Obama: "Subprime Mortgages were originally a good idea"

[Straw Man]

They funded them because they never had any intention of holding them!

actually they often held the worst tranches

also, without the triple A ratings they never  would have been able to sell them

and without the Credit Default Swaps they wouldn't have been able to game the system and create pools that were designed to fail (and trigger the CDS)

It's possible that one hedge fund called Magnetar was the straw that broke the camels back
Around 2005 they figured out they could design pools of loans to fail by becoming the buyer of the worst tranches. without which the pool never could have been created, and then bough credit default swaps on the entire pool.
There should have been a law against this but it was perfectlyh legal

Lots of good info about this here: http://www.propublica.org/series/the-wall-street-money-machine

direct link to Magnetar story: http://www.propublica.org/article/all-the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble

[howardroark]

ok but based on M2 doesn't explain why investment banks suddenly started to fund risky loans

Yes it does. If you're a bank and you're flooded with credit, you have to lend that money to someone. If you have too much to loan at a reasonable interest rate to "safe" investments, then you'll start doling out money to riskier investments in order to seek a higher return. This especially holds true in a bubble economy where even "risky" investments become "safe" due to certain uneconomic circumstances (e.g. constantly rising housing prices making refinancing a breeze).

M2 will grow as there is more money in the economy.  As RE prices rose it the asset bubble grew it drives up M2

You got the cause and effect wrong. Growing real estate prices didn't increase M2. Growing M2 increased real estate prices. More money in banks = more loans = higher demand for real estate.

investment banks were not regulated by the Federal Reserve at that time ( to the best of my knowledge)

The financial industry is one of the most regulated industries in the United States and across the world. Moreover, the financial crisis wasn't a problem unique to the American financial industry, but to banks in every developed economy in the world. The one commonality between all of these developed countries is that central banks around the world engaged in a concerted effort to lower interest rates in the early 2000s.

Lehman, Bear Stearns etc.. could never have created and sold these risky loans without having the triple A bond rate or the CDO's (collateralization) or CDS (insurance against default)

Notice that the loans they sold weren't risky because ever rising real estate prices basically guaranteed a return. Even in the case of a bankruptcy, the bank could have taken the real estate and sold it at a profit.

They were only risky with hindsight, when people finally realized that there was a massive bubble that was fueling the whole gig.

AIG was of course a big part of this too as they were selling insurance without having the necessary reserves (which I why they became insolvent in one day as soon as their rating was downgraded which immediately required more reserves which they did not have)

And again, you reverse cause-and-effect. AIG would not have been able to do that if we weren't in a bubble-economy. They would have gone bankrupt looooong before 2008/2009. It is the bubble that fueled risky behavior and not vice versa.

I certainly believe the Fed played a role but I don't think they were the cause

You can believe what you want but logic is not on your side. Even with CDO's, CDS's, and all the other innovative financial instruments, no bubble could have formed. The more people would have bought houses, the higher interest rates would have gone. The higher interest rates, in turn, would have reduced demand for housing. It's as simple as that. But because the Fed follows an interest rate policy, it in effect fueled a bubble.

[Straw Man]

Yes it does. If you're a bank and you're flooded with credit, you have to lend that money to someone. If you have too much to loan at a reasonable interest rate to "safe" investments, then you'll start doling out money to riskier investments in order to seek a higher return. This especially holds true in a bubble economy where even "risky" investments become "safe" due to certain uneconomic circumstances (e.g. constantly rising housing prices making refinancing a breeze).

You got the cause and effect wrong. Growing real estate prices didn't increase M2. Growing M2 increased real estate prices. More money in banks = more loans = higher demand for real estate.

The financial industry is one of the most regulated industries in the United States and across the world. Moreover, the financial crisis wasn't a problem unique to the American financial industry, but to banks in every developed economy in the world. The one commonality between all of these developed countries is that central banks around the world engaged in a concerted effort to lower interest rates in the early 2000s.

Notice that the loans they sold weren't risky because ever rising real estate prices basically guaranteed a return. Even in the case of a bankruptcy, the bank could have taken the real estate and sold it at a profit.

They were only risky with hindsight, when people finally realized that there was a massive bubble that was fueling the whole gig.

And again, you reverse cause-and-effect. AIG would not have been able to do that if we weren't in a bubble-economy. They would have gone bankrupt looooong before 2008/2009. It is the bubble that fueled risky behavior and not vice versa.

You can believe what you want but logic is not on your side. Even with CDO's, CDS's, and all the other innovative financial instruments, no bubble could have formed. The more people would have bought houses, the higher interest rates would have gone. The higher interest rates, in turn, would have reduced demand for housing. It's as simple as that. But because the Fed follows an interest rate policy, it in effect fueled a bubble.

