That's all very well. But what does Norman Rogers think?

Greenspan caused much more than a little of this.

2004

It seems to me that Greenspan got us into this mess; but, does not wish to be recognized as the culprit. Of course, Georgie Porgie and the Republicans played a big role, too.

A year ago we all thought this election would be about Iraq (Obama's issue) and health care (Clinton's issue). Now we find out it's going to be the economy.

All I can say is that the Bush administration has f**ked the country every which way imaginable. Hasn't his behavior actually been treason?

Kevin, you commie pinko socialist! The only reason there is a market issue at all is that people have failed to understand that the only way to BEAT terrorism is to go shopping. No less a personage than George W. Bush OUR PRESIDENT pointed this out. You have only yourselves (well and the Liberal Mainstream Media) to blame for failing to follow through on your part of the bargain.
(To wit, you get American Idol, Cheetos, and Football, and you spend yourself into debt until We tell you to stop.)
Also, no gay sex. That scares the market.

Greenspan's bland pronouncements, made with the air of a disinterested bystander, remind me of a local arsonist who used to torch empty buildings, then stand around remarking with mild surprise about the size and heat of the fire.

I would try to separate normal boom and bust activity like the dot com era from fraud driven events like the current crisis or the S&L debacle.

The dot com certainly featured some fraud but overall I think it was our way of dealing with a new opportunity. A large number of competitors rushed in and a small number survived.

There is nothing new about mortgages. What was new was how they separated the risk from the person making the loan. When the local bank made and held the loan it was in their interest to only make reasonable loans. Bundling and reselling loans was OK as long as there was transparency. I still don't quite get how they managed to strip the risk from these bundles of loans. These are supposed to be hard nosed bankers. Was this magical thinking or were they lied to?

" . . . the fact that traumatic events have become more common in the global economy over the past couple of decades, which is certainly true."

Really? TBS, the heyday of the Bretton Woods system saw less currency instability, because currencies were pegged to each other and to gold. But recent times have also seen what economists call the Great Moderation, in which fluctuations in the world economy have dramatically lessened in intensity. One hypothesis for why this is so is, simply, good luck--and that string of good luck may now be at an end. Stay tuned.

"In other words, all those risk management systems created by the rocket scientists weren't designed to take into account the possibility that there was any actual risk in the system."

But there isn't any risk in the system for the financial institutions. If they really screw up, they get bailed out with somebody else's money. We are the ones with the risk. The only possible risk they face is when a investment doesn't go bad enough to warrant a bailout. And their systems can already deal with minor market fluctuations like that. From their perspective, they have all of this figured out perfectly. When the market goes up, they profit, when it goes down, we bail them out. They always win under the current system. What's wrong here is that we let them get away with it.

Mazurka: It seems to me that Greenspan got us into this mess

It only seems that way because it's true. There is no one person more responsible for this debacle than Greenspan. And it was plenty predictable - it's just that the economists who predicted it didn't get much press.

What next - Charles Ponzi telling us that pyramid schemes are unsustainable?

reining in the wild west of global finance a bit might be a useful thing to do

Just as with Enron, we have a crucial weak link in accounting and transparency. As in frame 29 from the Subprime Primer when the Czar of Accounting responds, "Blow me."

If no one can tell what's going on, no one can assess risk, or worth.

I would be interested in reading about proposals which improve disclosure, particularly if they empower shareholders rather than government agents.

"all those risk management systems created by the rocket scientists" - Kevin

Hey, don't blame us rocket scientists.

Big Shitpile is the best reason to vote for John McCain for President. If he's elected, it'll become almost immediately clear that the problem wasn't just Bush, it's Republicanism as a whole. And in November 2010, there'd be a Democratic midterm sweep that would make 2006 look trivial by comparison.

It seems that a lot of the conventional wisdom has been wrong for a long time.

If I had a nickel for every paragraph that started with this: "Economists were surprised today ..."

I would be rich! Rich I tells ya!

Economists seem to be in a perpetual state of shock these days. I am going to stop listening to them and return to astrology, goat entrails, and heavy drinking.

Given the $30 billion in financing advanced by the feds in this Bear-Stearns deal, the GOP handwringing and other furor over the Mexican Bailout during the Clinton years seems rather quaint.

Today is one of those days when the majestic market principles so championed by Alan Greenspan can be distilled to:

"Privatize profits, socialize losses."

The neoliberal scheme is sold with the fine rhetoric of liberty only to be revealed at moments like this as the cover for unrepentant looting.

The pattern that reveals itself is not a program for free markets. The no bid contracts, the government bailouts, the crony capitalism, the externalization of risk points to nothing more than theft.

I still don't quite get how they managed to strip the risk from these bundles of loans.

John Bird and John Fortune do a good job of explaining the basic bamboozle.

The question is why sophisticated parties like the insurers, the bond raters, and the large institutional investors failed to properly assess risk underlying securities such as the "Bear Stearns High Grade Structured Credit Enhanced Leverage Fund".

low-tech cyclist,

Why wait tell 2010? By November the economy will probably be pretty damn bad. I have listened to McCain and the Republicans on the economy. They have nothing more than a wish and a prayer in their tool box. Elect Democrats right now.

low-tech cyclist wrote: "And in November 2010, there'd be a Democratic midterm sweep that would make 2006 look trivial by comparison."

