sub-prime) loans.

[...]

My advice to President Obama, Timothy Geithner, Shaun Donovan, and Austin Goolsbee is that merely applying myopic bandages to the symptoms of these problems, and reinvigorating the GSEs, is emphatically not the long-term answer. The entire system of housing finance needs to be transformed to a bank-based balance-sheet focus. At some point, the GSEs should be fully nationalised and, alongside other public housing finance agencies, phased out of the day-to-day private credit infrastructure. Governments have a role to play supplying the public goods of liquidity and price discovery when markets fail – but only when markets fail.

In the long run, the Obama administration needs to create something that has been beyond previous governments: a robust and nationally-integrated private banking infrastructure, which is funded mainly through retail deposits, in order to firmly reposition balance-sheets as the principal repository of housing finance in the US. While there are undeniable diversification benefits to be garnered from securitisation, there is no evidence that the third-party capital available through this process should supplant the savings system.

Well, here's the gist of it:

In simpler terms:

Encouraging willy-nilly giving out of mortgages and covering your ass with Ponzi-scheme CDOs and credit default swaps is what got us into this mess. Combined with the ridiculous moves by Greenspan over the years, and the deregulation of this market by both Republicans AND Democrats (including one Larry Summers), we are fucked.

Trying to reinflate the Ponzi scheme by throwing a trillion dollars into it is not going to make it better, neither will it solve the problem.

Did I miss anything?

Did I miss anything?
I think you kinda missed the point. This isn't about CDOs or Ponzi Schemes, but the way home loans are sold and treated in the US as opposed to other countries. There are basically no normal banks which just lend money and wait for it to be paid back.

There are two reasons for that: Freddie and Fannie have artificial advantages and can push competition out of the market, and until fairly recently there were regulations against banks operating across individual states. As a result, there are few national banks, and even fewer which are actually in the business of originating and keeping home loans. Securitisation is the only way in which these small banks can operate, and because of that and their small size, they're exceptionally vulnerable.

So essentially there are these serious systemic imbalances here which are the result of bad policy which no one fixed in decades.

I think you kinda missed the point. This isn't about CDOs or Ponzi Schemes, but the way home loans are sold and treated in the US as opposed to other countries. There are basically no normal banks which just lend money and wait for it to be paid back.

There are two reasons for that: Freddie and Fannie have artificial advantages and can push competition out of the market, and until fairly recently there were regulations against banks operating across individual states. As a result, there are few national banks, and even fewer which are actually in the business of originating and keeping home loans. Securitisation is the only way in which these small banks can operate, and because of that and their small size, they're exceptionally vulnerable.

So essentially there are these serious systemic imbalances here which are the result of bad policy which no one fixed in decades.

Remember why we have Fannie Mae and Freddie Mac. It's a government plan to make home ownership possible for more people.

The reason that
a) no one foresaw how banks would game this out
b) how investors would game this out
c) how home buyers would game this out
d) how poor people would game this out
e) why no one fixed it

is that everyone said, "it's going to make more homeowners, and what's wrong with that, especially if it's an idea from the government"?

As long as home values went up, and as long as fairly creditworthy home owners were in the mix, it looked good on paper.

When shitty uncreditworthy homeowners got in, and banks were dumb enough to lend to them, it all blew up in their faces.

See the link I posted to the full explanation.

http://www.youtube.com/watch?v=_MGT_cSi7Rs&feature=related

http://www.youtube.com/watch?v=hxMInSfanqg

"Nothing wrong here. Move along."

When shitty uncreditworthy homeowners got in, and banks were dumb enough to lend to them, it all blew up in their faces.


That was never the problem. Sub-prime is a catalyst, maybe - the straw(man) that broke the camel's back.

Banks serve an intrinsic purpose in an economy - they hold money. That can take indirect forms - like transferring money, with the banks each assuring the debt incurred by the others.

