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Bear Stearns Collapses:

JP Morgan is buying the company, recently valued at well over $100 a share, and selling for over $50 as recently as last Thursday, for $2 a share. Bear Stearns is a victim of the subprime debacle. What's next? Perhaps the collapse of large hedge funds that leveraged their investments in mortgage-backed securities? A similar collapse of a major international bank like Citicorp?

I've said it before (e.g.), and I'll say it again. I simply didn't, and still don't, understand how anyone could have thought that giving people, often people with terrible credit histories, mortgages with no money down and often with no documentation of income--and after an unprecedented increase in prices left the market especially vulnerable to a downturn in prices--was a good idea. Maybe if I had studied for an MBA in Harvard and worked my way up to the top of the investment banking industry it would somehow have made sense to me.

Bill Poser (mail) (www):
I have the sneaking suspicion that the difference between the investment strategy of a fancy Wall Street financier and you and me is not their superior knowledge of finance but the fact that the money they are risking is not theirs.
3.16.2008 10:04pm
DaveG (mail):
It's pretty simple: if you had done that, you'd have gotten a several-hundred-million dollar bonus each each before 2008. All you'd have to do is make sure your bonus was kept in diversified assets, not in the lenders' stocks.


This year, you might not get a bonus, or even lose your job, but with that kind of money, a year off might not be a bad thing.
3.16.2008 10:04pm
Mac (mail):

Maybe if I had studied for an MBA in Harvard and worked my way up to the top of the investment banking industry it would somehow have made sense to me.


I think you nailed it. Proving that you have to work really, really hard to become that stupid.
3.16.2008 10:09pm
Albert:
Any bank that wanted to expand had to embrace the Community Reinvestment Act, which basically entailed making loans to unqualified people. End result: a poorly performing portfolio plus the extra added bonus of being acused of "targetting minorities," which was the whole idea in the first place.
3.16.2008 10:24pm
Awenz (mail):
I thought the CRA was designed to promote the siting of bank branches (and increasing deposits) in minority neighborhoods.
3.16.2008 10:31pm
Mike& (mail):
I imagine David Berstein is now a multi-millionaire. Since, being so confident in his predictions, he must have been short in all of the banks that have been failing.
3.16.2008 10:40pm
Colin S (mail):
In witnessing the subprime market collapse, the broader implications of it have worried me as a humanist.

In the microfinancing sector, lenders have operated on the premise that people with limited financial means and no credit history or dependable income are able to pay back their loans. The entire sector is based on the idea that the very poor will pay back their debts.

Here in America, that has not seemed to be the case.

What makes the poor worldwide different from the poor in America? Could there be a "Third World Bubble"?
3.16.2008 10:43pm
JB:
What Bill Poser and DaveG said.

This crisis is above all a failure of incentives.

It doesn't happen to Harvard MBAs either. I work in microfinance, and my organization had to explain to one client bank why it was a terrible idea to reward loan officers based on the number of loans extended, rather than the number of loans with good repayment records.
3.16.2008 10:45pm
mike123:
Some you may have missed it but Chris Cox, head of the SEC, said earlier in the week that BSC (Bears) liquidity was fine. If you followed his counsel, you'd have lost most of your investment. Cox is a regulator who lied to everyone.
3.16.2008 10:51pm
JB:
Colin,
To answer your question, loans are checked up extensively. First, they are issued in amounts that the lender is sure they can repay. Second, there's never an issue of accumulating interest due to minimum payments, etc--the borrower pays a predetermined amount weekly, at a fixed interest rate. Third, they don't just lend to any shmoe. People get turned down a lot. The third-world equivalent of the subprime mortgage borrower wouldn't get a microloan at all.

Some microfinance institutions violate these, but if they fail all that happens is some donor doesn't get good social returns on their investment. The lenders who are plugged into the international capital markets are very strict about these things.
3.16.2008 10:55pm
Mac (mail):
Second, there's never an issue of accumulating interest due to minimum payments, etc--the borrower pays a predetermined amount weekly, at a fixed interest rate.

JB,

I'm confused. A lot of these loans started out at very low rates like 1% and were not fixed but adjustable, I think, and had increases in the rate built into the loan if rates went up. At a minimum. you could end up owing more for a house after 5 years than you started out owing as you weren't paying the actual interest rate let alone even a tiny amount of principle.
3.16.2008 11:07pm
Gaius Marius:
Chris Cox is a former member of Congress and therefore an idiot. If Mr. Cox had been a corporate officer of BSC, he would be indicted tomorrow for numerous SEC violations.
3.16.2008 11:12pm
Gaius Marius:
I think Lehman Brothers is going to be the next bank to fail. I give Lehman until about next Sunday to survive as an independent bank.
3.16.2008 11:17pm
Truth Seeker:
I heard from a gold dealer that Citi is going down soon.
3.16.2008 11:27pm
Truth Seeker:
By the way, could the decline of the dollar be the plan to solve the crisis?

The problem is that the price of housing bubbled. Rather than let it collapse 20-30% to where it was, if they inflate the price of everything else 20-30% over a few years all the prices would be back in line without a drop in housing prices or loss of anyone's housing equity.
3.16.2008 11:32pm
fuckbearstearns (mail):
This is EXCELLENT NEWS.

$2 a share!! 93% down!!! Bear Stearns DEAD!!!

Now, let's hope those @#$#@$% at Merrill Lynch, Citi, Lehman go up in flames next.

It would be a wonderful thing to see about five MAJOR and five minor names turn to ashes.

Might clean up the industry for 40 years.
3.16.2008 11:33pm
DavidBernstein (mail):
Truth, inflation is one possibility. Another is to make U.S. assets so cheap to foreigners that they buy up the the land, etc. But all that assumes that the government actually has a coherent plan.
3.16.2008 11:35pm
Gaius Marius:
Asian markets are already five percent down and the trading day is still young. Expect double digit losses in Asia by tomorrow morning.

The U.S. Dollar is starting to go into free fall and one begins to wonder how much longer foreign investors and governments are going to resist dumping their holdings in the U.S. Dollar to avoid being the last one holding the bag.
3.16.2008 11:36pm
CDU (mail) (www):
Bear Stearns is a victim of the subprime debacle.
Considering Stearns aided and abetted the subprime mortgage market, I think it might be more accurate to call them a perpetrator, rather than a victim.
3.16.2008 11:36pm
Mac (mail):
Albert,

A

ny bank that wanted to expand had to embrace the Community Reinvestment Act, which basically entailed making loans to unqualified people. End result: a poorly performing portfolio plus the extra added bonus of being acused of "targetting minorities," which was the whole idea in the first place.


Do you have a link to this info? I don't doubt you, would just like to learn more about it.
I would not be a bit surprised to find out the Congress was behind it. I have heard something about this before, but I don't know much about it.
Is the Congress going to bring down the banking system every 20 years? In 1987, they changed the tax laws and started the S&L debacle which cost taxpayers a fortune.

Everyone could see this coming. Why didn't Congress step in earlier? Oh, I forgot, they are dumber than MBA's.
3.16.2008 11:41pm
A. Zarkov (mail):
"I simply didn't, and still don't, understand how anyone could have thought that giving people, often people with terrible credit histories, mortgages with no money down and often with no documentation of income …"

Not hard to understand at all. The mortgage originators in most cases did not have to bear any default risk. The more loans they made, the more money they made. Thus it was to their benefit to give a loan to anything with a pulse. Many underwriters even believed their own bullshit. If real estate always goes up, then the borrower can do a refinance before his 2/28 loan resets and get another teaser rate for another two years. And so on. Like all Ponzi schemes it had to blow up one day and it did. What surprises me is that it took so long.

"What's next?"

We really don't know for sure, but the whole MBS market is chump change compared to Credit Default Swaps. The notional value of the market here is $45 trillion—up from $0.9 trillion in 2000. That's right, a factor of about 50 in 8 years. A CDS is essentially insurance to cover the default on a risky loan. But you need a license to sell insurance, and you must meet certain requirements. But not if you find a lawyer who gives a legal opinion that the CDS really isn't insurance. Now why would a bank make a risky loan? Simple they want to keep the borrower happy so they can collect huge fees on the investment banking side of the business. Commercial banking is boring and not nearly as profitable as investment banking. That's one good reason to keep commercial and investment banking separate as mandated by the Glass-Steagall act. But we repealed that wise piece of New Deal legislation. So now with a little help from the lawyers and corrupt politicians, we might be really screwed if the CDS market tanks.
3.16.2008 11:44pm
Gaius Marius:
I normally don't agree with you but you're absolutely right, A. Zarkov.
3.16.2008 11:48pm
Mac (mail):
A. Zarkov


That's one good reason to keep commercial and investment banking separate as mandated by the Glass-Steagall act. But we repealed that wise piece of New Deal legislation.