Yeah, that's something to look forward to, considering how the 2006 Democratic midterm sweep put the Democrats in the majority in both houses of Congress and then they ended the Iraq war, brought war profiteering contractors to justice, rolled back the Bush tax cuts for the ultra-rich, reinstated Constitutional civil liberties, imposed essential regulatory oversight of the financial sector, limited corporate ownership of the media and reinstated the Fairness Doctrine, and put in place a national strategy for developing clean renewable energy and mitigating global warming, and all.

then come prepared when discussing the maestro and how he refused to listed to warnings:

December 18, 2007
Fed Shrugged as Subprime Crisis Spread
By EDMUND L. ANDREWS
WASHINGTON — Until the boom in subprime mortgages turned into a national nightmare this summer, the few people who tried to warn federal banking officials might as well have been talking to themselves.

Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.

But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman.

In 2001, a senior Treasury official, Sheila C. Bair, tried to persuade subprime lenders to adopt a code of “best practices” and to let outside monitors verify their compliance. None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms. Bair recalled recently, soon let them slip.

And leaders of a housing advocacy group in California, meeting with Mr. Greenspan in 2004, warned that deception was increasing and unscrupulous practices were spreading.

John C. Gamboa and Robert L. Gnaizda of the Greenlining Institute implored Mr. Greenspan to use his bully pulpit and press for a voluntary code of conduct.

“He never gave us a good reason, but he didn’t want to do it,” Mr. Gnaizda said last week. “He just wasn’t interested.”

http://www.nytimes.com/2007/12/18/business/18subprime.html?scp=1&sq=greenspan%2C+warned%2C+subprime%2C+2005&st=nyt

fostert: But there isn't any risk in the system for the financial institutions

You don't work for Bear Stearns, I take it? The Fed rescued the investors in the CMBS, not the investment bank that underwrote them.

TJM, Don't worry the bankers running Bear Stearns will figure out how to get money out of the system to pay for satisfactory golden parachutes. If they don't I am sure they will be laughed out of the country club.

"In other words, all those risk management systems created by the rocket scientists weren't designed to take into account the possibility that there was any actual risk in the system."

Actually, I find this quite inaccurate. The current environment merely illustrates that risk management by diversification cannot protect against all risks (especially of the systemic variety). About all the evidence shows is the risk management strategies employed recently were not as well designed as possible, not designed for the types of events that were realized, or that the resulting risks were understated/undercalculated. Whether this was out of greed or just stupidity, I'm inclined to think greed.

Creamy Hussein asks: "The question is why sophisticated parties like the insurers, the bond raters, and the large institutional investors failed to properly assess risk underlying securities such as the "Bear Stearns High Grade Structured Credit Enhanced Leverage Fund".

Because they were all in bed with each other in a huge circle jerk of unregulated conflicts of interest designed to enrich themselves immensely at the expense of ordinary investors and the general public -- that's why.

In the midst of these our economic travails, where is the indomitable rdw to crow about the strength of the economy, the low unemployment and the genius of George W. Bush?

Where is tbrosz to point out some arcane indicator that doesn't make a rat's ass difference in all this mess that was slightly lower under Carter - and then when refuted by having his claim put into some kind of actual context fall back on the old (and false) claim that Democrats couldn't have done any better?

As a friend pointed out to me recently, the Great Wingnut Reversal is begun.

"In other words, all those risk management systems created by the rocket scientists weren't designed to take into account the possibility that there was any actual risk in the system."

The reduction of risk by pooling in the MBS seems to have been predicated on the assumption that defaults would be independent of each other. I'm sure that can't be true, because it should be obvious that defaults come in waves, but it does looks like that assumption was given more credence than warranted.

In other words, all those risk management systems created by the rocket scientists weren't designed to take into account the possibility that there was any actual risk in the system.

No.

There was risk, and those systems were designed for it. In fact, that's how they made more money than they would have done. (Really, it's silly to say that everything went up all the time; there were fluctuations just as there have always been, even if the broad trend was upward.)

The problem, as Krugman and others have observed, was correlation of risks. Thus, for example, the risk reduction of MBS's works if you consider only independent individual financial risks but not if you consider the common risk of a general decline in housing prices. The same effect is now at work in the broader market, as common financial risks (e.g., reduced credit, "systemic margin calls") affect previously much more independent classes of assets.

Blame is great; I'm all for it going to the appropriate places, but what's next is more important. I agree with Krugman, who says the Bear Stearns bailout is just the beginning: But the big bailout is coming. The only question is how well it will be managed.

After that, if we're going to socialize the risk for financial markets, we need to socialize the playing field and bring real oversight and regulation to financial markets. No more assurances that markets and really smart people will take care of everything. Many of those people are very smart, but have the judgment of a dog in heat; many of the rest are just hucksters in really nice suits.

Those of us who are old enough have seen this crap over and over, but it's getting worse, as we've surrendered any interest in establishing and enforcing rules in the financial marketplace. It can be done if enough of us demand it.

Cazart's First Law of Economics:
People are fuckin' greedy.

