Gautam Mukunda <[EMAIL PROTECTED]>
> From: John Williams > Gee, really? It couldn't possibly be just a little more complicated than that? > > Me: > There are more factors, Yes, that is what I was referring to. > but in the short-term money market, not that many, really. Surely the laws of supply and demand still hold? In other words, if the supply of money to be lent (in aggregate) goes down, then the price (interest rate) will have upward pressure. > We had enormous market events followed > immediately by a pretty-much unprecedented increase in money market interest > rates, paired (presumably not coincidentally) by a massive flight of > investors > from the money markets Several large firms were in imminent danger of failing. I would pull my money out, too, if I thought I might lose it or it might get tied up in a bankruptcy. > This flight was particularly odd given that _no person_ lost money in such > investments. Do you wait until you have been in an accident to put on your seat belt? > I would say this is an opinion without a lot of evidentiary support. The > government was not "largely responsible" for the run-up in home prices. It > certainly didn't help - it was at least partly responsible. It seems silly to argue about what constitutes largely. But here are some important factors: - 1997 Taxpayer Relief Act created a $500 thousand home capital gain tax exclusion http://www.businessweek.com/bwdaily/dnflash/jul2005/nf20050726_4208_db013.htm - 1999 ''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.'' "Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings." http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260&sec=&spon=&pagewanted=1 - 2001 "These privileges do more than just give the GSEs a funding cost advantage, they also reinforce the perception of a federal guarantee on GSE debt obligations. In order to avoid a federal bailout like the one we saw with the savings and loan industry, policymakers may want to consider a variety of alternatives, including privatization of one or more of the GSEs." http://www.mercatus.org/PublicationDetails.aspx?id=21118 - 2002 "The new underwriting systems being used by Fannie Mae and Freddie Mac, which are analogous to the credit-scoring systems used by banks, allow for higher loan-to-income ratios than in the past to encourage home buying. That's good for borrowers, but the relaxed ratios could pose serious problems in the future." http://www.businessweek.com/magazine/content/02_10/b3773052.htm - 2008: "In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of "affordable housing." They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse. It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans. Their accounting had just been revealed as fraudulent, and they were under pressure from Congress to demonstrate that they deserved their considerable privileges." http://online.wsj.com/article/SB122212948811465427.html > JPMorganChase (run by Jamie Dimon) and Goldman Sachs (run by Lloyd Blankfein) > didn't. If the government were responsible, you'd have to explain why they > were > immune to pressure. Instead they - brilliantly - handled this potential > crisis > exactly right. Which would be great if the government didn't interfere. The strong companies that made good decisions would survive, and the others would fail. But instead we have the government bailing out the bad companies. > For example, we had a series of events occurring. We saw the > mark-to-market value of financial instruments constructed based on subprime > mortgages drop to near zero. Functionally that explains the collapse of > Lehman > and AIG. Although the value of these instruments is presumably substantially > lower than their purchasers thought they were, a true value of zero is > implausible at best (absent strange > leverage constructions _unviersal across the instruments_ this would imply a > default rate on subprime mortgages of nearly 100%, which is clearly not going > to > happen). This collapse forced Lehman to declare bankruptcy while it was > technically still solvent - an unprecedented event, so far as I know. As I mentioned in another post, there is a practical definition of solvency and a technical definition. The market seems to follow the practical one. Extreme leverage necessitates a probabilistic definition of solvency. > But, because of how > investment banks are structured, if > people demand higher interest rates for short term loans from them, they > would > be forced to go under immediately. Note the problem here: No increase in > interest rates, no bankruptcy. Increase in interest rates caused by fear of > a > bankruptcy, however, can _cause_ the bankruptcy. Any individual investor, > knowing the bankruptcy would not occur, would happily lend the money. But > because that certainty does not exist, the money might not be lent. The 5 big investment banks entered uncharted territory: leverage of 20x or 30x with large amounts of money-market funding. Evidently, this is not a reliable structure. It is also a little scary that Paulson (ex Goldman), who certainly had involvement with that risky structuring, is now asking for a $700B or more blank check to buy risky assets. > In the face of such events, government intervention is an > entirely reasonable - indeed, necessary, thing to do. You sound like a politician. We can save you! We have the technology! Too bad the track record is emphatically otherwise. _______________________________________________ http://www.mccmedia.com/mailman/listinfo/brin-l