What the complete lack of regulation (historically) has done, is allow for diversification. Which looks good on paper, looks good in the short-term, and makes money... but it means that banks are not doing 'banking' as the lion's share.

Housing prices have been inflated, and it's largely been by shuffling numbers on paper. Predatory trading of property has accounted for a large share of that, as has predatory acquisition... and the banks have enabled it by lending money they didn't have, by acting as a resource for outsourcing debt.

It's been a house of cards that has been building. Sooner or later it's been inevitable that the height would outstrip the width of the base, and it's been getting increasingly unstable ever since.

Subprime mortgages aren't the problem. They're not really even a drop in the ocean.

What the complete lack of regulation (historically) has done, is allow for diversification. Which looks good on paper, looks good in the short-term, and makes money... but it means that banks are not doing 'banking' as the lion's share.

It's not the lack of regulation so much as it is the lack of proper deregulation. The biggest problem was the continued existence of the GSEs and government bailouts; if everything were deregulated, the market would have not only punished firms that failed but it would not have tolerated the kind of risky investments that these companies made. However, when you've not only got two massive government entities distorting the market but also the basic guarantee that you're going to be rescued if you screw up, risk is massively and artificially depressed and the result is the kind of disastrous decisions that have led to our current crisis.

I personally feel the best plan is to tighten regulations and then completely privatize all GSEs. Once the market is free, regulations can be loosened if justified; the most important things are that we make sure that regulations protect against distortions and secondly eliminate the sources of those distortions.

That was never the problem. Sub-prime is a catalyst, maybe - the straw(man) that broke the camel's back.

Banks serve an intrinsic purpose in an economy - they hold money. That can take indirect forms - like transferring money, with the banks each assuring the debt incurred by the others.

What the complete lack of regulation (historically) has done, is allow for diversification. Which looks good on paper, looks good in the short-term, and makes money... but it means that banks are not doing 'banking' as the lion's share.

Housing prices have been inflated, and it's largely been by shuffling numbers on paper. Predatory trading of property has accounted for a large share of that, as has predatory acquisition... and the banks have enabled it by lending money they didn't have, by acting as a resource for outsourcing debt.

It's been a house of cards that has been building. Sooner or later it's been inevitable that the height would outstrip the width of the base, and it's been getting increasingly unstable ever since.

Subprime mortgages aren't the problem. They're not really even a drop in the ocean.

If you read what you just quoted from me, that's what I was saying.

Guess you missed that.

It's not the lack of regulation so much as it is the lack of proper deregulation. The biggest problem was the continued existence of the GSEs and government bailouts; if everything were deregulated, the market would have not only punished firms that failed but it would not have tolerated the kind of risky investments that these companies made.


Not true. The market would have allowed such companies to keep on diversifying and expanding as long as it was profitable - and it would have kept on being profitable until the bubble burst. Which is what happened.


However, when you've not only got two massive government entities distorting the market but also the basic guarantee that you're going to be rescued if you screw up, risk is massively and artificially depressed and the result is the kind of disastrous decisions that have led to our current crisis.


The decisions were disastrous, but suppression of risk isn't why - allowing that kind of gambling in the first place is the problem - and that can't be fixed by deregulation. Those kinds of gambles weren't made because risk could be offset, they were made for a return on investment, and risk being offset was a bonus - (and as long as the pyramid keeps expanding, the risk is minimal).

Banks should maybe have been allowed to invest in diversification - they shouldn't have been allowed to diversify.


I personally feel the best plan is to tighten regulations and then completely privatize all GSEs.


I agree with the first part, but I think the best plan would be to nationalise the GSE's.


Once the market is free, regulations can be loosened if justified; the most important things are that we make sure that regulations protect against distortions and secondly eliminate the sources of those distortions.

No, the most important thing is to deal with actual money, rather than selling on and selling on bundles of debt assets, juggling numbers on balance sheets, and throwing money from place to place.