A little-known tidbit about the regulation of these risky investments:

"As a result of pooling assets and issuing MBS [mortgage-backed securities], the SPV [special purpose vehicles] structures described above arguably fit under the broad definition of “investment company” as defined in the Investment Company Act of 1940 and, hence, would be subject to the extensive requirements of the Act. These requirements are widely viewed, including by SEC staff" [wonder how much that cost the lobbyists]", as being inconsistent with the normal operations of SPVs and, hence, virtually all SPVs have been structured so as to enjoy an exemption from the Act. The primary exemption relied upon is Rule 3a-7 of the Investment Company Act, which provides an exemption from the Act if an SPV issues fixed-income securities that, at the time of sale, receive one of the four highest categories of investment quality from a “nationally recognized rating agency” (typically S&P, Moody’s or Fitch). Pursuit of this exemption is one reason why it is important for an SPV and the securities it issues, to be structured so that they receive the necessary investment ratings." (from a paper by Jennifer Bethel on legal risk of these securities).

In other words, get an AAA rating slapped on one of these things and you are automatically exempt from regulatory oversight.
And the rating agencies were giving away AAA ratings in exchange for -- more business.
Any wonder things got out of hand?

Because they were all in bed with each other in a huge circle jerk of unregulated conflicts of interest

Brokers who actually arranged for the mortgages at a low level had a conflict because they got their fees so long as the deal went through, regardless of whether the loans made sense.

The insurers and the institutional investors, though, have lost huge amounts of money because they either purchased or guaranteed the value of resold debt that turned out to be overvalued. No conflict, just poor decisions based on poor analysis.

I'm interested in explanations from the people like Roubini, who predicted all this, not from people like Greenspan who said we shouldn't worry.

Feh. Is there anything that reckless GOP over-confidence hasn't ruined?

jrw: After that, if we're going to socialize the risk for financial markets, we need to socialize the playing field and bring real oversight and regulation to financial markets.

In other words, re-learn the lessons of the Great Depression. [insert obligatory quote from George Santayana]

trex: the Great Wingnut Reversal is begun.

No, I'm afraid they're more like cicadas. They'll just go underground, spawn a new generation, and wait until enough time has passed so that they can spout their ahistorical garbage without everyone laughing at them. Remember the wingnuts creed: ideology trumps reality.

Late 2001, I was glad to find that the boring old mutual fund company I've got IRA in didn't invest in Enron. One of the managers said they don't invest in companies whose business and structure they don't understand.

I hope they "didn't understand" these markets.

No, its much larger than just securitised mortgages it also derivatives [500 trillion market] that make it onto bank balance sheets.

http://www.allianzinvestors.com/commentary/mgr_billGross01012008.jsp

immy Stewart—they hardly knew ye! According to the Bank for International Settlements (BIS), CDS totaling $43 trillion were outstanding at year end 2007, more than half the size of the entire asset base of the global banking system. Total derivatives amount to over $500 trillion, many of them finding their way onto the balance sheets of SIVs, CDOs and other conduits of their ilk comprising the Frankensteinian levered body of shadow banks.

BTW Why does Jerf hate Larry Craig and Jeff Gannon?

Sigh. This is just so predictable and so stupid. It is not even very complicated.

The root of this is fraud and even the Sainted "Adam Smith" knew about the dangers of fraud. Regulations are there for a reason, An unregulated market is not stable nor sustainable. A taxed and regulated market is both stable and sustainable.

To be stable and sustainable a market must be constrained by an outside force which prevents fraud and which recycles some money from the "winners" back to the "losers."

The basics are not much more complicated than a steam engine. Sheesh.

"Government regulation" is another term for "the rule of law".

Republicans as well as Democrats who are bought-and-paid-for tools of America's Ultra-Rich Ruling Class, Inc. are opposed to "government regulation" of business.

That means that they want business to be exempt from the rule of law.

We see the results.

If voodoo economics sounds too good to be true, it probably is.

Chutzpah! Greenspan created the housing bubble and his Ayn Rand proto-fascist ideology help create the free market mania that did away with all regulations of out -of-contol-capitalism and now he's crying in his beer? Don't blame Al, he says. Blame Al, I say , and his corporate free market zanies.

A modern fable.

One day a bright young banker decide to spray-paint some turds with gold paint. They were real purty and he called 'em tnuggets. Good as real gold the banker said. In fact he got a buddy of his to declare that these were genuine triple-A tnuggets.

The sun shone and everyone admired how the tnuggets glittered in the sunbeams.

The tnuggets sold so well they made more and more of 'em.. they finally made so many that the bankers even had to go look for more turds to guild... and they brought them in by the truckload.

How the mountains of gold tnuggets glittered and gleamed... they piled up so high that snow gathered on the peaks. Everyone was happy with their mountains of gold.

Then one day... it started raining.

Glass-Steagall was abolished during Clinton's presidency.

"It's not going to end until house prices stop falling, which probably won't be until 2010 or so." Ever the optimist. How about 2015? Any other guesses anyone?

What I want to know is how we can fix this all with more tax cuts? *joking*

Seriously, though, I think Krugman and others are going a little hard when they blame Greenspan for a lot of stuff. Did he turn tail like a coward and become a Bush sycophant? Sure, that sounds like a reasonable interpretation of some of his pre-retirement behavior to me, based on Krugman's retelling of it.

But I think what happened with this guy wasn't so much that there wasn't anything redeeming about him to begin with, but that when Bush came to power, Greenspan was smart and well-informed enough to realize- even before a lot of the rest of us- that the real nutsy Nazis and Evangelicals had come to power, and he was just taking evasive action to keep his ass out of hot, boiling water. Greenspan probably thought things were going to be worse even then they have been, and can we blame him for being intimidated? Look at how nutsy and irresponsible the Bushies have proved themselves to be. I 100% believe they would cut off their noses to spite their faces, and then do it again and again-- that's how crazy they are. Rule by the Roves is rule by the criminals-- they have to stopped, but it's a little involved to start stopping them.