When was it repealed?
3.16.2008 11:49pm
Gaius Marius:
Glass-Steagall was repealed in November 1999 by Bil Clinton. Hmmmm...soon afterward the foundation for the sub-prime bubble started to be laid. Coincidence? I think not. If Obama was smart, he would start to hang the repeal of Glass-Steagall around Billary's neck like an albatross.
3.16.2008 11:54pm
Mac (mail):
Gaius Marius:

Thank you. Any idea why is was repealed?
3.17.2008 12:04am
Jon Lubin (mail):
Since it was so obvious to you, I'm sure you shorted equity positions in mortgage lenders or in mortgage backed securities before default rates spiked? No? See, the whole problem with bubbles is that they generate what Prof. Robert Shiller calles "new era stories." Every bubble is "different" from the bubble before it, because THIS time there is something specific to the asset class that makes it a can't miss opportunity. Few thought the market was "especially vulnerable," like you did, because, for whatever reason, real estate came was viewed by extremely intelligent people as "different." Sure, it turned out they were wrong. But, because there are irrational forces at work in the market, smart money didn't perceive the downturn in the real estate market that set off this whole mess.
3.17.2008 12:04am
Kevin Murphy:
I don't know about Glass-Steagall being the culprit. Reflecting on the S&L crisis of the 80's and the internet stock bubble of the 90's, I suspect that there's always an angle to play.

Close one avenue and they'll find another.

If you really want to stop this stuff, you have to have criminal sanctions and hang some CEOs every decade or two. And that probably won't work either.
3.17.2008 12:07am
Mac (mail):
Jon Lubin (mail):
Since it was so obvious to you, I'm sure you shorted equity positions in mortgage lenders or in mortgage backed securities before default rates spiked?

Seeing a macro pattern and timing it are two different things. One can be sure the bubble will burst because they always do. Knowing exactly when, or even getting close enough to time a short, is another story.
3.17.2008 12:07am
TerrencePhilip:
Hasn't Cox been floated as VP nominee material? Not so much anymore, if ever, I'd think.

I always start from the assumption there are better lawyers than me on these threads; now that we are also in a thread with what I take to be good finance minds as well, I will ask about this "crisis:"

Other than people not paying their mortgages as agreed to, what has changed? No third party actor is causing them harm and preventing them from paying, right? What is actually causing the 'subprime meltdown' anyway- multiple credit risks coming home to roost all at once? Interest rates haven't gone up, right- so ARMs haven't doubled, right? Real wages haven't fallen in half? Unemployment is still 5%? Banks (before this week) haven't failed, right?

So what is going on?
3.17.2008 12:08am
David M. Nieporent (www):
In the microfinancing sector, lenders have operated on the premise that people with limited financial means and no credit history or dependable income are able to pay back their loans. The entire sector is based on the idea that the very poor will pay back their debts.

Here in America, that has not seemed to be the case.

What makes the poor worldwide different from the poor in America? Could there be a "Third World Bubble"?
Perhaps in the third world, people who are poor are poor thanks to government -- excessive taxation and regulation of the market, lack of property rights, not much rule of law -- so them being poor doesn't say much about them.

Whereas in the U.S., being poor is the exception, not the rule; poverty is primarily the fault of the poor.

Or, to be more precise in this context, we're not really talking about "the poor" per se. Subprime loans aren't given to "the poor," but to those with lousy credit. It's hardly surprising that the subset of the population with lousy credit -- people who are irresponsible -- would represent bad lending risks.
3.17.2008 12:13am
CDU (mail) (www):
Interest rates haven't gone up, right- so ARMs haven't doubled, right?

Interest rates have gone up for a lot of people because the artificially low 'teaser' rates on their ARMs have run out. They can't refinance because the popping of the housing bubble means their homes are worth less than their mortgages.
3.17.2008 12:15am
AnonLawStudent:
Mac,

From a prior comment on the CRA:

[T]he CRA, 12 USC 2901 et seq, does not directly require lenders to make subprime loans. However, it does permit activists to severely retard the ability of a bank (or thrift) to merge or expand its business, or even open a new branch, by filing a "protest." As a result, major banks have been pressured to make fixed, multibillion dollar commitments to lend in underserved areas, regardless of whether the quantity of creditworthy borrowers in those areas can justify that level of capital infusion. In a brief search, I wasn't able to find anything quantifying the impact on subprime lending. Two claims point in opposite directions, however: (1) An activist group, the National Community Reinvestment Coalition, claims to track more than $1 trillion dollars in pledges, but (2) the NY FRB indicates that as of 2003, less than 30% of lending institutions were covered by the CRA. The NY FRB has a fairly good history here: http://www.ny.frb.org/research/epr/03v09n2/0306apga.pdf

Zarkhov: "The mortgage originators in most cases did not have to bear any default risk."

Technically correct, but I don't think it represents the entire picture. By securitizing the mortgages and selling them to third party investors, banks (which were often mortgage originators) were able to move a very large percentage of the subprime mortgages off of their balance sheets. However, many large investors bought the securities on margin, funded by the same banks. What we are beginning to see is margin calls by the lending banks as the value of the underlying collateral - subprime mortgage CDOs - drops. The toilet loans are thus shifting back to the bank's balance sheets when the bank seizes the collateral for failure to repay. It is entirely possible that the market is on the verge of a vicious cycle where large investors try to meet the margin calls via liquidation, thus flooding the market with CDOs, which in turn drops the value even more and results in yet more margin calls.
3.17.2008 12:21am
Gaius Marius:
Terrance, this financial crisis has evolved beyond sub-prime mortgages. This financial crisis is now about the lack of liquidity in the markets. Nobody wants to extend credit to anyone, even those with good credit, because nobody can value proffered collateral with any confidence.

Since borrowers are having a hard time obtaining credit to fix their balance sheets, they are being forced to sell assets such as equities to raise cash. This in turn is facilitating a downward spiral in the markets.

David, I disagree to the extent that one can stereotype all poor people as irresponsible. A lot of poor people, and minorities are financially illiterate and do not fully appreciate how to wisely utilize credit.

Mac, there are many theories as to why Glass-Steagall was repealed. I don't mean to cop out but just do a google search for Glass Steagall and you'll get a bunch of papers as to why it was repealed.
3.17.2008 12:25am
Jon Lubin (mail):
"Mac (mail): Seeing a macro pattern and timing it are two different things. One can be sure the bubble will burst because they always do. Knowing exactly when, or even getting close enough to time a short, is another story."

Bubbles are products of irrational and behavioral influences on market psychology. Despite the fact that every bubble since Tulip mania has crashed spectacularly, human decision making is predictably and optimistically skewed by wishful thinking. All I'm saying, Mac, is that even the Harvard MBAs that the post's author disparages are part of this process. Bernstein doesn't see how anybody could have thought practices in the mortgage industry were a good idea. During boom times, people don't question the means. It's not until the music stops that investors and institutions like Bear are left without a chair looking foolish.
3.17.2008 12:26am
AnonLawStudent:

Close one avenue and they'll find another.

If you really want to stop this stuff, you have to have criminal sanctions and hang some CEOs every decade or two.


If you're very smart, you realize that there is always someone smarter - and Wall Street can afford to hire him. And if you're in the government, you realize that the rest of the world can move ten times faster than you can. That's why Greenspan was such a strident proponent of less "do it this way" regulation, but increased transparency requirements and fraud prosecutions. Facilitate counter-party surveillance, and the market go a long way toward taking care if itself.
3.17.2008 12:26am
Warmongering Lunatic:
Since it was so obvious to you, I'm sure you shorted equity positions in mortgage lenders or in mortgage backed securities before default rates spiked? No?

"The market can stay irrational longer than you can stay solvent." Shorting a bubble is a good way to lose a lot of money; all the bubble has to do is last long enough that the margin calls bankrupt you.
3.17.2008 12:28am
Jon Lubin (mail):
All true, Warmongering. My point, made in a more provocative way then necessary, was just a general hindsight bias one.
3.17.2008 12:30am
SMatthewStolte (mail):
I trust that many of you have already seen the humorous "How the markets really work," from John Bird and John Fortune. In case you haven't, though …
3.17.2008 12:32am
DavidBernstein (mail):
I'll tell you something about shorts with regard to a sector, and it's a very good reason not to bet the house on them: it's very hard to time them right. Lots of smart people went broke shorting tech stocks in 98 and 99. They were completely right about the market, but too early.

And if you shorted FNM or FRE through just a few months ago, you would have lost big bucks. Countrywide kept going up long after I was dead sure that it was toast. Same with LEND. Housing stocks rallied from Fall '06 to Spring '07 for no discernable reason, and indeed contrary to all common sense. Home Depot kept rising past 40 long after it became clear (at least to me) that the housing market was tanking. And so on.

