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A cartoon primer on the subprime debacle:

Here. Informative and amusing.

Dan Weber (www):
I've read this three times now, and I still laugh at it.
3.18.2008 2:58pm
Alan P (mail):
My favorite is the Accountant
3.18.2008 3:02pm
Jim at FSU (mail):
That is awesome and sad at the same time.
3.18.2008 3:04pm
Allan (mail):
One would think there would be something about the lawyers. Guess the legal profession came out of this smelling like a rose.
3.18.2008 3:05pm
Houston Lawyer:
I don't believe that there have been allegations of lawyers structuring fraudulent transactions in connection with this debacle. If a client wants to enter into an unwise transaction, the lawyer's job is to tell him about the risks. After that he is on his own.

I see clients agree to things all the time that I don't like. No risk, no reward.
3.18.2008 3:28pm
Lou Wainwright (mail):
Wow, that was really useful. Thanks!
3.18.2008 3:49pm
CJS (mail):
Strikingly funny, because it's so true - who would have thought that basing the assumed mortgage default rate on the old default rates (back when banks actually held the mortgages and did due diligence on the borrowers), and then changing the banks' incentives, would be problematic? Particularly when combined with historically low interest rates, and property appraisers working for mortgage brokers?

"It's just unfathomable how this could have occurred."
3.18.2008 3:54pm
JB:
In public policy school, half the core curriculum was on game theory, incentives, and organization structures, in order to teach us (a) not to do stuff like this, and (b) why stuff like this happens anyway.

Good to see my education was useful for something.
3.18.2008 4:01pm
Jason F:
Great link.

On a related note, I'd love to see some blogging on the Bear Sterns situation, and in particular whether what the Fed did has implications under the Takings Clause. If the Fed basically ordered the Bear Sterns shareholders to sell to JP Morgan Chase at $2 a share, isn't that a taking?
3.18.2008 4:11pm
Dan Weber (www):
JPM is apparently taking a write-off, even acquiring BS at $2 a share.

Of course, JPM did this for a reason. One way or another they think this is in their best interest.

I'd say "follow the money" but I'm not sure just where that leads.
3.18.2008 4:27pm
ChrisIowa (mail):

If the Fed basically ordered the Bear Sterns shareholders to sell to JP Morgan Chase at $2 a share, isn't that a taking?


If the alternative was Bear Sterns' bankruptcy, the $2/share could be considered a gift.
3.18.2008 4:57pm
c.gray (mail):

If the Fed basically ordered the Bear Sterns shareholders to sell to JP Morgan Chase at $2 a share, isn't that a taking?


The Fed hasn't ordered the shareholders to sell. Its given them the option between getting $2 per share instead of nothing.

Bear Stearns was suffering a run, and lacked cash on hand to pay their creditors and depositors. What they DID have was an enormous pile of mortgage backed securities that nobody is currently willing to buy at a price anywhere near what BS (what an unfortunate acronym) needed to cover its liabilities.

In short, they had a severe liquidity problem. They were heading for Bankruptcy Court...within hours. And the shareholders of a financial services business are highly unlikely to get ANYTHING back after the trustees are through with it.

The Fed was worried that letting BS go into bankruptcy would spread the crisis to other somewhat less wobbly firms. So they offered to temporarily take BS's big stinky pile of mortgage backed securities as collateral for a 30 Billion dollar loan _IF_ somebody stepped in to buy BS and cover its obligations.

Apparently, JP Morgan is the only one willing to give the shareholders ANYTHING. $2 a share. Is the shareholders reject the deal, BS is almost certain to go into Bankruptcy court where they will get nothing.

My own suspicion is that the Fed is perfectly happy to see BS shareholders get sheared. It provides powerful incentives for financial industry firms to straighten out their balance sheets rather than doubling down on their bets and hoping for a fed bailout if things go even further south.
3.18.2008 4:58pm
Glenn W. Bowen (mail):

My favorite is the Accountant


that's what I referred to in my subject line when I emailed it around.
3.18.2008 5:02pm
c.gray (mail):

Of course, JPM did this for a reason. One way or another they think this is in their best interest.