Kevin Drum >"...reining in the wild west of global finance a bit might be a useful thing to do...."

If those finance cowboys had to eat their own horse`s poop things would be different.

shortstop >"Greenspan's bland...heat of the fire."

The most excellent analogy about this stuff I have ever seen. Thanks !

“Revolutions, before they happen, appear to be impossible and after they occur they appeared to have been inevitable.” - Alexis de Tocqueville

optical weenie: Hey, don't blame us rocket scientists.

But it's you rocket scientists that led us to believe that sometimes, at least, what comes up doesn't come down. At least not so damned quickly!

Who could've foreseen that Newtonian Physics might not apply to financial markets the same way it does to hunks of metal?

I hope the slow-learners who have been worshipping the God Ronnie and supporting Bush and other nutzos for the past 30 years finally figure out that conservative policies beggar America. Vote progressive in 2008.

But it is painful! For how many years have we railed against these obviously bankrupt (no pun intended) policies, but here at the end, like everyone else, we're stuck on the sinking ship, and those drunken pirates still claim that it wasn't their fault the ship ran aground.

Thersites,
The problem is that the Monte Carlo models they use to define risk have a difficult time accomodating for both positive and negative feedback correlation.
Kinda like solving Schrodinger's equation,exactly, for a system with oh, say 115 electroncs.
Actually the real problem is that you have a bunch of mathy nerds who have coded a series of program that in principal calculate/estimate risk, but in practice don't work well under ideal circumstances. To get over this it might be worth it for the finance companies to go back and actually hire real people who have at least some ideas how to read the economic entrails.
But naw, 25 year old programmers work for beans and most likely live off the North American continent.

But it's you rocket scientists that led us to believe that sometimes, at least, what comes up doesn't come down. At least not so damned quickly! - Thersites.

So Thersites, into your boner pills again today?

What is equally stunning is that the financial meltdown is just a speed bump on the front page over at RedState. The people who preach the loudest about personal responsibility and welfare, not a peep out of them about bailouts for bankers. No one over there can possibly admit, even for a nanosecond, that the fraud went from borrower, to Realtor, to appraiser, to broker, to bank, to packager, to Congress, to rater, to insurer and to the Fed. The levels of fraud are so epic that you just cannot point one finger at any one perpetrator, they all played their part.

optical weenie: it might be worth it for the finance companies to go back and actually hire real people who have at least some ideas

Just like it might be worth it to have people that have actually served in the military making military decisions?

Later for that. We make our own reality.

Drum:

In other words, all those risk management systems created by the rocket scientists weren't designed to take into account the possibility that there was any actual risk in the system.

? ?

Too many writers seem to be looking forward to the next great depression in order to be able to "told you so" to all the Republicans. I'm with you that the Repubs screwed things up, but anyone who cares about the common person should want a quick and painless recession. We should all hope an activist US government and Federal Reserve can prevent a depression, even if some bad guys get rich in the process.

The reality is one of the biggest problems we are currently facing is fear. I'm not sticking my head in the sand, but much of what I am hearing in media and blogs borders on ridiculous. For instance, I hear the talk about how many people will be walking away from their homes because the house is worth less than they own. The media presents it as a logical choice and doesn't raise all the negative financial, legal, and personal repercussions that happen when you "walk away." Try finding a new place to rent in the same school district and come up with the down-payment and moving expenses. Yes there will be some people who will walk away and definitely people who won't be able to pay their mortgages but these are still a limited number not the majority.

In regards to the housing bubble, a lot of the country didn't have a housing bubble. Yes California, Florida, Vegas, Arizona, etc had bubbles. Other places may have gone up in price but were not bubbles. Again the media has distorted the issue by focusing on Naples Florida instead of Peoria Illinois.

"The next big argument, I assume, is going to be between people like Greenspan, who essentially say there's nothing we can do about this, and others who think that reining in the wild west of global finance a bit might be a useful thing to do. Count me in the latter camp."

What! You're advocating Government Intervention? Heresy! Treason! Oh, foul utterer of ungrateful recrimination! *Swoons, fans self with Bear-Stearns prospectus*

"...who essentially say there's nothing we can do about this, and others who think that reining in the wild west of global finance a bit might be a useful thing to do. Count me in the latter camp."

You'll take your Austerity measures and you'll like it, mister!

"Privatize profits, socialize losses."

That's the kleptocrats first law.

Other laws include:

"Taxes are for little people." (i.e. we'll tax income from actual work at a higher rate than income from investments)

"Private property is only for BIG people" (i.e. developer campaign contributions trump individual home ownership when it comes to defining "public benefit" in eminent domain cases)

"Caveat emptor is the only regulation needed to protect consumers in our magical "free" market"

"corporations must be protected from the disastrous effects of insolvency, individuals must be allowed to learn from their mistakes"

"performance bonuses need not be tied to actual performance for officers of the company -- only for mid-level managers and workers"

I'm sure you can come up with more...

Yeah, the hard times are a coming.

When the US banks fall, instead of merely savings and loan, which were bank enought already, than let it be know that all Repugs are mostly certainly retarded as most of knew already. Yes, listen to Rush radio talks does indeed mean you're stupid. There is NOTHING good about unbid contracts and favors that make Bush/Cheney's good buds in Big Oil and Big Pharma the only beneficiary in a deregulate world, (to remove laws that made the buisness world fair).