It takes both unusual confidence that the "experts" are wrong and lots of financing to see shorts through to when the rest of the market catches on, and very few of us have either, much less both. My first priority is to be able to sleep at night, which strictly limits how much I'll speculate on anything.
3.17.2008 12:33am
Bender (mail):
There's a difference between liquidity and assets. Essentially Bear Stearns suffered a run; a phenomenon that is every bit as irrational and psychologically driven as a boom. Cox was relying on an unbiased accounting by regulators when he said that Bear Stearns assets were sufficient to cover its debts. No one realized or expected that so many Bear Stearns debts would be called at once. Once some investors suspected there might be a run, a run was inevitable. Maybe a banking holiday might have stopped it. If the run had been stopped, I suspect that a careful accounting would have shown that Bear Stearns really wasn't in that bad shape. Hasn't anyone here read Friedman's analysis of the causes of the Great Depression? Hasn't anyone here seen "It's a Wonderful Life"?
3.17.2008 12:37am
Gaius Marius:
Sure sucks to be Joseph Lewis who recently invested $1 Billion in Bear Stearns only to see his money go down the toilet. At least he has another $1.5 Billion to play with for now.
3.17.2008 12:41am
DavidBernstein (mail):
Speaking of which, another example: WCI had, justifiably, the highest short of interest of any builder, and was about to hit the single digits. Then Carl Icahn announces that he wants to buy the company for $22, after sinking hundreds of millions of his own money into the stock. Do you want to bet that you know more than Icahn? No? Then you covered your shorts, and lost a bundle. OTOH, if you had the courage and the resources, it's now selling for around $3, and you're rich.
3.17.2008 12:44am
Gaius Marius:
Apparently Cox forgot to take a look at Bearn Stearns' liabilities in addition to its assets.
3.17.2008 12:48am
Truth Seeker:
Another is to make U.S. assets so cheap to foreigners that they buy up the the land, etc.

Whenever people worry about foreigners buying up US real estate or companies (like in the 1980s with japan or now), I think wouldn't that be dangerous for the foreigners because in an emergency we could impose a tax that would eat away at their investment. How about a 50% capital gains tax on foreign-owned real estate? Or a 10% asset tax on foreign-owned US asets? Or an annual profits tax?
3.17.2008 12:52am
PC:
We really don't know for sure, but the whole MBS market is chump change compared to Credit Default Swaps. The notional value of the market here is $45 trillion—up from $0.9 trillion in 2000.


This is the one that is worrying me too. There's something like $1 trillion in CDSs on GM, while GM has a market cap of $15 billion.
3.17.2008 12:52am
JRL:
I place the blame for all of this squarely at the feet of the Fed and reckless rate raising from June 04 - June 06. Those increases are indeed the proximate cause of the financial troubles we are experiencing today.
3.17.2008 12:55am
DavidBernstein (mail):
I'm not worried about foreigners buying up the country, I'm concerned that devaluing the dollar is a way of taxing Americans' wealth through non-legislative means, though it's not like I know how I'd handle this mess if I were the powers-that-be.
3.17.2008 12:58am
DavidBernstein (mail):
JRL, why not at the feet of Greenspan for recklessly keeping real short-term interest rates negative to avoid a recession after the NASDAQ crash and 9/11? He didn't learn his lesson after pulling the same stunt in '98, causing the NASDAQ bubble and subsequent crash.

It would have been more irresponsible to keep rates down and let the bubble grow further.
3.17.2008 1:00am
Gaius Marius:
I disagree JRL. I think there is near universal acknowledgement that in hindsight, Greenspan left the fed rate too low for too long thereby resulting in the credit bubble that has now manifested itself in the collapse of the sub-prime mortgage market, housing market, and has now led to the lack of liquidity in the markets.
3.17.2008 1:01am
JRL:
If it weren't for the run up in rates, there would have been no bubble!
3.17.2008 1:04am
Gaius Marius:
JRL, if you really believe what you just posted, then I certainly hope you are not employed in the financial services industry.
3.17.2008 1:07am
Paul Allen:
David: There is substantial evidence that the hedge-funds are overall fine. Indeed, the hedge funds have had good success at attracting the best and the brightest. Conversely the big banks have the classic large corporation problem: 80% incompetent dead weight.
3.17.2008 1:14am
JRL:
"JRL, if you really believe what you just posted, then I certainly hope you are not employed in the financial services industry."

JRL, JD, MBA (not Harvard!), CPA
3.17.2008 1:31am
ScottVA:

Conversely the big banks have the classic large corporation problem: 80% incompetent dead weight.


Geez, as a (thankfully) former federal government employee, I hesitate to attempt to put a percentage to government dead weight. I will say that my first thought was "8 out of 10 incompetent? well that's not so bad..."
3.17.2008 2:00am
Truth Seeker:
I'm concerned that devaluing the dollar is a way of taxing Americans' wealth through non-legislative means

Good time to buy assets that benefit from inflation?
3.17.2008 2:03am
Joeblow (mail):
Good time to short Chinese stocks, which have quintupled in just a couple of years, with much more leverage and uninformed speculation than the U.S. housing market.
3.17.2008 2:13am
Curt Fischer:

Maybe if I had studied for an MBA in Harvard and worked my way up to the top of the investment banking industry it would somehow have made sense to me.


This reminds me of Bill Gates' recent testimony to Congress:

Now that the credit bubble has burst, "maybe some of the bright minds going into finance will go into science and engineering," Gates said.
3.17.2008 2:30am
Dale Franks (mail) (www):
I simply didn't, and still don't, understand how anyone could have thought that giving people, often people with terrible credit histories, mortgages with no money down and often with no documentation of income--and after an unprecedented increase in prices left the market especially vulnerable to a downturn in prices--was a good idea.


Simple. The mortgage brokers generating the loans get paid for generating the loan. They could care less whether the the customer can pay the loan or not.

The banks thought they could securitize the loans by converting them into publicly traded investment instruments, and pass the risk on to investors in their new "Enhanced Leverage investment Fund".
3.17.2008 2:36am
Chuckles48 (mail):

I've said it before (e.g.), and I'll say it again. I simply didn't, and still don't, understand how anyone could have thought that giving people, often people with terrible credit histories, mortgages with no money down and often with no documentation of income--and after an unprecedented increase in prices left the market especially vulnerable to a downturn in prices--was a good idea. Maybe if I had studied for an MBA in Harvard and worked my way up to the top of the investment banking industry it would somehow have made sense to me.

You're looking from the wrong end of the problem. Go back to 2005. You're an investment banker in the mortgage industry, and (courtesy of the oil price runup) you're trying to find places to put unprecedented amounts of investment money. Your mortgage banking guys have already made loans to just about every good credit risk. So who do you loan to? Who's left? The bad risks, that's who. And you're competing for their business with all the other mortgage bankers who are in the same boat.
3.17.2008 2:51am
Tony Tutins (mail):
Why didn't Congress step in earlier?

A funny thing to be reading on this somewhat libertarian blog.

Another funny thing is the notion that risky loans carry higher interest rates was not matched with the notion that higher interest rate loans are at risk of default. Plus you have all these new people who haven't lived through the last downturn, who don't think it can ever happen.

With the dollar plunging as it is, I think we are at real risk of another Great Depression. Americans will no longer be buying all these Made-in-China tchotchkes, so China and the Asian dragons will be hurting. I wouldn't open a nail salon any time soon, either. Invest in beer (for crying-into purposes) and board games (something cheap for the whole family to do in the evening, after the giant plasma screen breaks).
3.17.2008 2:53am
EIDE_Interface (mail):
Bear Stearns is not a "victim" of subprime. They're a victim of their own stupidity.
3.17.2008 3:29am
A. Zarkov (mail):
The credit crisis has unexpectedly hit the municipal bond market. You can see this by looking at the plunge in the net asset value of a big bond fund like Vanguard's California Long Term Municipal Bond Fund-- VCLAX. These bonds have no direct link to mortgage backed assets, so why did they take a hit? Not so simple. But here are a two reasons. (1) Hedge funds got caught with margin calls on their highly leveraged CDOs and had to sell off some of their good stuff. (2) Monolines like AMBAC and MBIA insure municipal bonds, but they stopped being "mono" and went "poly," insuring structured products that tanked in August 2007. This made investors worry that the monlines were now too weak to cover muni defaults. Then Fitch lowered AMBAC's credit rating from AAA to AA triggering a massive devaluation of muni market. Thus things that were thought to be uncorrelated got very correlated when an adverse event occurred.

The unexpected link between the muni market and the sub-prime market demonstrates how financial engineering can fail. The financial engineers use historical data to calibrate their models, but this data doesn't provide information about conditional correlations that can occur when a very rare adverse event occurs. In other words, the hedge fails just at the time it's most needed. A lot of the problems we are now experiencing in the credit markets can be traced to the failure of financial engineering as well as regulatory failure. The monolines should never have been permitted to go outside their original core business.
3.17.2008 3:48am
A. Zarkov (mail):
JP Morgan just bought Bear Stearns for $2 a share. On Friday morning the shares traded for over $50. The Fed has hit the panic button:
The Federal Reserve on Sunday announced two initiatives designed to bolster market liquidity and promote orderly market functioning. Liquid, well-functioning markets are essential for the promotion of economic growth.