What this crisis has shown us is - when it came to an accounting, EVERYONE has been living on credit... and I don't just mean homebuyers. The whole underpinning of the economy is based on a bare cupboard.

It's not the lack of regulation so much as it is the lack of proper deregulation. The biggest problem was the continued existence of the GSEs and government bailouts; if everything were deregulated, the market would have not only punished firms that failed but it would not have tolerated the kind of risky investments that these companies made. However, when you've not only got two massive government entities distorting the market but also the basic guarantee that you're going to be rescued if you screw up, risk is massively and artificially depressed and the result is the kind of disastrous decisions that have led to our current crisis.

I personally feel the best plan is to tighten regulations and then completely privatize all GSEs. Once the market is free, regulations can be loosened if justified; the most important things are that we make sure that regulations protect against distortions and secondly eliminate the sources of those distortions.

That. And it applies to literally anything. When you have something that depends on government, or even worse, knows that it can always depend on government prop-ups, all thoughts about legit competition, productivity and efficiency go out the window.

I'll relate it to something more understandable to more people. It's exactly like in the American auto-industry, where nothing will change, nothing will be fixed until we let the companies fail and renegotiate the way they do business, for example in their relation with labor. Otherwise, they can depend on federal money (read, our money) but that is just prolonging life-support but not actually applying some pressure for them to fix what fucks them up in the first place, which is the assurance of public money should they fuck up, which then 'helps' them by making them not worry about lack of efficiency, quality and just running their business succesfully because they know that if anything goes bad, they can still stay in business by just pleading to the American government.

*rant*

I'm following this thread though to learn more about the mortgage crisis.

http://www.businessspectator.com.au/bs.nsf/Article/Joye-$pd20090226-PM69X?OpenDocument&src=sph

I just stumbled across this excellent, if a little long, article about the mortgage system in the US, how it is different from that in other countries and why it is particularly vulnerable to fucking itself up.

The basic idea is that compared to other countries, securitisation makes up a huge chunk of the market. That's not because of greedy people in Wall Street though, but because of the lack of truly national vanilla banks in the US. There are 8,400 banks in the States (1,000 of which are already projected to be toast within the next 3-5 years, by the way), there are maybe a dozen in Australia. The author argues that the reasons for that are largely due to the government's "emergency" regulations and, primarily, institutions designed to deal with crises such as the Great Depression staying around and distorting the structure of home lending over time.

What do you think? And does this offer any particular insight into how a mortgage rescue and a system reset might look like?
I think that it sounds interesting, but I don't know enough about other countries banking systems to really talk about it (Though I would be interested in seeing how Japan is set up because it seems to me that Japan LOVES regional banks. There are some very, very large banking behemoths here, but they seem to just carry smaller, regional, branches as a parent company).

I would say that getting a nationalized banking system is going to be very hard though. I've heard grumbling about BoA being too damn big as it is now and, because it is a nationwide chain, is not responsive to the local community and needs. American ideas of a perfect bank seems to be the S&L run by Jimmy Stewart in 'It's a Wonderful Life'. Getting us to change that ideal is probably going to be very, very hard.

American ideas of a perfect bank seems to be the S&L run by Jimmy Stewart in 'It's a Wonderful Life'. Getting us to change that ideal is probably going to be very, very hard.

Heh, I can't wait to get the form letter in the mail:

Dear Valued Customer,

Thank you for attempting your recent withdrawal. Please be aware that your money isn't here. Its in Fred's house, and Mr. Johnson's house down the road...

What the complete lack of regulation (historically) has done, is allow for diversification. Which looks good on paper, looks good in the short-term, and makes money... but it means that banks are not doing 'banking' as the lion's share.
There are no regulations requiring banks to act purely as vanilla lenders in other countries either. The Glass-Steagall Act was a very US-centric thing, other countries either didn't implement something like it at all, or abandoned it much earlier than the US did.