Having a president and VP as completely corrupt as Bush and Cheney have been, is the most fatalistic BS EVER.

Brojo: "Glass-Steagall was abolished during Clinton's presidency."

That kind of distorts history big time:
http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html

Swan: I think Krugman and others are going a little hard when they blame Greenspan for a lot of stuff.

No, Greenspan deserves everything that's thrown at him. As one former Fed Chairman described it, the job includes taking away the punch bowl just as the party gets started. Sycophants need not apply, which is the whole reason for the structure of the Fed (to make it reasonably independent of short term politics).

Not to say that BushCo didn't help - they not only refused to enforce existing mortgage and banking regulations, but dredged the law books for arcana to stop the states from regulating it (so much for federalism).

Plenty of blame to go around, but nobody deserves it more than mumbles.

"than let it be know that all Repugs are mostly certainly retarded as most of knew already"

fuckin 'ey. the most intelligent commenting seen on this blog in ages.

Clinton, Republicans agree to deregulation of US financial system (November 1999). An agreement between the Clinton administration and congressional Republicans, reached during all-night negotiations which concluded in the early hours of October 22, sets the stage for passage of the most sweeping banking deregulation bill in American history, lifting virtually all restraints on the operation of the giant monopolies which dominate the financial system.

Greenspan is a sad, pathetic old man who still craves the limelight, and was prone to hyperbole the entire time he was Fed chairman.

Yes, we are in a recession and it won't probably hit bottom for a year or so. However, his statement is grandiose. We were in much worse financial shape in the late 1970s and early 1980s than we are now - youngsters weren't there or won't remember, and Greenspan might not either.

Mustn't take our eyes off the ball. Our two biggest national problems are still the war in Iraq and oil. These are head and shoulders above the sub-prime problem.

To get over this it might be worth it for the finance companies to go back and actually hire real people who have at least some ideas how to read the economic entrails.

The models concocted for the MBS market took historical default rates, both in terms of payment risk as well as LGD (loss given default), for "sub-prime" borrowers in other industries. There is extensive history on such borrowers for cars and credit cards and that paper has been packaged and sold for decades.
This was a product created to meet the demand for higher yields. The IBs were happy to create a piece of paper to meet this demand and the investors were happy to buy.

JohnK:
These are supposed to be hard nosed bankers. Was this magical thinking or were they lied to?

It was greed.. greed blinds even the smartest, hard-nosed people.. the only one who escaped unscathed was Goldman Sachs.

Hey! I've got some paper here, let's print some money. That'll help, right?

The models concocted for the MBS market took historical default rates, both in terms of payment risk as well as LGD (loss given default), for "sub-prime" borrowers in other industries. There is extensive history on such borrowers for cars and credit cards and that paper has been packaged and sold for decades. There is extensive history on such borrowers for cars and credit cards and that paper has been packaged and sold for decades.Posted by: TJM

However, the hiccup in your sumation is "took historical default rate . . . for borrowers in . . . other industries." One of the best real world examples of apples to oranges I've ever seen.

Overwhelmingly, the underlying securitized loans heretofore in real estate had much higher qualifying thresholds. Qualifying to buy a couch at a rent-to-own store or crappy used car hardly has the inherent "downside" for a default as does a $400K house "purchased" for 0% down with an adjustable rate interest only loan. If the financial "experts" were really using this as a model (which they weren't) they were stupid beyond belief.

The fact of the matter is that everyone involved from the sleazy mortgage brokers to the banks to the security rating services all threw normal financial caution to the wind and completely discounted the possibility that the real estate market would either table at or even decline from it's bubble heights. Anyone who tries to explain it otherwise, particularly by comparing real estate lending to credit card or used auto lending, is willfully ignoring or does not understand how people qualify for mortgages and how different are the comparative risk between consumer and RE lending.

Far too many of the borrowers who have or are in danger of defaulting on these adjustable rate sub-prime loans wouldn't even qualify for a 30-year fixed at today's reasonably low rates.

The next big argument, I assume, is going to be between people like Greenspan, who essentially say there's nothing we can do about this, and others who think that reining in the wild west of global finance a bit might be a useful thing to do.

Free-market ideologues don't argue that there's nothing we can do, they argue that there's nothing we should do. They argue that a big crash every twenty years or so is actually a good thing, and that the constant fear of losing your shirt is the only effective form of economic regulation.

Ah, Kevin.

I can see your usual answer to economic problems is throw more big government spending at the problem. When did that ever help?

So long as there is sufficient confidence that everything is working well and everybody will make profits the models work and everything continues.

But, when something interrupts that well-oiled machine then suddenly there is no confidence and the game of musical chairs finds some people with no chair.

Then the government run by Bush steps in and hands over hard-earned tax dollars to help out his friends (who return part of it in campaign contributions).

It goes back to the question of how many times earnings a stock share should be worth. When there's confidence teh sky is the limit. When there's no confidence even the physical assets seem worthless.

One wonders how long it will take before rich old ladies who lost a few bucks at the roulette wheel in Vegas will start lobbying Bush for a bailout. After all, nobody could have expected their wild-assed bets to go belly-up, could they.

While your comments section is a nice reminder of why Leftist economic illiterates, sorry I believe you now prefer to be called 'progressives' or some such nonsense, should be kept away from economic policy, a word on two of your observations.

