July 11, 2008

Still not getting it on the credit markets

There is one critical point that's been left out of all the housing/asset/credit bubble mess and that is that consistently no one is pointing out the real underlying problem. Sure, there was lax underwriting, abusive fees and in a few cases outright fraud. However, the underlying issue is that NONE OF THIS WAS PRICED APPROPRIATELY.

The Fed is is going to extend it's lending to primary dealers, the investment banks who make markets in everything from debts to equities to commodities. This is kind of a mixed bag since, for all intents and purposes, the Fed is the US Government and it's become the lender of last resort to thinly regulated non-depository institutions. Needless to say, this opens them up for more regulation and opens us up for more liability. However, that's not what caught my eye in the article. This is...

Mr. Bernanke said that the Fed would issue next week long-awaited rules to restrict new exotic mortgages and high-cost loans for people with weak credit. Such mortgages have been a central cause of the current market problems.

No, these loans AREN'T the reason for the crisis... the PRICES paid by end investors caused the problem. For one thing, institutions and to a lesser extent individual investors were buying these loans at prices that competed with fully documented, low risk FNMA loans. Which is insane since they represented FAR riskier credits. Part of that was a perception that these were rock solid loans, the other was masking the true credit quality by means of structured finance.

However, the underlying product was not a terrible one. A no-doc loan makes since for a self-employed borrower with difficult to document credit, an established housing history and an excellent credit profile. With the changes the Fed aims to put in place, these loans will no longer exist. And it will become extremely difficult for SE borrowers to get loans.

There is, at the base, no such thing as a toxic financial product. There is only one that is priced too expensively. While these mortgages were NOT worth as much as a traditional A credit, they were worth something. The problem is, people were buying them as if they WERE A credits... and borrowing against them. That's how a house of cards collapses.

Because eventually, no matter how you dress it up, a risky credit is going to perform like a risky credit. Investors were stupid and, in many cases, willfully misled. That's a problem. However, the underlying products were not necessarily bad. They just needed to be priced for their risk which would have put an automatic brake on the number of these being originated.

And now, the Statesman chimes in. And it's clear as hell they know not of what they write. Hey guys, leave this to people who actually know something about it, K?

Posted by mcblogger at July 11, 2008 08:08 AM

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Absolutely. It's not that we should ban things like this, but a free market requires full disclosure of things like risk.

Now we hear news about a possible takeover of Fannie and Freddie by Uncle Sam... I'm anxious to hear your thoughts about that, but I personally feel a bit extorted that these guys have got us by the nards to back up their debt. Did they pay into an insurance fund like FDIC?

What is ironic to me, but not surprising, is that whenever we have any sort of natural disaster where we ask the government to help out, the right-wing pundits trip over themselves to blame the victims. They talk of personal responsibility and question "why do they live in risky places?" They say it's not the government's responsibility to intervene.

But let a major financial institution get itself into a bind, and watch how fast the government can swoop in. If only FEMA were as responsive...

Posted by: WhosPlayin? [TypeKey Profile Page] at July 11, 2008 10:54 AM

Actually, I've got something going up about that. Well, I do as soon as I write it. I've been trying to figure out what the big deal is other than Poole's comments, especially since OFHEO says both are adequately capitalized.

Posted by: mcblogger [TypeKey Profile Page] at July 11, 2008 12:37 PM

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