Housing prices have been inflated, and it's largely been by shuffling numbers on paper. Predatory trading of property has accounted for a large share of that, as has predatory acquisition... and the banks have enabled it by lending money they didn't have, by acting as a resource for outsourcing debt.
Banks never "have" the money they lend. They are overleveraged by definition, no bank can ever survive a bank run, no matter how well it is run or capitalised.

Not true. The market would have allowed such companies to keep on diversifying and expanding as long as it was profitable - and it would have kept on being profitable until the bubble burst. Which is what happened.
It's not about diversification. AIG was super-diverse, it was just one particular line of business undertaken by one particular department that undid the entire business.

The actual crux of the issue for these banks (and I'm not talking BofA or Citi here, but your regional bank - the reason that it is in trouble is subtly different to the reason Citi is) is that because they were small and had to compete with many others, particularly the GSEs, securitisation was the only way they could keep their business going. The strategy was dictated to them by the structure of the US banking industry. Whether or not the likelihood that there would suddenly be no market for securitised mortgages anymore was appreciated properly doesn't immediately matter - as a small regional bank in that market there just was no other possible course of action. They could have tried to ensure themselves a little bit better, but ultimately the only way to do that properly is to secure access to more capital and a bigger market - in other words to grow or consolidate up to the national level.

Banks should maybe have been allowed to invest in diversification - they shouldn't have been allowed to diversify.
Now I'm confused. Exactly what do you actually mean by diversification?

I agree with the first part, but I think the best plan would be to nationalise the GSE's.
It's their existence as a gigantic duopoly with an advantage in securing cheap capital that forces their competition (ie all the small banks) to rely on securitisation and divide the risk assessment from the actual taking on of risk. If they're nationalised, I have no idea what kind of role you'd want them to play and where they'd get their money from - the only way thing you could do is gradually liquidate them. If they're privatised, presumably they'd still get cheaper capital by virtue of their size and the problem might be lessened but wouldn't disappear.

I'd say the GSEs have to go completely and the quickest way to do it is to split them apart and perhaps offer what is left of their books up for auction. That might help with the consolidation aspect as well.

No, the most important thing is to deal with actual money, rather than selling on and selling on bundles of debt assets, juggling numbers on balance sheets, and throwing money from place to place.
And that, kinda, is what I've been trying to say. The problem is then that the structure of the US banking industry is dictating that the immediate selling-on of debt is the primary MO of the entire sector and everyone in it.

That I think has to be considered separate (where possible) from issues of Wall Street and investment banks. Although most of the important players there had some line of business dedicated to creating mortgage securities, they obviously weren't the main originators of these mortgages to start with.

American ideas of a perfect bank seems to be the S&L run by Jimmy Stewart in 'It's a Wonderful Life'. Getting us to change that ideal is probably going to be very, very hard.
Well, the fact of the matter is that most of these little banks are suffering badly. Many of them are going to disappear, and the FDIC is going to distribute the remains around. With the right incentives and the right regulations, this might be the best time to set off a consolidation process that will only leave banks large enough to actually operate both as originators and holders of mortgages to a larger degree than the ones that exist today.

I mean, we've got the same thing in Australia. There are the Big 4 banks which operate nationally, and a number of smaller, regional ones (which often try to expand beyond their local region as well). The latter try to attract customers by talking about how local and community-focused they are and promising better service. But there aren't enough of them (nor are there any GSEs) to actually cause competition to get so fierce that the only way to survive is to exist purely by securitisation and wholesale funds.

Banks never "have" the money they lend. They are overleveraged by definition,

You keep saying that, and it's not been true yet.

You keep saying that, and it's not been true yet.
What would a bank with a 1:1 asset to capital ratio look like? It could only lend the money its shareholders put in, and it could not take any deposits. A deposit is a liability, the cash it holds in return would have to end up on the balance sheets as an asset. Hence assets would be greater than shareholder capital.