Wow this is really scary. We really could be headed for a major meltdown of the financial system.
3.17.2008 4:20am
canadianguy:
lets not all get crazy and panic like fools. If things get worse they feed upon themselves and get even worse. Dont start shooting ourselves in the foot. Also the stock holders have to vote on this and what i have read one large stocks holder is going to vote for chapter 11.
3.17.2008 4:53am
SS:
This $2/share sale intended to prevent Bear from having to liquidate their holdings quickly, thereby harming the value of the assets of all the other banks &funds.. We shall see how well it works.

Besides the sub-prime loans, there's also the Alt-A loans, which nobody seems to be talking about yet. I used to think the Alt-A's were the same as sub-prime but evidently they are detailed separately. A whole new class of loans likely to go bad. Means the borrower had good credit, but otherwise no proof of income, that old fashioned idea of "debt to income ratio" not checked, etc.

I have known a ton of "house flippers" over the last several years. They kept telling me to come join the fun. My gut said no, as I watched them prosper.

Kind of one of those games where you don't want to be the last one in. Now, I am sure a ton of them are holding the bag, or soon their banks will be.

Miami, Phoenix, many other cities just FULL of "flipper" deals. Besides the sub-prime loans &Alt-A's.

In the Great Depression, which my parents and grandparents talked a lot about, those who lived on farms at least ate pretty well. I don't know what percentage of the population had farms &gardens, but suspect it was high.

Today, people don't know how to cook, much less grow vegetables.

Question of the day: Is gold the next bubble?

SS
3.17.2008 5:10am
David Smith:
Oh, the horror. Where will these folks earning 500k+ go next?
3.17.2008 7:52am
David Smith:
One other thing. When I was getting my MBA in the 1980's, and worked for a financial guarantor (before the 86 tax act), already there were ultra-sophisticated models for appropriate buffers for CMO's.

I left that industry in 1990, with no further knowledge, and I cannot even imagine how much further those must have evolved in the past 20 years.

And for them to fail so....
3.17.2008 8:05am
Lioni Albers (mail) (www):
Truth, inflation is one possibility. Another is to make U.S. assets so cheap to foreigners that they buy up the the land, etc. But all that assumes that the government actually has a coherent plan. Webseite eintragen Fertiggarage Carports
3.17.2008 8:12am
A. Zarkov (mail):
"Also the stock holders have to vote on this and what i have read one large stocks holder is going to vote for chapter 11."

Yes according to the WSJ, the BS building alone is worth $8 a share. Then BS has a performing, but illiquid portfolio of CDOs. I don't see why the shareholders would approve such a blatant giveaway.
3.17.2008 9:10am
Bandit (mail):
Bear Stearns is a victim of the subprime debacle

No BSS was a victim of their own greed and stupidity - or is it stupidity and greed
3.17.2008 9:15am
Nate H (mail):
It's amusing how people will employ any number of mental gymnastics in order to avoid discussing the elephant in the room. The government required lenders to increase lending to minorities and "get them into houses" and now you are surprised that unqualified people got loans, yeesh. Read this
3.17.2008 9:16am
occidental tourist (mail):
my anecdotal candidate for what blew the bubble makes reset ARMs and low-doc needles. I trace the bubble itself to the post 9-11 consumer pyschology. The globetrotting unanchored ways of post X generations quickly changed focus to something more perceptually secure and rooted like the homestead.

Construction inflation and investments from reno to trading up homes was rampant as were market responses on overall real estate valuations (not insubstantially affected als by resource dislocations related to the abrupt needs of the American military and civilian operations abroad, especially in Iraq). Couple this with the psychology that operating in a global economy filled with militant islamic bombers was going to be difficult and you get real estate favored over stocks.

I really got the feeling at the time that this was driving consumer decisions implicitly and remained more or less convinced in my own operations highly leveraged in real estate that investment decisions should surround 2001 valuations and anything you got beyond that was gravy.

There was plenty of money to be made buying and selling in the interim and I think you could also have taken the approach of funding new projects off the last projects as long as you sheltered your nest eggs then you might get stuck holding the last one.

The worst I have read of banks in this whole thing is that they were loaning money for people to buy the collateralized securities they were selling. That left them with the same exposure. Maybe they were making money off the fees.

I don't think they way around this was government regulation, but even Greenspan is, today, expressing concern regarding the likelihood of "counter-party surveillance" taking care of this but favoring self-regulation based on coginizance of the failure of present understandings of diversification to effectively insulate investors from risk.

In the meantime the ideal bailout stategy would be to leave it to the private market. Assuredly this means some fire sales, but I'm not sure that government strong arming for the kind of result we got in the Bear Stearns deal is sensible. Rather - counterintuitively to the pro-regulatory types -- what is needed is to waive or vacate various interpretations of anti-trust and collusion such that financial interests could close ranks on a problem like this.

Indeed, what happened here, if negotiated by a compendium of private banks, probably would be challenged as an evil corporate machination.

It is possible on the money supply side that fed contribution to liquidity could be a positive result but filtered through the traditional institutions its effects may be muted. I would think populist liquidity is still the most important and might reduce more to cooperative efforts at mini-credit (as contrasted with micro-credit) among citizens more than just at the margins, but these will be hampered by the regulatory vice designed by such brilliant statesmen as Eliot Spitzer.

Meanwhile, I wonder which party will realize that the economy could be jump started by reindustrializing the united states -- the best if remotely possible result.

Brian
3.17.2008 9:34am
Gaius Marius:
There is no question that by looking at the assets alone, Bear Stearns is worth more than $2 per share. However, when you look at both assets and liabilities, I seriously doubt Bear Stearns is worth more than $2 per share.

Bankruptcy for Bear Stearns is certainly an option but it would also trigger an unprecedented global market crash far surpassing the 1929 market crash because contracts with various banks and hedge funds would get tossed out the window thereby causing them seize up. By contrast, JPMorgan will be stepping into the shoes of Bear Stearns and honoring Bear Stearns' obligations pursuant to agreements with various banks and hedge funds. That one large shareholder who purportedly is going to vote against the sale of Bear Stearns because he prefers bankruptcy is a complete moron since shareholders are always last in line to be paid out.
3.17.2008 9:34am
DVK:

"JRL, JD, MBA (not Harvard!), CPA"


JRL, you were working at a mortgage desk at Bear Stearns, weren't you? :)
3.17.2008 10:08am
erp:
This mess was caused by the social engineering of doing good, not good financial decisions. Remember this when you vote in November. A vote for a Democrat means much more of this.
3.17.2008 10:19am
occidental tourist (mail):
Gaius,

I'm not suggesting that I favored bankruptcy or that the $2 is necessarily way off. What I'm saying is that if the government strong arming and participation in the Bear Stearns buyout is supposed to be a surrogate for public interest that this probably could have been represented by private banks operating cooperatively reflecting their own interests in not seeing a cascade of demands on liquidity that could challenge those not in as theoretically leveraged positions relative to those assests currently sinking.

But that our anti-trust tradition actually impells public choice manuevering where a private public partnership is made to dance around the anti-trust implications and that while the instant decision they made may reflect sound policy it is still implicitly guided by the seizure of government backing by an individual player in the monetary field.

Better, i think more than in theory, that those private firms at risk from a domino effect of bear stearns got together and made the rescue plan. I don't see this as ganging up on the consumer. Rather I see the government plan as ultimately making the taxpayer the backer of all this for 'his own good'. I don't mean that snidely or that there is not a great temptation to intervene, but I think that is because government regulation prevents the private circling of the wagons that might happen otherwise.

Let other commercial or investment banks who, for instance, could make the demands on Bear Stearns that present the liquidity crisis buy the bank for cents on the dollar. I'm fine with that. For all I know JP Morgan was such a major creditor or transactor, or maybe was just in a more favorable position to make good on short term guarantees but I would tend to trust that outcome if it were more clearly worked out by the compendium of collateral interests rather than an apparent public choice end run. I'm certainly open to hearing how such a private negotiated solution would fall short, or the representation the JP Morgan is only operating within the parameters available to any private firm under the liquidity guarantees made by the federal govt. and there is less govt. arm twisting on this particular deal that there appears.