How about Fed tells JPM: "If you do this we'll help your brokerage house clients &swap partners get through the now inevitable rough patch by letting them borrow directly from the Fed window for a few months."
3.18.2008 5:12pm
Dennis Nicholls (mail):
My joke is that Bear Stearns should now change the spelling to "Bare Sterns".
3.18.2008 5:37pm
Curt Fischer:
It is disturbing to me that the presentation remembers and displays the names of who viewed it, at least if you click on it while signed into a Google Account.
3.18.2008 5:44pm
darelf:
I still don't get it. Isn't every investment at risk of loss? Even, perhaps, total loss? I don't get why anyone wouldn't understand that buying a bundle of "subprime" loans would be a huge risk with a possible huge payout. It seems like common sense.

It's like betting on the underdog in a boxing match. If you lose, you shouldn't be crying about it.
3.18.2008 5:50pm
c.gray (mail):

I don't get why anyone wouldn't understand that buying a bundle of "subprime" loans would be a huge risk with a possible huge payout. It seems like common sense.


Many lenders (and bond purchasers) thought it was _impossible_ to lose more than a few months interest payment because, after all, the USA real estate market was never, ever, EVER, going to experience a sustained drop in prices.

A significant fraction of buyers of these securities knew the above was nonsense. But most of these people bought into another line of nonsense: that when a real estate market correction occurred, they could simply liquidate their holdings of mortgage-backed securities before they fell too far in price.

Problem is, when the correction happened in the real estate market, no one with any sense was willing to buy the securities, because nobody knew if they were worth anything at all, let alone how much. The "market" simply evaporated.
3.18.2008 6:30pm
wfjag:
I really miss David Halbersham. He wrote The Reckoning (c) 1980, and explained how the MBA mentality (be concerned only with next quarter's "profits", or at most year end "profits", and stock prices at those times -- since your bonuses and stock options depend on those) destroyed the US auto industry in general, and Ford, in particular. He wrote that he could have used either the steel or ship building industries just as well, but Americans love a car story. And so Robert S. McNamara clones -- who could tell you to the penny how much it would cost to move the gas tank for a Pinto, or F-150 PU, to avoid an explosion in event of an accident, but thought that a few crispy customers wasn't a problem -- took control and put the US auto industy in the tank.

If you've been watching the US auto industry's problems for the past few years, and want to fully understand them, just read his 1980 book -- he accurately predicted it over 25 years ago.

The same mentality then was applied to the US Defense Department when McNamara's number crunchers took over there. For the result, I suggest reading Strategy for Defeat: Vietnam in Retrospect (c) 1978, by Admiral U. S. Grant Sharp (who had a ring side seat).

Is there any wonder that BS and, likely, other brokerage houses, are in trouble? c.grey is correct:


Many lenders (and bond purchasers) thought it was _impossible_ to lose more than a few months interest payment because, after all, the USA real estate market was never, ever, EVER, going to experience a sustained drop in prices.


Of course, that that is exactly what happened to housing in the Oil Patch in the 1980s, which collapsed the real estate market there and caused the failure of multiple S &L's (and prosecution of quite a few attorneys, appraisers and S &L officers and directors), was a lesson largely forgotten. Inflated prices, even in real estate, eventually are subject to reality.

Too bad Halbersham is dead. He could have explained it in terms that even MBAs and politicians could understand.
3.18.2008 7:08pm
Cactus Jack:
Does anyone have any links handy to recent MBS/CDO default rates? I'm curious about the degree to which this liquidity drought is being driven by actual defaults on MBS/CDO instruments (i.e. are they presently defaulting at an increasing rate) as compared to expectations of default and concerns about bond insurer solvency.
3.18.2008 7:52pm
Christopher Cooke (mail):
David:

I saw that yesterday. My favorite slide too is the Office of the Accountant Czar's response to a request for accounting rules that promote greater transparency regarding these transactions: "Blow me."

I don't remember the Chief Accountant of the SEC saying that when I worked there, but you never know.
3.18.2008 10:01pm
Pennywit (mail):
Thanks for the link. This actually explained things rather well. I guess my only real question is this: did any of the mortgage-backed securities include, shall we say, more traditional mortgages in which the borrowers were more likely to make their payments, or did the lenders hold onto those mortgages for themselves?