Banks are conduits of money, which involves the transfer of claims to income, ie financial assets and liabilities. A bank that was required to keep these equal to its capital could not function as a bank.

What would a bank with a 1:1 asset to capital ratio look like? It could only lend the money its shareholders put in, and it could not take any deposits. A deposit is a liability, the cash it holds in return would have to end up on the balance sheets as an asset. Hence assets would be greater than shareholder capital.

Banks are conduits of money, which involves the transfer of claims to income, ie financial assets and liabilities. A bank that was required to keep these equal to its capital could not function as a bank.

You said that banks 'are overleveraged by definition'. I don't see how you support that.

A building where you placed money, and later came back and reclaimed it, would be definitively functioning as 'a bank'. A bank doesn't need to be more than a specialised storage facility.

You can add extra conveniences to that - like making loans, or transfer transactions, but those things are additional sevices - it's the 'holding money' that defines the bank.

I think you are confusing what a bank is, with what makes a bank a successful proposition for shareholders.

You said that banks 'are overleveraged by definition'. I don't see how you support that.

A building where you placed money, and later came back and reclaimed it, would be definitively functioning as 'a bank'. A bank doesn't need to be more than a specialised storage facility.
http://dictionary.reference.com/browse/bank
bank

1. an institution for receiving, lending, exchanging, and safeguarding money and, in some cases, issuing notes and transacting other financial business.
2. the office or quarters of such an institution.

I didn't decide what makes a bank a bank. I didn't make up the word, I'm going by the proper, applicable definition.

Your problem isn't with what banks do, your problem is with what banks are. That's fine too, but you can at least be open about wanting to eliminate the entire financial system.

I think you are confusing what a bank is, with what makes a bank a successful proposition for shareholders.
And the people who deposit their money there and expect interest, of course. You equate a bank with a building that contains safes. That's just plain false.

At any rate, you're in effect making the same mistake intelligent design advocates make: if banks don't lend (and therefore necessarily take on "excessive" leverage), someone else has to. You've just moved the same problem one level higher: the US economy isn't going down the drain right now because deposits are being lost, but because lending institutions are winding back their leverage and the same process would be possible in a world in which banks don't exist as they do today. ID-supporters at least have some motive for doing this, because they have their own explanation for that next level. What's yours?

http://dictionary.reference.com/browse/bank


I didn't decide what makes a bank a bank. I didn't make up the word, I'm going by the proper, applicable definition.


Okay. And the definition you just provided, supports me. So...


Your problem isn't with what banks do, your problem is with what banks are. That's fine too, but you can at least be open about wanting to eliminate the entire financial system.


I'm not sure where you get that from - the definition you provided (not me) supports me, and suggests that all the things you were referring to as 'definitive', are optional extras. Your own definition says that banks receive, exchange, safeguard, etc and 'in some cases' provide some other services (which I largely have referred to as 'diversifying').

Given an economy that uses a financial system, I have no problem with what banks SHOULD be, or what they SHOULD do - I have a problem with what they sometimes ARE, and what they might tend to DO.


You equate a bank with a building that contains safes. That's just plain false.


And yet, the source you linked shows that to be a better 'definition' than your own.


At any rate, you're in effect making the same mistake intelligent design advocates make: if banks don't lend (and therefore necessarily take on "excessive" leverage), someone else has to. You've just moved the same problem one level higher: the US economy isn't going down the drain right now because deposits are being lost, but because lending institutions are winding back their leverage and the same process would be possible in a world in which banks don't exist as they do today. ID-supporters at least have some motive for doing this, because they have their own explanation for that next level. What's yours?

My explanation? For your strawman?

Okay. And the definition you just provided, supports me. So...
Huh? Read again.

bank

1. an institution for receiving, lending, exchanging, and safeguarding money and, in some cases, issuing notes and transacting other financial business.
2. the office or quarters of such an institution.

See it now?

*gets pitchfork*


so who do i blame???