Brian
3.17.2008 10:27am
Tom952 (mail):
Suppose you are a mortgage broker. In come Mr. and Mrs. B, who want to borrow some money and get in on the real estate action. You pull their credit and find they have a 580 mid score, and you sense that they are not very bright. You find a sub-prime lender who is interested in their business (say Delta or Indy Mac, you don't have to go far to find a lender who will fund the deal), and you propose a nice No Income, low down payment loan for them with an interest rate of about 9.8% on the first 80% and 19% on the remainder. You tack on about 3% yield spread and 3% fees for a nice commission of 6% of the gross loan amount. You honestly and clearly explain the terms to Mr. and Mrs. B., who can't sign the forms fast enough, including the Federally mandated Reg Z TIL form with the APR in BOLD TYPE, and the pro-forma Good Faith Estimate that explains all the fees to them in with no mumbo-jumbo. They don't care. On a $300,000 loan, you make a cool $18,000 gross commission. Mr. and Mrs. B are adults with full citizenship rights, no mental impairment except greed, and an IQ that falls well within normal limits.

Does that clear it up?
3.17.2008 10:50am
J. F. Thomas (mail):
This mess was caused by the social engineering of doing good, not good financial decisions.

Oh give me a freaking break. It is beyond credible that banks were forced to lend money to anyone they didn't want to lend money to. The government has not and has never said that banks must lend money to unqualified buyers. The lenders just didn't care. This was a PONZI scheme and they knew it.
3.17.2008 10:54am
EIDE_Interface (mail):
JF Thomas:

There was mutual fraud between the lenders and lendees. They deserved each other. Spare me the faux tears.
3.17.2008 11:25am
PC:
It's clear that all of these financial problems are the fault of Democrats, minorities and poor people. Remember when the Democrats increased credit default swaps from $900 billion to $50 trillion in 7 years? Or how minorities created $500 trillion in derivatives? Or what about poor people slashing the interest rates, causing the dollar to free fall.

Just this morning I saw a couple of homeless people bundling some CDOs while their friends were giving the CDOs a AAA rating. Damn those socialists for being leveraged 33:1.
3.17.2008 11:30am
Justin (mail):
"Perhaps in the third world, people who are poor are poor thanks to government -- excessive taxation and regulation of the market, lack of property rights, not much rule of law -- so them being poor doesn't say much about them. "

I can play this game too. Perhaps we all really live in a futuristic society controlled by AI machines, and we just don't know it because we're hooked up to an interactive mainframe - a matrix of sorts, shal we say....
3.17.2008 11:37am
Gaius Marius:
I totally agree with J.F. Thomas. Even if banks were purportedly strong armed by the government to lend to minorities, nobody forced these banks to subsequently repackage these sub-prime mortgages into securities and sell them to other banks.

Occidental, I didn't think you were advocating bankruptcy. Also, I'm not sure the Fed was strong arming JPMorgan to purchase Bear Stearns. If anything, I suspect that JPMorgan held the proverbial gun to everyone's head on Wall Street and said 1) we are not going to pay $15 per share but only $2 per share and 2) the Federal Reserve (aka John Q Public) is going to bear ultimate liability for Bear Stearns' liabilities or else we are going to let Bear Stearns go into bankruptcy, which will cause a market crash of biblical proportions. Finally, JPMorgan was in the best position to purchase Bear Stearns because of its relationship with the latter. What I am concerned about is whether the other Wall Street banks did not rescue Bear Stearns because they are financially unable to rescue even themselves.
3.17.2008 11:40am
LN (mail):
Hilarious. Yes, stupid poor people with bad credit, aided by do-gooder liberal Democrats, they are the ones who brought the global financial system to its knees, destroying trillions of dollars of value in the process. Why won't people acknowledge the obvious?
3.17.2008 11:47am
SeaDrive:

This was a PONZI scheme and they knew it.


What's your definition of a Ponzi Scheme? How does it fit?

I worked briefly as a computer consultant for a major lender in the mid-90s, and I was amazed at how the community development programs had them lending to people they would otherwise not lend to at all, and giving the loans bigger (relative to the home price and income) than they would give to their most qualified customers. I assumed there were gov't guarantees involved.
3.17.2008 11:54am
Don Miller (mail) (www):
10 years ago I was working for a Small Regional Bank. I worked in the Consumer Loan Servicing Group.

After 6 months exposure to the industry, I cut up all my credit cards and started the process of paying off 100% of my debt. I continued to work at the bank for 4 years and it just confirmed by belief I was doing the right thing.

Two years later I heard a guy on the radio putting words to how I felt. Dave Ramsey was the guys name.

1. Don't spend more than you have
2. Write a new budget every month and live by it
3. Invest using the Grandma rule. If you can't explain the investment to your Grandma in 5 minutes, you probably don't understand it well enough to invest in it.
4. Pay off your mortgage and don't get HEL. Housing market downturns aren't so scary if you don't have a mortgage.

A lot of people claim that credit is a tool that anyone can learn to use. This debacle should teach all of us that credit is the assault rifle of finance. It is the perfect tool in the right hands, it is extremely dangerous to the user and the general public in the wrong hands. The average consumer is like a 6 year old with an assault rifle.
3.17.2008 12:01pm
Gaius Marius:
I totally agree with Don Miller.
3.17.2008 12:11pm
Bender (mail):
If I own a $200,000 house outright, have $15,000 in debts owed to me but not payable until next year, have $7,500 in a savings account, and owe $20,000 payable on demand, then my net worth is $202,500. If my creditor demands immediate next day payment, I may have to give him everything to settle the debt.

That does not mean that I was stupid, greedy, an evil capitalist, or whatever. It does not mean that the real net value of my assets was not $202,500. It does mean that I was screwed by a lack of liquidity. No one else will be. My creditor will make out like a bandit. Whoever buys my house will still wind up with a $200,000 house.

This is the exactly analogous situation that Bear Stearns ran into. A panic caused its demise not any underlying unsoundness in its total portfolio.

Panics are just as stupid -- and more dangerous -- than booms. And everyone I've been reading in this column seems to have little understanding of what's really going on here. This is the end result of a run on a bank caused ultimately by that bank's lack of liquid assets (not total assets).

Go back and read a little history about how the Great Depression started. It was not because of over-valuation but primarily because of panic and bank runs. Exactly the kind of irrationality that seems to have infected almost every blogger posting here.
3.17.2008 12:15pm
RainerK:
Bender,

"If my creditor demands immediate next day payment...."

If you have a contract with the lender prohibiting him to demand full payment any time he feels like it that couldn't happen, right?
3.17.2008 12:30pm
byomtov (mail):
Glass-Steagall was repealed in November 1999 by Bil Clinton. Hmmmm.

A touch more precision, please. The Gramm-Leach-Bliley bill, repealing Glass-Steagall, was signed by Clinton in 1999. Isn't Gramm advising McCain these days?
3.17.2008 12:30pm
David Chesler (mail) (www):
Why are housing market downturns less scary if I don't have a mortgage? I'm 10 years into a 30-year mortgage on a 50-year-old house (that last is for those that say middle classers are poor today because we live in bigger houses.) If I've got a mortgage, I've got a fixed dollar-denominated payment each month, and I'm sitting on a lot of equity (a little amortization and a lot of appreciation. Sure it would be nice if I had a paid-off house, but it would be even nicer to have two paid-off mansions. Suppose I were frugal and had investments equal to what would pay off the mortgage. I can invest in something stable and pay off the mortgage on schedule, and if it ever gets to be too much I can sell trade in the house for a smaller house; if the house is paid off I don't have other options. Sure the sheriff can't come to my door to evict me, but if I'm so house-poor and can't eat, that doesn't help me.

As for timing the collapse, some time in the early 80s my father, whose dream was to make it big in the market, went into cash when he could get 18%. He stayed in cash ever after, saying he was waiting for the next Great Depression and then he'd invest after the crash. Black Monday 1987 wasn't enough to trigger his investing, neither was the Dot.Bomb. Meanwhile he'd bought his townhouse retirement home for cash, and was living off the interest, banking his pensions. Did he make it? I don't know. He didn't lose any actual money in all this time. If he'd bought the Dow Jones he'd have had even more money. He died last year without ever making his killing, but he left my mother enough money that unless we have hyperinflation without matching interest rates, she doesn't have to worry.
OTOH, I married a woman whose innumeracy and bouts with cancer and family history led her to lead each day as if it were her last, and one day last year she was right, and I don't have any regrets that she spent it all and then some. (You can take it with you if it's a debt, and a lot of her credit cards were in her name only.)
No particular moral, just a different perspective -- I'm generally broke but I've got a roof over my head and enough food to eat. I'd like to be a little more comfortable, but it's not a big deal. (I'd have to be a lot richer to be able to afford college if my children don't get into a need-blind full-scholarship Ivy-type school, so that doesn't matter much.) In the long run we're all dead anyway.
3.17.2008 12:33pm
AnonLawStudent:

"Perhaps in the third world, people who are poor are poor thanks to government -- excessive taxation and regulation of the market, lack of property rights, not much rule of law -- so them being poor doesn't say much about them. "

I can play this game too. Perhaps we all really live in a futuristic society controlled by AI machines, and we just don't know it because we're hooked up to an interactive mainframe - a matrix of sorts, shal we say....