First, as some of the more informed commentators have noted, "In other words, all those risk management systems created by the rocket scientists weren't designed to take into account the possibility that there was any actual risk in the system." is absolutely wrong.

Rather, the modelling systematically was wrong on the assumed frequency of "rare" events (as an aside, I do find the poorly disguised nativist xenophobia in comments about modellers from outside the US of A amusing; inaccurate as the Quants as they are called are well paid and in NY largely. But given an excuse Left nativism rears its own ugly head). You would be well served to read Nasim Taleb's recent two works on this very question. Might help you understand where the errors in risk management came from - in part.

Second:
In any case, Greenspan alludes to the fact that traumatic events have become more common in the global economy over the past couple of decades, which is certainly true.

Eh? More common? Traumatic events seem about as common as any time. The only difference financial interconnexion has probably amplified single big country crises to wider global effect.

Unfortunately, panicked populist reaction is likely to produce solutions that make the situation worse, not better. A la mark to market rules.

Right Lounsbury, the "conservatives" or "whack-jobs" as they are correctly called, have done a smashing job of showing why they should be allowed to run the economy. Which perfectly explains why BS sold for less than the physical cost of their building.

Your condescension is duly noted as the character flaw it is, your inability to recognize that the only socialism going on is that of subsidizing the losses while privatizing the rewards is also noted as the idiocy it is.

Low-Tech Cyclist is right in a sense, and Secular Animist is right in a sense with his snark.

If Clinton or Obama is elected, and Greenspan and others are right that we haven't seen bottom yet, she or he could well be a one-term president.

Piling on the Snark-o-Meter, maybe it would be good to elect Schmuck Talk Express™. He does, after all, have Keating Five experience in these types of things.

"The Fed rescued the investors in the CMBS..."

Yeah, too bad the Bush Administration wasn't similarly expeditious in rescuing fellow Americans from their rooftops in New Orleans.

hancock

Rather, the modelling systematically was wrong on the assumed frequency of "rare" events . . .

"Rare events"? Horse shit. Nothing surprising or "rare" about people who didn't qualify for conventional loans at already low rates defaulting on loans that had interest adjustments that would make a loan shark blush, unless the so-called financial experts were so dumb as to expect RE values to continue rising at 10% or more nationwide for the next decade to cover this at a time when incomes for about 90% of the workforce had been stagnant for over five years.

. . .I do find the poorly disguised nativist xenophobia in comments about modellers from outside the US of A amusing;. . . Posted by: The Lounsbury

None of this has fuck-all to do with your redundant non-sequitur about "nativist xenophobia" (I guess that would be as opposed to foreign xenophobia?). Rather, it has everything to do with Greenspan being a callous piece of shit and the current administration completely unconcerned with how to help manage the economy for the good of the nation instead of tilting its rewards to the upper 5% income bracket.

The Lounsbury: Rather, the modelling systematically was wrong on the assumed frequency of "rare" events

Bottom line: it was wrong.

If it seems too good to be true, then it probably is.

BTW, I earn a living largely using mathematical models (albeit it of a different sort) so I know the score: choose any conclusion you want and with the right assumptions you can come to it. A scam accompanied by mathematical masturbation is still a scam.

Unfortunately, panicked populist reaction is likely to produce solutions that make the situation worse, not better.

Bernanke engineered a sweetheart buyout of BS by JPM, with the Fed lending the money and taking a lot of risk.

Under the circumstances, it was not the worst thing he could have done (Greenspan would probably still be mumbling).

The "populists" here, including myself, wonder if receivership wouldn't have been a better option. When a business fails and the investors loose their money, it's part of a system called "capitalism". If Joe's Pizza goes belly up, nobody is going to engineer a rescue. BS? Oh, they're a lot bigger, so we better have some socialism for the "capitalists".

BTW, since the Fed is playing with my money, where's my cut if the BS buyout turns a buck? I know I'll be footing the bill if it does badly.

P.S. How is Her Majesty, Queen Victoria? Is she still dead? How's the empire these days? Enjoying the sunsets?

Its hard to tell from the outside but it seems to me that the risk models just didn't take into account correlations between apparently unconnected risks. If, in fact, corporate paper default rates for example are (perhaps only psychologically) correlated with sub-prime mortgage default rates than diversifying assests does not really reduce the overall risks factors. Duh!
Many years ago ago an MIT professor did a study of nuclear plant reliability and came to a similar conclusion. Just like a fire can destroy unconnected redundant nuclear plant safety systems a financial crisis can destroy valuations in uncorrelated investments. Both the MIT engineers of the 50s and the current Harvard MBAs fell into the same trap.

BFR: Many years ago ago an MIT professor did a study of nuclear plant reliability and came to a similar conclusion.

Hidden lack of redundancy crops up in safety critical systems all the time, and it can be hard to find.

True example: 3 engine airliner left Miami. Within a fairly short time all 3 engines died. Fortunately they just made it back (the plane turned back after the 1st engine failure).

With modern jets the odds were enormous. What happened? The same mechanic changed the oil on all 3 engines and neglected to put seals on the drain plugs.

Seriously, though, I think Krugman and others are going a little hard when they blame Greenspan for a lot of stuff. Did he turn tail like a coward and become a Bush sycophant? Posted by: Swan

As a matter of fact, yes. You don't remember his idiotic shilling for the Bush tax cuts by "testifying" before congress that government surpluses hurt the economy? Given the enormous stupidity of that remark, I'm surprised he didn't either deflate and collapse in his chair or spontaneously combust.

