Thursday, June 04, 2009

Subprime Spawn

This recession hasn't been all bad. Housing is now more affordable, and now we have Kentucky Grilled Chicken, Pasta Hut, Domino's Subs, and $5 burgers at Morton's. Necessity is the mother of fast food invention. On the other hand, we are awash in books reflecting the proverbial blind men describing an elephant.

Two new books are out of the financial crises. One's a recap of Nassim Taleb's arguments in Lecturing Birds to Fly by Pablo Triana, the other a journalist's expose of greed and hubris in Fool's Gold. As this crisis was peaking in October, I imagine many editors got contracts to pen their dramatic explanation of what the heck is going on, so like making babies, we will see a bevy of of such books for the remainder of the year. Right now, I put them into the following themes for laying the blame:

The Fed: Getting Off Track (John Taylor), Two Trillion Dollar Meltdown (Charles Moris), Too Big to Fail (Stern and Feldman)

Too much government: Meltdown (Thomas Woods), Bailout Nation (Barry Ritholtz).

Bubbles: The Subprime Solution (Robert Shiller)

Greed/Hubris: Fool's Gold (Gillian Tett), Meltdown (Paul Mason), Chain of Blame (Muolo and Padilla), Looting of America (Les Leopold), Meltdown (Katrina vanden Heuvel)

Models/Quants/Math: Lecturing Birds (Pablo Triana)

Everything: Panic (edited by Michael Lewis), Financial Shock (Mark Zandi)

That's three 'Meltdown' books on the same subject by different authors! Mark Zandi is the chief economist at Moody's, and he supposedly saw this all coming, highlighting my earlier claim about Simon Johnson, that no one listens to their Chief Economist, which is very useful in hindsight recollections because no one would ever think a Chief Economist was a driving force behind anything an institution actually did (of course, there's a reason no one listens to them).

Bloggers and Journalists are more on the models/quant side (eg, Taleb, Felix Salmon), but some emphasize regulatory arbitrage via derivatives (Arnold Kling).

Clearly, each view has some valid points. There was, and is, greed and hubris. Models are not infallible maps of reality. People--investors, homebuyers--chase trends. The Fed had low interest rates in the early naughts, regulators and legislators were encouraging lower mortgage standards, derivatives were increasing in complexity, and with hindsight housing followed a classic bubble trajectory. The key is to focus on the primary drivers, the theory, because the facts themselves are rather ambiguous. Thus, descriptive books on the Bear Stearns collapse or Dan Gross's Dumb money are somewhat useful, but really are just like reading newspaper stories about what happened. History without a good theory is very barren, and it's easy to focus on irrelevancies, especially because it's tempting to focus on personalities (hubris anecdotes or emphasis on pot-smoking CEOs) or diagnoses that would be really clever and interesting if they were true (obscure math errors).

For me, the best explanation comes from two parts. Stan Liebowitz's account on how we slowly eroded mortgage standards with the best intentions, led by academia, regulators, legislators, and investment banks. And then the accelerator mechanism outlined by Gary Gorton. Neither are books.


Matthew Gunn said...

Mortgage lending standards weren't the only lending standards eroding. Private equity and all kinds of groups were getting incredible lenient terms. I still remember a talk at Stanford, Jan 08, by Rubenstein of Carlyle where he described banks going back and forth, giving easier and easier terms (interest optional, no covenants etc...) all trying to get Carlyle's business. As I see it, the underlying driver that caused all this erosion was a lengthy period of cheap money. This crisis has a number of critical links in the casual chain, but the first big failure appears to be easy monetary policy by the Fed.

Zitron said...

For some reason, there is always a culprit who is never mentioned. I mean the press, the fourth power, the controller of the powers-that-be. No mea culpa from their side on how they missed the whole thing. If journalists see themselves as some form of regulators, they also failed miserably. But again, no apologies from them.

I hope that the reason is not that most journalists benefited from the boom, either because they owned houses, or could build up debt.

But What do I Know? said...

How about stability spawns instability? Isn't that the thesis of your professor Minsky? Or I suppose that you could use a drug metaphor--easy credit leads to addiction to easy credit and generates the infrastructure (pushers, crack houses, fences) to provide the drug, legally or illegally? But it's human nature to assume that if nothing really has gone wrong then everything must be OK. If you don't understand how a car works, then you only do something when the dashboard light comes on.

But please expand sometime on your opening--that the recession hasn't been that bad. I often say that nothing really bad has happened yet (like civil unrest, currency collapse, starvation, crime increases, martial law, etc.), but sometimes I feel I may be insulated from the problems other people are facing. In my lighter moments I can credit the Powers That Be with good but misguided intentions in trying to "fix" the "problems" with methods that have a large possibility of leading to real trouble. You are one of the few bloggers that I read who generally poo-poohs the breast-beating zeitgeist, so I'd be interested in your thoughts in this area.

Anonymous said...

it wasn't the mortgage lending standards, it was the poor judgment of people thinking that the creators of mortgage-backed securities like REIT's who decades ago made their fortunes and congratulated themselves were merely the first generation of many to come that would profit handsomely from these bets. no one wanted to consider what they were based on: an asset who's value can rise and fall overnight due to the widest assortment of subjective factors i can imagine.
you can't put these factors on a balance sheet. they are pure subjectivity.

if a corporation has cash, it's arguably worth something *in that moment* and this can be reasonably assessed and recorded with some degree of objectivity.

but real estate is worth nothing until it's sold. it is 100% speculation.

leave the speculation to the real estate industry. if people want to get involved with betting on real estate, let them be directly involved with the purchase.

i've seen too many of these mortgage investment trusts go south (regardless of their degree of sophistication or the reputation of the individuals running them) and in each case i see that investors are not made whole.

alternatively, you can play the fool, and then whine about it when things go south, pointing the finger at someone else. that is always an option.