Except that there aren't reams of academic literature - including by left-wing third-world economists, e.g., Hernando DeSoto - backing up the Matrix fantasy. That the lack of property rights and rule of law is one of - if not THE - major impediment to third world economic development is acknowledged and generally well-understood. The disagreement between (for lack of better terminology) right-wing and left-wing economists is what to do about it.
3.17.2008 12:36pm
Joe Bingham (mail):
David, I disagree to the extent that one can stereotype all poor people as irresponsible.

He said "primarily."
3.17.2008 12:37pm
Christopher Cooke (mail):
Does the fact that the Fed had to guarantee some of BS's liabilities, in order to entice JP Morgan to buy BS for $2/share, not repudiate, to some extent, the libertarian anti-regulatory view on this blog? Or do the libertarians think this is a bad thing, and that BS should be allowed to fail, along with the other investment banking firms and banks they happen to drag down with them? Please note I am just curious about how those who call themselves libertarian view the merits of what the Fed did, and whether those who support the Fed's actions can explain the seeming inconsistency between such support and the libertarian views they believe in.

For example, someone decried the repeal of Glass-Steagall Act and said it was responsible. Repeal of that statute had virtually unanimous bipartisan support. It was largely done because Citibank wanted to merge with The Travellers, which owned an investment bank. I would bet that repealing that statute did not directly encourage banks to invest in CMS, or to make bad loans. And, if the statute were on the books today, JP Morgan would not be able to buy Bear Stearns.
3.17.2008 12:38pm
IB Bill (mail) (www):
That the lack of property rights and rule of law is one of - if not THE - major impediment to third world economic development

True. Unfortunately, there are tough cultural factors at play here. It's very difficult to impose the rule of law and respect for property rights when there's a critical mass of people who do neither.

Back in Peace Corps-Africa, I saw this first hand. A woman started to sell brochettes and bananas in the market square at night. Her business took off like gangbusters. Every ex-pat in town went there every night. Lasted about two months. It became the place to meet up with everyone at night. She was raking in bucks and talking about building a restaurant and hiring staff.

One day, she was gone. The police had dropped by for her "unpaid taxes" which were suddenly and inexplicably due right that moment. They took almost all the money she'd made and let her go. She ended up building a small shack outside of town where she could only serve a few people at a time, and even when the expats caught up with her, she insisted she didn't want her business "to be too successful" again. Too costly to get attention.

That's what it's like. You don't pay your police enough, they shake down businesses, payoffs rule, you pay to play, and before you know it, everyone's just trying to keep their head down and not run afoul of the authorities. I think it's called kleptocracy.
3.17.2008 12:49pm
DDS:
I've said it before (e.g.), and I'll say it again.

Well, I definitely don't doubt that you'll say it again.
3.17.2008 12:50pm
A. Zarkov (mail):
Christopher Cooke:

"For example, someone decried the repeal of Glass-Steagall Act and said it was responsible. Repeal of that statute had virtually unanimous bipartisan support."

I wrote that. Of course it had bipartisan support, look at who makes huge contributions to both parties. This bar graph shows the top contributors to the Senate Banking Committee. To get specific, look at Senator Schumer's (banking committee member) top contributors. Almost every one a bank or financial services company.

"I would bet that repealing that statute did not directly encourage banks to invest in CMS, or to make bad loans."

You would be making a bad bet. Banks make bad loans because they want the borrower's investment banking business. That's where they get the big fees. The conflict of interest here is similar to the accounting business. Arthur Anderson (put out of business for its crimes) cooked the books for Enron to get huge "consulting fees." Now the bank needs to get rid of the risk and get that toxic loan off the books. Enter structured finance. A credit default swap will do both. You get a third party to insure the loan and create an SPV to carry it.
3.17.2008 1:30pm
A. Zarkov (mail):
J.F. Thomas:

"It is beyond credible that banks were forced to lend money to anyone they didn't want to lend money to."


Not true. This article shows how underwriting standards deteriorated under pressure to make loans to minority groups.

From the current hand-wringing, you'd think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards - at the behest of community groups and "progressive" political forces.

snip

In 1989, sympathetic members of Congress got the Home Mortgage Disclosure Act amended to force banks to collect racial data on mortgage applicants; this allowed various studies to be ginned up that seemed to validate the original accusation.

snip

" … the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: "discrimination may be observed when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants."

snip

" … the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant's ability to manage debt."

snip

"A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities."

"Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department."
Now forcing banks to make bad loans is only one part of the sub-prime mess. Obviously the banks decided to make a good buck while keeping the regulators happy.
3.17.2008 1:48pm
erp:
The guvmint has a lot of tricks other than laws "forcing" banks to give mortgages to those who don't qualify and they aren't necessarily minorities although playing the race card is always a smart move when dealing with the feds. Local banks took the credit [pun intended] for being good citizens, sold the mortgages to larger banks and so on ...

It's a ponzi scheme just like the miracle economy of the Clinton years. Newcomers keep putting in new money to pay off those who came before. Pretty soon there aren't any more new suckers and it all falls down.
3.17.2008 1:48pm
Gaius Marius:
Christopher, you make a good point. I wonder though if it is fair for the Federal Reserve to stand back and do nothing to prevent the collapse of Bear Stearns or other banks when the Federal Reserve (particularly Alan Greenspan) bears responsibility for creating the circumstances underlying the present liquidity crisis.
3.17.2008 2:31pm
J. F. Thomas (mail):
Now forcing banks to make bad loans is only one part of the sub-prime mess. Obviously the banks decided to make a good buck while keeping the regulators happy.

It is disingeneous at best, outright lying actually, for the banks to now claim that the only reason they are in this mess of their own making is that they were forced by the big bad government to loan money to poor minorities.

If people like you weren't such vicious racists and were willing to give credence to patently ridiculous claims that crafty poor minorities, with the aid of the federal government, were able to threaten the financial systems of the U.S., it would be funny.
3.17.2008 3:26pm
AnonLawStudent:

It is disingeneous at best, outright lying actually, for the banks to now claim that the only reason they are in this mess of their own making is that they were forced by the big bad government to loan money to poor minorities.

If people like you weren't such vicious racists and were willing to give credence to patently ridiculous claims that crafty poor minorities, with the aid of the federal government, were able to threaten the financial systems of the U.S., it would be funny.


Was the CRA (and similar regulations) THE cause of the subprime meltdown? No. However, it has nothing to do with racism when one points out that heavily incentivizing economic actors to allocate assets in a manner other than based on purely economic considerations results in an inefficient allocation of capital. When even proponents of that capital reallocation claim that it involves over FOUR TRILLION DOLLARS in assets, it is "disingeneous [sic] at best, outright lying actually" to claim that the resulting loans to otherwise unqualified borrowers played no part in the current financial situation.
3.17.2008 3:38pm
Cato (mail):
I believe Goldman Sachs is up to its eyeballs in the Bear collapse. Since Goldman was the specialist in Bear, I figure they probably lost a bunch of money -- probably in the hundreds of millions of dollars -- making a market for Bear stock last Friday. I was looking to trade that insight today, but low and behold I discovered two extraordinary facts. First, someone bought 55,000 puts at 30 in Bear with only 10 days left to go on the options. Second, on Thursday Goldman pushed Bear over the edge by saying they would not accept Bear as a counterparty. The 55,000 puts are now worth almost $600 million.
3.17.2008 4:10pm
Harry Eagar (mail):
Hmmm.

Treasury and the Fed had all weekend to put lipstick on the pig's corpse.

Makes me wonder what would have happened if BS had suspended on a Wednesday.

If you had asked me, at the beginning of the year, whether I'd have expected the government to force me to give the Rockefellers $100, I'd have said no. And if you'd said the government would pat itself on the back for transferring my $100 to the Rockefellers, I'd have laughed.

Joke's on me.
3.17.2008 4:36pm
Piano_JAM (mail):

It is disingeneous at best, outright lying actually, for the banks to now claim that the only reason they are in this mess of their own making is that they were forced by the big bad government to loan money to poor minorities.


I don't believe it was said that the ONLY reason for this collapse was lending to poor minorities. There is NO Denying that it was a factor. JF - not every remark somewhat critical of the activities of minorities is Racist. Facts are facts.
3.17.2008 5:00pm
A. Zarkov (mail):
J.F. Thomas:

"If people like you weren't such vicious racists and were willing to give credence to patently ridiculous claims that crafty poor minorities, with the aid of the federal government, were able to threaten the financial systems of the U.S., it would be funny."