I have to run so I'll respond back later but I don't agree with this statement

You got the cause and effect wrong. Growing real estate prices didn't increase M2. Growing M2 increased real estate prices. More money in banks = more loans = higher demand for real estate.

growing RE prices created income (borrowed equity, inocme from sales) which definitley increases M2

Investment banks did not get any money from the Fed and banks don't lending more because they have more money.

The problem right now is that banks have plenty of money but lending is tight because they've tightened up credit guidelines (Bernake has even talked about this)

The RE Boom could not have gotten sparked without the subprime lenders regardless of how much money the commercial banks had

sorry I have to run but I will respond back in more detail later

[howardroark]

growing RE prices created income (borrowed equity, inocme from sales) which definitley increases M2

Wrong. Rising prices don't create money. How can you possible even link a causal relationship between the two?

Investment banks did not get any money from the Fed and banks don't lending more because they have more money.

You don't have to get money directly from the Fed in order to benefit from credit expansion. Money is fungible - increased credit easily spreads throughout the entire financial system.

The problem right now is that banks have plenty of money but lending is tight because they've tightened up credit guidelines (Bernake has even talked about this)

Yes - they've tightened up credit because the economy is weak. We are no longer in a bubble economy, Bernanke has been running deflationary policies concurrently to his inflationary ones, and there is a lot of political uncertainty coming down from DC.

The RE Boom could not have gotten sparked without the subprime lenders regardless of how much money the commercial banks had

And what if we had the subprime lenders but no credit expansion? What would have happened? People would have borrowed more to purchase more housing and interest rates would have risen in order to reflect a limited supply of loanable funds. Housing prices would not have risen enough to create a bubble, regardless of subprime lending.

[Straw Man]

Wrong. Rising prices don't create money. How can you possible even link a causal relationship between the two?

rising home equity creates wealth (due to sale or borrowing against equity) some of which get's deposited into savings, money market etc.. which is part of M2.  The same is true of rising stock market

BTW - M2 is higher than ever and so why don't we still have a growin asset bubble and the bank are flush with cash and won't lend. What is the missing element? Why aren't there are abundance of subprime and alt A loans if it was all created due to rising M2 rates (the answer is below although I've mentioned it before)

You don't have to get money directly from the Fed in order to benefit from credit expansion. Money is fungible - increased credit easily spreads throughout the entire financial system.

sure but that doesn't explain the mechanics of how investment banks were able to create altA and subprime loans and being able to package up the good with the bad and sell the whole bundle as top rated securities

Yes - they've tightened up credit because the economy is weak. We are no longer in a bubble economy, Bernanke has been running deflationary policies concurrently to his inflationary ones, and there is a lot of political uncertainty coming down from DC.

They've tightened up credit because they can't sell the debt....period

a weak economy would actually be a time to loosen credit whichi is what Bernake has said in many of his recent statements before Congress but the banks aren't doing it because there is no one to sell the debt to (other than Fannie and Freddie who are making banks buy back loans whenver possible)

And what if we had the subprime lenders but no credit expansion? What would have happened? People would have borrowed more to purchase more housing and interest rates would have risen in order to reflect a limited supply of loanable funds. Housing prices would not have risen enough to create a bubble, regardless of subprime lending.

by defintion - subprime lenders existed long before AltA products showed up in the late 1990's

Subprime loans had required large down payments (usually 30% or more) and we not utitlized to a great extent by the average borrower.  Although these loans might have been "stated income" that often required bank statements to prove cash flow and still have debt to income requirements

It was the introduction of AltA and the gradual (and then fast) deterioration of standard underwriting guidelines that changed the entire landscape and in the end the Alt A lenders were doing 100% financing on non-owner properties with no income or asset verification.   These become the loans of choice for people who could not qualify and had no hope of repayment.  Their sole purpose was to hold the property for 12 months or less and sell if for 100k or more than they paid for it.       

None of this could have happened without the combination of fraud by bond rating companies and the use of credit default swaps in order to create pools of loans that werer created for the sole purpose of failing and thereby triggering the CDS's

If you need one definining moment that created the asset bubble we saw in Real Estate is was the deregulation of the commodities market in the late 1990's

[howardroark]

rising home equity creates wealth (due to sale or borrowing against equity) some of which get's deposited into savings, money market etc.. which is part of M2.  The same is true of rising stock market

M2 is a measure of the stock of money - not of wealth. Money isn't created by someone having equity in their home - it's created by government and their proxies.

BTW - M2 is higher than ever and so why don't we still have a growin asset bubble and the bank are flush with cash and won't lend. What is the missing element? Why aren't there are abundance of subprime and alt A loans if it was all created due to rising M2 rates (the answer is below although I've mentioned it before)

Because when a bubble crashes, the market needs to clear before another bubble can form. The policies coming down from D.C. have prevented the market from clearing, which is why the recovery has been so lackluster.

sure but that doesn't explain the mechanics of how investment banks were able to create altA and subprime loans and being able to package up the good with the bad and sell the whole bundle as top rated securities

But what does? The bubble economy. Those securities were top-rated for a reason: housing prices were constantly rising, so in the event someone didn't have enough money to pay their mortgage, they could simply refinance; or if they couldn't refinance, the bank could take it over and sell it with a profit to boot.