If Joe's Pizza goes belly up, nobody is going to engineer a rescue.

Hell no.

And if the property occupied by Joe's Pizza could be put to better use as a big box store, sports arena, or luxury condo development, then he's entitled to go fuck himself while the state in collusion with the old boy network takes his pathetic little enterprise away from him in exchange for "fair market value," as defined by the folks doing the taking.

Great fucking system.

...threw normal financial caution to the wind and completely discounted the possibility that the real estate market would either table at or even decline from it's bubble height..

I would simply note that a description of the model used by the IBs, as an answer to another comment about bringing in people to examine the economic entrails, is not an endorsement of same. The fact remains, however, that residential real estate values last declined in 1991/92. Models include expectations of default using historical data.
The IBs saw a demand and met it, made a lot of money and were wrong. As they were about LBOs, commercial real estate in the early 90s, the dotcoms, etc. etc. One sizeable differ

Oops, bad palm, Anyhoo..a sizable difference today from 2000 to 2002 is the small investor (to the extent there are any, lost their money in the NASDAQ then, their house now.
$5-6 trillion was lost in the dotcoms, looks like the same magnitude now?

TJM: $5-6 trillion was lost in the dotcoms, looks like the same magnitude now?

That $5-6T was mostly a loss in market cap, and hence only in theoretically realizable capital gains. Assuming you're not leveraged out the wazoo then having your $500/share split-three-times-already wonder stock go to zip only looses you your original investment - you owe nothing. You may cry on the way home, but you probably still have a home to go to.

By contrast this is a banking crisis. The whole idea of banks (and banks-in-all-but-name) is to have money that's liquid and safe. Yes, a certain default rate is factored in, but it's not supposed to be like the stock market roller coaster.

Economies about which we speak are naturally unstable, a fact which can be proved and will soon bee generally accepted by economists.

So, when large funds seek stability, it is impossible, and like all linear system functions with excess energy, the energy finds its way out in high frequency variations. When hedge funds blocks unstable movements of medium term, they cause the energy to be released on shorter cycles.

So, being potential Nobel laurites, we can modify Alan's statement. Negative correlations don;t just fail in uniform falling prices, they actually cause uniform falling prices.

Alternatively, when the assets are revalued, we will see an upshoot just as dangerous, except Kevin will be hailing the rapid overshoot as a wonder of regulation.

re: "Over the past half-century, the American economy was in contraction only one-seventh of the time."

That works out only if you start the count in a new long-term expansion - a new secular bull market, through the subsequent contraction, and then to the end of the next secular bull market like the one that just ended. But doing this skews the result because it omits the contraction that preceded that first expansion.

Economic contractions tend to last at least half as long as the expansions, and amount to at least a third of the total time.

For fans of Fibonacci ratios, the contraction phases tend to last somewhere around the key Fib. of 38.2% of the total cycle, which also happens to be another key Fib. of 61.8% as long as the expansion phases.

Here are the approximate dates of these long-term economic cycles:

1904-1929 Expansion
1929-1942 Contraction
1942-1968 Expansion
1969-1982 Contraction
1982-2007 Expansion
2008-2020+ Contraction
(Notes: the first economic expansion listed above as starting in 1904 could by some measures have started earlier, perhaps as early as 1898. The 1932 stock market low was a panic-induced outlier; it's clear that the next expansion phase began no earlier than 1942 (due to a huge ramp up in military production). The economic expansion that peaked in the late 1960s could have ended as early as 1966 - the inflation-adjusted stock market peak, or by other measures as late as about 1969. A quick look at an inflation-adjusted chart makes it clear that the subsequent contraction did not end until August 1982.
ref.: http://homepage.mac.com/ttsmyf/

In summary: long-term economic expansions last about 25 years. Long-term economic contractions last about 13 to 15 years. The total cycle length is about 40 years.

Although there are socio-economic similarities between subsequent cycles, the alternate cycles (80 years apart) tend to be even more similar. 80 years is long enough that almost all of the participants in the earlier cycle are dead, taking with them the wisdom of their anecdotal observations. This tends to cause participants in the current cycle to repeat many of the same mistakes made 80 years earlier (even though they may think they're avoiding them, it winds up being like the movie Groundhog Day).

As economic conditions improve in the beginning of a new 25-year expansion phase, the incumbent president wins re-election and his party then wins one more term ( e.g.: Taft; Truman; Bush 41). Things get jumbled up a bit during the more politically chaotic economic contraction phases.

Here's a little trivia: Bill Clinton's counterpart from 80 years earlier was Woodrow Wilson. Both Clinton and Wilson won elections that featured strong third-party challenges from former Republicans. Clinton and Wilson won two terms without ever winning a majority of the popular vote. In fact, Clinton and Wilson won re-election with the exact same 49.2% of the popular vote.

There is also one very big difference compared to the cycle from 80 years ago: in 1928, the stock market had not yet topped when Coolidge's Commerce Secretary Herbert Hoover was elected president. But the economic cycle is a little farther along this time, and former Senate Commerce Committee Chairman John McCain has a much tougher task ahead of him to win the presidency. Of course McCain will play to fears over national security that were not an issue in the 1928 elections.