It's too bad that you can't express yourself without recourse to insults. If you think pressure from regulators had absolutely nothing to do with the lowering of underwriting standards, then you know very little about the banking business.
3.17.2008 5:00pm
A.C.:
And I suppose that once the lending standards are lowered, it isn't just poor minorities doing the questionable borrowing. It's an unintended consequences argument, not an argument that somehow a bunch of poor black people tanked Bear Stearns all by themselves.

I've run across these situations before, on a smaller scale. A desire to help a group that may legitimately need a bit of help starts a ripple effect that ends up hurting everyone, including the intended beneficiaries.

For the next ripple, see what happens when the government tries to make prescription drugs a lot cheaper.
3.17.2008 5:18pm
Christopher Cooke (mail):
Zarkov: As I recall, the academics all (from economists, to business school profs, to law profs who were experts on these laws), virtually unanimously, also endorsed repealing Glass-Steagall. The thinking was that the "wall" between banking and investment banking was (1) no longer necessary, given the regulatory oversight of the Fed over banks and (2) a fiction, anyway, given that so many brokerage firms were acting like banks and providing a multitude of financial services. I don't think you can plausibly assert all of academia was biased, and supported this reform for the money.

I think it is a little simplistic to blame the current subprime debacle, ensuing credit crunch, and run on Bear Stearns (and possibly other investment banking firms) on the repeal of this one law, or on the Community Reinvestment Act, but I am sure that Congress will have some interesting hearings on this financial meltdown, and I will try to keep an open mind about the causes.
3.17.2008 5:32pm
Harry Eagar (mail):
Yes, blast those janitors and housemaids for taking out those jumbo mortgages with no income verification.
3.17.2008 5:56pm
PC:
Yes, blast those janitors and housemaids for taking out those jumbo mortgages with no income verification.


Unqualified borrower = drug user
Mortgage writer = drug dealer
Originating bank = drug producer

And given the exuberance of the mortgage writers, they could easily be compared to a drug dealer hanging out on play grounds giving away free samples of crack:

MW: Hey kid, you ever try an ARM with a 1% rate? It's great stuff. It will make you flyyyyy.
3.17.2008 6:09pm
A.C.:
The big problem is basic bubble psychology, and those of us who have been hollering about it for the past five years feel oddly vindicated by recent events.

What puzzles me is why everybody went so crazy over HOUSES, of all things. I mean, even tech stocks involved companies that made products and sold them and presumably made some sort of profit if all went well. But houses just sit there. The only way you can make a profit on a house is if the next guy is a bigger sucker than you. And the folks who took out the most recent batch of subprime loans turn out to be the biggest suckers of all. I'm happy to watch the property flippers get hurt, and I feel sorry for any families that legitimately thought subprime debt was a way to get a backyard for the kids. But even in the latter case, I can't help wondering what on earth they were thinking.

Why this turned into a run on the bank is every bit as mysterious as why anybody fell for the game in the first place. It's a backwards bubble as far as I'm concerned, but my main concern is how to prevent future bubbles in both directions. Asking for proof on income on a loan seems like one very basic strategy, even if it means that some people have to stay in rental housing a bit longer. It's not that bad, really -- I've been there, waiting out the bubble, all this time.
3.17.2008 6:13pm
Gaius Marius:
Lehman Brothers lost 20% in share value today. Ouch! Also, it now appears that Lehman has far greater exposure to sub-prime mortgages than Bear Stearns. However, it appears that Lehman has more friends on Wall Street than Bear Stearns. Nevertheless, if JPMorgan is the only player on Wall Street who can play White Knight, then JPMorgan will purchase Lehman and emerge from this liquidity crisis in one hell of an enviable position.
3.17.2008 6:15pm
Adam J:
comical- the regulators forced me to do it. That argument has as much credibility as the dog ate my homework. The loosening of regulatory standards has been the work of a republican congress that has been in power for the past decade. Nor do I blame the Congress- that's what people wanted... the fault is the banks, and their unfettered greed and inability to create an incentive structure that properly balances risk and reward. Nobody made the banks take out the highly leveraged positions that have led to these crashes. They make a fortune in completely risk free fees and yet they have to gamble the house by over-leveraging trading strategies that have tremendous risk exposure to macroeconomic events like the credit crunch. Its truly pathetic to blame the least empowered players here.
3.17.2008 6:25pm
Mr. Bingley (www):
Well, just from my experience I place the weightier part of the blame on the lending agencies. In '99 when my Bride and I were shopping for a house we carefully budgeted and figured out how much of a loan we could afford. The mortgage company promptly approved us for a loan 2.5 times as large.

We said 'no' to them, but I can imagine a lot of folks allowing those 'experts' to talk them into larger loans.
3.17.2008 6:28pm
A. Zarkov (mail):
Christopher Cooke:

"As I recall, the academics all (from economists, to business school profs, to law profs who were experts on these laws), virtually unanimously, also endorsed repealing Glass-Steagall. The thinking was that the "wall" between banking and investment banking was (1) no longer necessary, given the regulatory oversight of the Fed over banks …"


I don't know if that's true about academics, but let's say it is. Don't you think that events have proven them wrong?

You're right, brokerage firms do seem to act like banks, but if you look under the hood you will see a bank.

We want something like Glass-Steagall to keep the commercial banks from making bad loans. Commercial banks handle credit risk while investment banks handle market risk. That's essential difference between the two. Now market and credit risk have become commingled and that's not good.

"I think it is a little simplistic to blame the current subprime debacle, ensuing credit crunch, and run on Bear Stearns (and possibly other investment banking firms) on the repeal of this one law, or on the Community Reinvestment Act, …"

I never blamed the sub-prime crisis solely on those two laws. That would be simplistic. A whole bunch of factors were responsible in creating this perfect storm.
3.17.2008 6:35pm
PC:
Oh look, the minorities must be causing JP Morgan to do insider trading:

Here's how it works:

1. An insider client transfers all or a portion of their company stock into a JP Morgan Securities Inc. brokerage account.

2. The insider then develops, in conjunction with the 10b5-1 team, a 'phased, pre-planned sales program to be executed at either market or specified prices'.

3. Depending on the information available to the insider (but not the public), the insider can decide whether to execute the sale or not.

By gaming the system this way, JP Morgan teaches insiders how to use their knowledge to create a rigged market, one in which it is the "house" that always wins, and the small investor that always loses.

According to a statistical research paper published by Stanford's Graduate School of Business in September last year, executive 10b5-1 trades beat gains relative to non 10b5-1 executive trades by more than 500%.
3.17.2008 6:36pm
Gaius Marius:
Mr. Bingley, loan approval for 2.5 times income is actually conservative. Many mortgage companies have no problem approving loans 3.0 times income.

Adam J, you make a good point. Banks certainly are being enabled to act recklessly by the Federal Reserve if they know that when it comes time to pay for such reckless decisions that it will be John Q Public picking up the tab.

A.C., a big part of the problem is that no one currently knows how to confidently price the mortgage backed securities. If there is no price, then there are no buyers. If there are no buyers, then there is no market for these instruments. If there is no market for these instruments, then these banks cannot sell them to raise their liquidity.

Instead, these banks (and hedge funds) are being forced to sell down their equity positions to raise cash, which is driving the market indices down. As these market indices are driven downward, the banks and hedge funds are being forced to meet margin calls on their leveraged positions, which further results in the sale of additional equities to raise cash since they cannot raise cash via mortgage backed securities like they could one year ago. Accordingly, the equity markets are now in a downward spiral until the market can begin pricing the mortgage backed securities with confidence.
3.17.2008 6:46pm
Bad (mail) (www):
"I simply didn't, and still don't, understand how anyone could have thought that giving people, often people with terrible credit histories, mortgages with no money down and often with no documentation of income--and after an unprecedented increase in prices left the market especially vulnerable to a downturn in prices--was a good idea."

Do you understand why the government has to reward such behavior with a bailout though? I mean, if regular people who didn't even themselves speculate are hurt as banks go nuts and balloon their rates, that's just how it is: government help is just, well, immoral in such a situation, even to keep working people solvent.

But if a couple of CEOs are in trouble because they encouraged their firms to play ridiculous risks while they played bridge, well golly gee, 30 billion at the drop of the hat, asap! Can't let them face the consequences of their actions: what would the world come to?
3.17.2008 6:50pm
PC:
Can't let them face the consequences of their actions: what would the world come to?


Privatize the profit, socialize the risk.
3.17.2008 6:59pm
A.C.:
Perhaps the biggest question is why people get so stupid when you put $$$ in front of ordinary numbers. It doesn't seem to matter whether the people involved are rich or poor, lenders or borrowers, white or brown or purple or whatever. EVERYBODY has been doing things that defy common sense, and for some reason everyone seems to have woken up on the same day. The sound you hear is that of hundreds of millions of pairs of bare feet hitting a cold floor.