They've tightened up credit because they can't sell the debt....period

Do you believe the people who head banks are stupid? Would YOU lend in an environment where unemployment is high, the economy is weak, inflation is on the horizon, and government debt is soon approaching a precipice?

a weak economy would actually be a time to loosen credit whichi is what Bernake has said in many of his recent statements before Congress but the banks aren't doing it because there is no one to sell the debt to (other than Fannie and Freddie who are making banks buy back loans whenver possible)

A weak economy is when certain economists believe that the CENTRAL BANK should loosen up credit. It is not a time for private banks to loosen up credit - if they did so, they'd most certainly lose money.

by defintion - subprime lenders existed long before AltA products showed up in the late 1990's

Of course they did. You're not proving a thing with that statement.

Subprime loans had required large down payments (usually 30% or more) and we not utitlized to a great extent by the average borrower.  Although these loans might have been "stated income" that often required bank statements to prove cash flow and still have debt to income requirements

It was the introduction of AltA and the gradual (and then fast) deterioration of standard underwriting guidelines that changed the entire landscape and in the end the Alt A lenders were doing 100% financing on non-owner properties with no income or asset verification.   These become the loans of choice for people who could not qualify and had no hope of repayment.  Their sole purpose was to hold the property for 12 months or less and sell if for 100k or more than they paid for it.       

None of this could have happened without the combination of fraud by bond rating companies and the use of credit default swaps in order to create pools of loans that werer created for the sole purpose of failing and thereby triggering the CDS's

If you need one definining moment that created the asset bubble we saw in Real Estate is was the deregulation of the commodities market in the late 1990's

Fact: If housing prices didn't continually rise, this bubble would have never occurred. And the only thing that can explain the continual rise in housing prices and the start of the bubble is Fed intervention with the money supply and interest rates. Had demand for housing increased in the natural course of things, the demand for loanable funds would have increased, thereby increasing interest rates and thus choking off any incipient housing bubble. There's not a single deregulation that could have accomplished that.

[howardroark]

The very notion that housing prices could rise with no end in sight without the government pumping in money like there was no tomorrow is simply laughable. It's basic supply-and-demand.

[Straw Man]

Definition M2 from Saint Louis Fed:

http://research.stlouisfed.org/fred2/series/M2

M2 includes a broader set of financial assets held principally by households. M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs). Seasonally adjusted M2 is computed by summing savings deposits, small-denomination time deposits, and retail MMMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.

As home values rise, home equity is cashed out (via borrowing of equity or sale of the asset) and if that money is deposited in any of the categories listed above then it is included in M2

The notion that rising M2 caused the asset bubble is absurd and has not foundation at all in fact.

We know exactly what caused the asset bubble and like you said it was a factor of "supply and demand"

Subprime lenders offered a supply of very easy credit to unqualified borrowers which created a surge is sales (and resulting surge in building of new units).   Greenspan said this excess is supply was due to great demand by "securitizers" for more product.  ProPublica did an investigation of one such hedge fund (Magnatar) who was part of this demand" and how their objective seems to have been to create pools of loans designed to fail.

you can read about Magnatar here:
 http://www.propublica.org/article/all-the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble/single



This increase in sales is what created the risings "values" and the cause was a direct result of Lack of Regulation.

Ayn Rands disciple Alan Greenspan admitted this and it's not really a debatable fact among anyone who knows the industry or even just understands the credit markets

If you need to find one specific cause for the RE Bubble it was deregulation of the commodity and banking industries in the late 1990's

Again, not Fannie or Freddie, not M2, not too much regulation etc...
 
http://www.nytimes.com/2008/10/24/business/economy/24panel.html

Critics, including many economists, now blame the former Fed chairman for the financial crisis that is tipping the economy into a potentially deep recession. Mr. Greenspan’s critics say that he encouraged the bubble in housing prices by keeping interest rates too low for too long and that he failed to rein in the explosive growth of risky and often fraudulent mortgage lending.

“This crisis,” he told lawmakers, “has turned out to be much broader than anything I could have imagined. It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount.”

Many Republican lawmakers on the oversight committee tried to blame the mortgage meltdown on the unchecked growth of Fannie Mae and Freddie Mac, the giant government-sponsored mortgage-finance companies that were placed in a government conservatorship last month. Republicans have argued that Democratic lawmakers blocked measures to reform the companies.

But Mr. Greenspan, who was first appointed by President Ronald Reagan, placed far more blame on the Wall Street companies that bundled subprime mortgages into pools and sold them as mortgage-backed securities. Global demand for the securities was so high, he said, that Wall Street companies pressured lenders to lower their standards and produce more “paper.”

“The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower,” he said.

[Soul Crusher]

BUMP for Whork to delete his account