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Tom Paxton On The Financial Crisis

January 16, 2010

Folksinger Tom Paxton has always been a favorite.  We used to take our kids to see him at the Barns and Wolf Trap when he did children’s concerts.  His music covers the gamut from kids’ songs to love songs to topical material.  This YouTube video showcases the latter.

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Won’t Be Fooled Again, Part II

January 11, 2010

Chinese Real Estate

On the eve of US banks announcing what are expected to be large bonuses following a rapid reversal in fortunes led by a trading and speculating strategies, the head of the Financial Stability Board is warning lenders to learn from past lessons before they give the world economy a mulligan.  The Wall Street Journal reports in its January 11, 2010 edition that, 

“Mario Draghi, chairman of the FSB and governor of the Bank of Italy, said banks ran the risk of of overrating the strength of the economic recovery and recklessly returning to dangerous old habits even as “substantial fragilities” remained in the system.

‘The general situation is much better than we could have expected a year ago but, at the same time, it is not as good as the market thinks it is,’ Mr. Draghi said at a news briefing Saturday night after the group’s biannual plenary meeting.

“Moreover, he added, banks must pay more attention to compensation practices with an aim toward ensuring that pay policies don’t encourage dangerous speculation. Those comments come as banks prepare to announce large bonuses for staff following a year of surprisingly strong performance.”

Meanwhile, China’s cabinet is worried that its overheated real estate market is heading for the same fate as the USA’s.  Noting that house prices in Shanghai and Beijing have doubled and redoubled over the last four years, the Washington Post reports that 

Some economists and bankers fear that they have read this script before. In Japan at the end of the 1980s and in the United States in 2008, residential real estate bubbles ended in big crashes, battered banks and slow recoveries. With China acting as a key engine of global growth, a bursting of the Chinese real estate bubble could be a pop heard round the world.

The article quotes a variety of folks arguing that of course it’s a bubble, but it’s not close to bursting, or China’s economy is “different” and therefore not likely to suffer the same consequences as the US and EU.  One observer even recycles former Citigroup Chairman Charlie Prince’s unfortunate metaphor from the height of the bubble, saying “at some point the music will stop.”  

Dance on, dance on.

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Covered Bonds An Answer for Frozen Mortgage Market?

January 10, 2010

Covered bonds are the main source of funding for fixed rate mortgages in Denmark, and have been used in other countries like Germany, as well.  They function like MBS, but there is not a forward delivery TBA market in them because the bonds are typically issued contemporaneously with the mortgage closing.  They generally require downpayments larger than the norm in the U.S..  In Denmark, these typically run 20 percent, for instance.  Ever since the collapse of the mortgage securitization market some in the industry have promoted covered bonds as an alternative.  The presumption is that large banks would issue the bonds and provide the mortgages that back them.  An article in Housing Wire notes introduction of federal legislation by NJ Republican Rep. Scott Garret designed to provide uniform federal regulation of the bonds in hopes of stimulating more widespread use.  The article says that Democratic Rep. Paul Kanjorski (PA) has signed on as a co-sponsor.

Others who have looked at the covered bond structure have cautioned that while it could be part of a future mortgage system, given the scale of the American mortgage market and consumers’ expectations for forward rate locks and lower downpayments they are not likely to absorb a very large share of the market.

Old-fashioned, pre-mania style securitization remains the predominant form of mortgage lending today.  As much as 90 percent of all loans being originated today are destined for securities guaranteed either by Ginnie Mae, Fannie Mae or Freddie Mac.

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Principal Reductions Redux

January 07, 2010

Just a day after I posted my blog entry on principal reductions as a way to help prevent foreclosures, the New York Times Sunday Magazine posted an article on its website by Roger Lowenstein providing an eloquent and trenchant examination of the “moral hazards” of principal reductions and owners’
so-called strategic defaults.  A very insightful piece, worth your time.

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Won’t Be Fooled Again?

January 06, 2010

The New York Times’ David Leonhardt has a trenchant piece published in its January 5, 2010 edition that highlights a critical lesson of the financial crisis.  Summarizing Bernanke’s recent speech before the American Economic Association in which he blamed lax regulation rather than interest rate decisions for the mortgage and finance crisis, Leonhardt notes that while asset bubbles of any kind are hard to call, the Fed and other regulators had plenty of warning.  Experts within and outside of the government amassed and arrayed all kinds of data pointing to unsustainable housing price growth.  And consumer advocates and others were clamoring for the Fed and other regulators to spike the dangerous mortgages that helped fuel the bubble using regulatory authorities they already had.  Leonhardt asks, 

So why did Mr. Greenspan and Mr. Bernanke get it wrong?

The answer seems to be more psychological than economic. They got trapped in an echo chamber of conventional wisdom. Real estate agents, home builders, Wall Street executives, many economists and millions of homeowners were all saying that home prices would not drop, and the typically sober-minded officials at the Fed persuaded themselves that it was true. “We’ve never had a decline in house prices on a nationwide basis,” Mr. Bernanke said on CNBC in 2005.

He and his colleagues fell victim to the same weakness that bedeviled the engineers of the Challenger space shuttle, the planners of the Vietnam and Iraq Wars, and the airline pilots who have made tragic cockpit errors. They didn’t adequately question their own assumptions. It’s an entirely human mistake.

Which is why it is likely to happen again.

He might have added CIA officials who invited last week’s suicide bomber/triple agent onto their base where he blew up himself and seven officers, or all of the intelligence agency employees who handled intelligence about the Under-Bomber but were unable to put the puzzle pieces together and stop him.  

Human frailty and the reluctance of large organizations to change course when confronted with complex datasets and decisions that challenge orthodoxy are constants.  This is especially true when entrenched interests—both inside and outside organizations  — stand to lose if policies are changed.  As Leonhardt points out, acknowledging failure and analyzing its roots is the first step in reducing the chances of it happening again.  Organizational cultures have to support contrary views and reward decision making that forces people outside of the comfortable boxes in which they live day to day.  Breeding a culture of curiousity and challenge makes big shots uncomfortable.  But it can also spark unconventional thinking that puts old “certainties” under pressure and forces recognition—or at least preparation for—events that rock the boat and shift key assumptions.  

This is one reason that the proposals to create a Consumer Financial Protection Agency make so much sense to me.  Opponents, including Bernanke, argue that a separate agency will separate prudential from consumer oversight and regulation.  This disconnect will weaken regulators’ ability to see the “big picture,” and potentially put the two at odds.  Bankers argue that this potential tension will put them in an untenable position and at a minimum greatly increase their regulatory burdens. 

But the prudential agencies subordinated consumer interests consistently to those of the companies they were regulating.  The Fed and other prudential regulators had all the regulatory tools they needed to spike the excesses of the mortgage industry that led to the crisis.  Indeed, consumer advocates and others implored them to do so.  They did not.  An agency tasked with examining these issues from a consumer protection point of view is likely to see things differently and challenge the orthodox views of a regulator tuned to a safety and soundness frequency.  

When something ain’t broke, it’s reasonable to argue against fixing it. But broken systems that fail to work as designed should be fixed.  A total shift of responsibility that puts consumer protection first is one way to do it.

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