I'm not prepared to let the ordinary consumer off the hook for all this, especially not the ones who have been looking down on me for my un-flashy lifestyle in recent years. People who have been overconsuming and judging others by their possessions, a problem that is NOT confined to the highest income groups, have done a lot to fuel this mess. Wall Street and the Chinese have been happy to indulge them until now, and I have no doubt that both will contrive to make the problem worse before it gets better. So yes, Wall Street gets some of the blame. But ordinary people are still responsible for themselves and their actions. Don't people know you don't have to take everything that's offered?
3.17.2008 7:03pm
Bad (mail) (www):
"This mess was caused by the social engineering of doing good, not good financial decisions. Remember this when you vote in November. A vote for a Democrat means much more of this."

Yes yes, because as we all well know, flooding the market with bonds to pay for the war (essentially no different than raising taxes without having to admit that you've done it) had no effect at all on the economy...

I also love the idea that if only we'd listened to the Republicans... I mean, one of the big issues I remember being a major cause in progressive city government politics was trying to prevent predatory lending and irresponsible sub-prime loans being heavily marketed to minorities (which back then was making these companies rich because when they foreclosed on the property, it was actually worth something to them instead of being dead weight). Who was telling us that all such regulation was bad and unamerican?

The very same people and party who now apparently think that minorities forced banks to loan them money, the crafty sneaks!
3.17.2008 7:04pm
Gaius Marius:
Bad, you are describing the moral hazard dilemma. Whether we agree or not, the Federal Reserve has decided that its intervention in the markets is the lesser of two evils -- for now.

As for the CEO of Bearn Stearns, he was compensated primarily in share of Bearn Stearns that was worth $160 per share not too long ago. Now, his shares are worth only $2 each. In addition, the CEO will likely be a named defendant in shareholder lawsuits for breach of fiduciary duty and a host of other claims. I don't know about you but I would not want to trade places with that particular CEO.

What is somewhat amusing is seeing Her Highness Hillary Clinton spouting platitudes about how more needs to be donw right now. Well, I don't exactly see Her Highness rushing from the campaign trail to take the floor of the U.S. Senate and spelling out a detailed plan for resolving this liquidity crisis. At least Barack Hussein Obama is actually talking about NOT rolling back the Bush tax cuts if he is elected President.
3.17.2008 7:10pm
Gaius Marius:

Yes yes, because as we all well know, flooding the market with bonds to pay for the war (essentially no different than raising taxes without having to admit that you've done it) had no effect at all on the economy...


You're quite right, Bad. Fighting in Iraq and Afghanistan has cost future generations approximately $3 Trillion in additional debt. I think the War in Afghanistan is justified given that the Taliban and Al Quaida executed 9-11. However, Iraq has cost twice as much as Afghanistan with no progress on the political front being made. (Remember when that idiot Paul Wolfowitz guaranteed that the War in Iraq would only cost $50 Billion and that the War would pay for itself from the oil revenues?) We sure could have used that $2 Trillion that was mispent in Iraq.
3.17.2008 7:19pm
ReaderY:
An issue where I'm interested in the libertarian point of view -- United States business has repeatedly constructed arrangements in which people are rewarded for behavior which is non-constructive or destructive over the long term. Bank officers rewarded for originating and securitizing loans have no incentive for assessing loan quality; executives with stock options have no incentive to accept short-term pain for long-term gain. Our incentive systems almost uniformly turn out to reward behavior that increases short-term cash flows and paper profits but results in long-term losses.

What is the libertarian answer to this? It seems that people left to themselves pursue an extremely short-sighted conception of self-interest. It seems that structuring incentives to avoid pervere ones requires some sort of regulation.
3.17.2008 7:22pm
Bad (mail) (www):
"Whether we agree or not, the Federal Reserve has decided that its intervention in the markets is the lesser of two evils -- for now."

I'm a big fan of being quite paranoid about moral hazard. That's why I remain extremely skeptical of most non-market health plans. I just don't appreciate the fact that the calculation always seems to use different math depending on who it happens to benefit.

"Fighting in Iraq and Afghanistan has cost future generations approximately $3 Trillion in additional debt."

It's not just that though. It has very real effects on the economy right away. The fact that the government will inevitably have to raise that money in taxes is a pretty major economic signal for investors to base their decisions on. And selling so many bonds period affects all sorts of subsidiary markets.

I don't really agree that it affects future generations any more than it affects us though. Future generations may face higher taxes, but they ALSO face getting the earnings (via inhereitance, etc.) from the money that WASN'T taxed away in the first place. That is, provided their parents didn't sink that money into Bear Sterns.
3.17.2008 7:39pm
Bad (mail) (www):
An "a" fell out of there somehow. I found it.
3.17.2008 7:40pm
Gaius Marius:

I don't really agree that it affects future generations any more than it affects us though. Future generations may face higher taxes, but they ALSO face getting the earnings (via inhereitance, etc.) from the money that WASN'T taxed away in the first place. That is, provided their parents didn't sink that money into Bear Sterns.


Bad, I hope you are right that future generations will be inheriting a lot of wealth from the baby boomer generation. However, the evidence is growing that the baby boomer generation will not be passing much wealth to subsequent generations because baby boomers are living longer than expected thanks to medical advances and spending down that wealth to pay for ever increasing medical expenses. The worst case scenario is going to be that subsequent generations do not inherit the baby boomer generation's collective wealth and yet are stuck with the tab for the $10 Trillion national debt (and growing) and pending tabs for Social Security and Medicare.
3.17.2008 7:49pm
Mr. Bingley (www):
Gaius, I apologize for not being clearer: they did not approve us for a loan of 2.5 times our income (in fact, based on some of the research we had done that was about the max we wanted and ended up with something a tad less than that) but they approved us for a loan 2.5 times what we thought we could afford.

In other words, if after reading all the various "financing for dummies" books we figured the max we could afford was $200,000 the mortgage company promptly approved us for $500,000.

And they seemed somewhat affronted when we said "no thanks" to the extra $300 grand.
3.17.2008 8:00pm
Robert Pratt (mail):
To Colin S:

"In the microfinancing sector, lenders have operated on the premise that people with limited financial means and no credit history or dependable income are able to pay back their loans. The entire sector is based on the idea that the very poor will pay back their debts.

Here in America, that has not seemed to be the case."

--------

First, giving someone a $200 loan when their yearly income is $50 doesn't seem like that much of a stretch.

Giving someone a $400,000 house when their income is only $35,000+ is criminal. The fine print (remember a lot of Americans can not read past 4th grade level, let alone legal documents) where increases in payments are not clearly indicated by the sellers who earn healthy commissions for each sale, makes it criminal.

Now, in simple terms, a 4:1 ratio of debt to income is easier to take than a 12:1 ratio.

But your understanding of micro-credit and the mortgage fiasco is abysmal. Micro-credit borrowers are not using the money to buy 3000 Sq.Ft. homes. They are using it to start businesses, and in many cases creating other jobs in the process.

Your understanding of micro-credit is abysmal. In fact, an entire bank, Grameen Bank, is founded on the principles of micro-credit. They report a 98.5% repayment rate.

Meanwhile.......a boy in New York in suspenders buys a mercedes with the money of people who are about to be kicked out of their house.
3.17.2008 8:33pm
Tony Tutins (mail):
the government tries to make prescription drugs a lot cheaper.

I read about the current Chinese heparin scandal in the paper today. Eighty percent of ingredients for drugs sold in America come from foreign sources. Forty percent of drugs in America are produced outside our country. The FDA does not inspect drug or ingredient producers in India or China. And yet the government does not want Americans to buy drugs in either Canada or Mexico, because the lack of an FDA blessing might mean they're unsafe.

Helloooo People -- the drugs Americans take aren't being inspected as it is. Let's at least be able to buy uninspected drugs cheaper.
3.17.2008 9:53pm
Harry Eagar (mail):
In 1975, Edward Herman explained all this before anybody had ever even heard of an internationally traded securitized mortgage bundle.

"Conflicts of Interest: Commercial Banks and Trust Companies," Twentieth-Century Fund.

I don't know where Mr. Herman is now, but I imagine he's shaking his head ruefully and saying, "I told you so."
3.17.2008 11:01pm
A. Zarkov (mail):
This article A Generalized Run on the Shadow Financial System by Roubini neatly sums up the situation. The Fed has now become the lender of last resort for the shadow financial system of non-bank "banks." This is a system that it does not regulate, so it can and does take on excessive risk. The ultimate in economic moral hazard.
3.18.2008 12:17am
Bruce H (mail):
I keep hearing that guy saying "Lost another loan to Di-Tech".
3.18.2008 12:20am
erp:
bad, I haven't seen the victims of the scam being blamed in any of the comments although they should have used better judgement. It's the "do-gooders" who are to blame. CRA's are a menace even in the small town where I live.

It's really quite simple. Adults are responsible for themselves and no we shouldn't bail anyone out when they face the consequences of their bad decisions, individuals or billion dollar banks.
3.18.2008 11:59am