--|PW|--
3.18.2008 10:03pm
Thales (mail) (www):
"Does anyone have any links handy to recent MBS/CDO default rates? I'm curious about the degree to which this liquidity drought is being driven by actual defaults on MBS/CDO instruments (i.e. are they presently defaulting at an increasing rate) as compared to expectations of default and concerns about bond insurer solvency."

It's a little more complicated than the latter explanation. In a lot of the securitization transactions there are mortgage pool delinquency and default performance triggers that cause the rating agencies to downgrade the related bonds. Once that happens, a lot of the insurance companies and pension funds (and maybe small Norwegian villages, as in the presentation) that are required to invest in only investment-grade paper must sell their holdings. Of course, since there was a small pool of buyers and no ready secondary market, it is difficult/impossible to actually value the paper. Worse, many banks and other institutions that use "mark to market" accounting are required to periodically adjust the book value of their assets to the market price. So even if, as you suppose, the actual and expected default rates are not in the catastrophe zone and the bond holders would get a healthy return if the bonds were held to maturity, the book value of some of the assets is zero because there is no secondary market for them. Also, on the insurers: insured deals are rated on the credit risk of the insurer, not the issued securities (in the case of asset-backed securities) or the issuer (in the case of regular corporate or sovereign debt). If the insurer goes under or if the rating methodology is thrown into serious question, the whole thing goes out the window.
3.18.2008 10:41pm
Hrm:

did any of the mortgage-backed securities include, shall we say, more traditional mortgages in which the borrowers were more likely to make their payments, or did the lenders hold onto those mortgages for themselves?


I can't speak for all banks, but in my area the banks definitely cherry-pick. When I bought a new house in 02, it was made clear to me that the bank would personally service my loan. They used it as a selling point in fact. About the same time, one of my wife's friends got a mortgage from the same group at the same bank, and they apparently sold her loan immediately to some company in Texas (who sold it to some other company a year later). I've heard similar stories from other people I know.

I suspect the way it works is that most of the local banks have a "commercial" group who does business loans and such. When the mortgage group finds someone who looks solid and they expect to make payments and not default, they probably use the commercial staff to service the loan locally since that staff is already doing similar work. And then instead of just making a quick commission for selling the loan to someone else, they make a rather nice taking over the life of the loan (and honestly, they continue their relationship with you which may lead to other good things for them in the future) :)
3.18.2008 11:14pm
Pennywit (mail):
All in all, it makes me want to do business with my friendly neighborhood credit union.

--|PW|--
3.19.2008 1:11am
Elliot123 (mail):
I suspect there is value in these sub prime mortgages. There may be no market because buyers and sellers cannot come to an agreeable price, hence there are no trades. But, someone will pay X for the mortgages. Someone else is willing to sell for Y. The spread is probably large, but X and Y still are real numbers. Does anyne have any info that would give any indication of what X and Y may be?
3.19.2008 1:14am
Bill Poser (mail) (www):

The spread is probably large, but X and Y still are real numbers.

I don't think I want to know what would happen if Wall Street types found out about imaginary numbers.
3.19.2008 3:15am
Mr. Bingley (www):
Hehehe, that's great. Thanks for that!
3.19.2008 9:05am
Curt Fischer:

I don't think I want to know what would happen if Wall Street types found out about imaginary numbers.


Where have you been for the last 200 years?
3.19.2008 9:41am
Mr. Bingley (www):
I don't think I want to know what would happen if Wall Street types found out about imaginary numbers.


You mean their balance sheets?

And the federal government's...
3.19.2008 9:44am
c.gray (mail):

Does anyone have any info that would give any indication of what X and Y may be?


Until someone with cash is convinced that 1) the housing market correction is over and 2) that _nobody_ responsible for administering the arcane, multilevel mortgage-backed securities has any financial skeletons in their closet, X appears to be very close to 0.

2) is probably going to prove a huge obstacle to unraveling this mess. Nobody is certain who owes who money and who owns what share of any given defaulters debt. They are also unsure if the organizations they buy insurance from to deal with this kind of uncertainty are going to survive the shakeout.
3.19.2008 12:29pm
zforce (mail):
I actually know the guy that made this. It was for a final project in a high-level course. Pretty hilarious and informative. Apparently some of the executive types in the class were upset that it wasn't "professional". He still got an A on it :)
3.20.2008 4:04pm