Was this magical thinking or were they lied to?
Posted by: JohnK on March 17, 2008 at 3:40 PM | PERMALINK

George's Daddy called it "Voodoo Economics".

I can't tell you how TICKLED I am that he is still alive to see the outcome, some 28 years later, of what he and his chums have wrought.

The question is why sophisticated parties like the insurers, the bond raters, and the large institutional investors failed to properly assess risk underlying securities such as the "Bear Stearns High Grade Structured Credit Enhanced Leverage Fund".
Posted by: Creamy Hussein Goodness on March 17, 2008 at 4:05 PM | PERMALINK

No.

The real question is why VOTERS failed to properly assess risk underlying electing USED CAR SALESMEN to run our economy.

The bankers knew what the hell they were doing. They're getting their bailout.

You and I are paying for it.

AGAIN.

The reduction of risk by pooling in the MBS seems to have been predicated on the assumption that defaults would be independent of each other. I'm sure that can't be true, because it should be obvious that defaults come in waves, but it does looks like that assumption was given more credence than warranted.
Posted by: luci on March 17, 2008 at 4:19 PM | PERMALINK

Rate and mortgage resets came in waves.
Mass-layoffs of workers came in waves.

So, of course the loan defaults would come in waves.

One can make all the mastrubatory mathematical models one wants to try to assess risk and predict outcome.

But if they're based on false premises, (ie. if house values are always rising, then workers salaries don't need to go up in order for our computation of wealth to go up. Or: energy and food are volatile, so we'll just ignore those when we compute inflation. . . ) - then the models will yield misleading results. What feels like sex, is actually just the firm grip of your accountant's right-hand.

"It's not going to end until house prices stop falling, which probably won't be until 2010 or so." Ever the optimist. How about 2015? Any other guesses anyone?
Posted by: wab on March 17, 2008 at 5:23 PM | PERMALINK

. . . see my guess, below. . .

What I want to know is how we can fix this all with more tax cuts? *joking*Posted by: Swan on March 17, 2008 at 5:32 PM | PERMALINK

Yes! more tax cuts.

Housing values will drop a little more; but measured in Dollars, will be meaningless, right? Because the dollar will be fucking worthless. Hence the rate-cuts. They're doing this on purpose.

What they are doing - and what they can't SAY they are doing, is they are accepting the REALITY that we are not in a housing bubble. We are in a US CURRENCY BUBBLE! And have been for decades. Driven by cheap oil, and cheap credit. They are deflating the value of the US Dollar. This has slowed the plummet of our house prices (relative to the dollar), and the rise in commodities has reflected this, and consumers aren't going to get hit by this right away, there's lag in the system. We're only now starting to hear about gas prices, wheat prices, etc. In the next couple of years, we're all going to take a huge shot in our standard of living. Tough crap guys. They're also solving the illegal immigration problem too! No Mexican will want to come here once Bush is done with America.

When you think about it; this has been their effort since NIXON, they've been trying to suck the wealth out of the middle class in America. Too much wealth, too much socialist-political power. Too many people to share national park campgrounds with. Too many people waiting in emergency rooms. Too many people who have too much free time on their hands, enough to vote, and write letters (or hell, enough free time to go to school! put those lazy slackers to work in the fields, dammit!)

If you have $100,000 in the bank, a massive currency deflation will kill you.

If you have $100,000,000 in the bank, you're still rich.

While your comments section is a nice reminder of why Leftist. . . .
Posted by: The Lounsbury on March 17, 2008 at 8:59 PM | PERMALINK

Jeez, more Clownsbury?

Still waiting for the bombing to stop in Iraq, so you can get on with your steel-selling deal, I see? You've been waiting since what, 2003, for Iraq to magically turn into a Free Market paradise? (Hint: It already IS! get in there and sell baby!)

You must not be praying to the Invisible Hand hard enough. Clap your hands and shout: "I do! I do! I do believe in Capitalism!" - and maybe the jihadis will go home and let you sell your scrap in peace, eh?

Or maybe you can continue to BE A PARASITE AND SUCK THE LIFE BLOOD OUT OF OUR ECONOMY BY FUNDING WHAT IS ESSENTIALLY A PRIVATE SECURITY FORCE FOR YOUR LITTLE BUSINESS VENTURE.

Yeah, I'd really have no problem with that if you Free Market Fundamentalists would just pay for the frickin war out of your own pockets, and leave the rest of us who didn't want the war OUT of it.

BFR: Many years ago ago an MIT professor did a study of nuclear plant reliability and came to a similar conclusion.
Hidden lack of redundancy crops up in safety critical systems all the time, and it can be hard to find.
True example: 3 engine airliner left Miami. Within a fairly short time all 3 engines died. Fortunately they just made it back (the plane turned back after the 1st engine failure).
With modern jets the odds were enormous. What happened? The same mechanic changed the oil on all 3 engines and neglected to put seals on the drain plugs.
Posted by: alex on March 17, 2008 at 11:01 PM | PERMALINK

Ah - they engineered redundancy into the plane, but forgot to engineer it into the maintenance plan. (or, more likely, the maintenance plan was changed while the corrupt Bush-appointed FAA inspector looked the other way).

Well, although personal:
Jeez, more Clownsbury?

Odd how often that childish deformation comes up.

Still waiting for the bombing to stop in Iraq, so you can get on with your steel-selling deal, I see? You've been waiting since what, 2003, for Iraq to magically turn into a Free Market paradise? (Hint: It already IS! get in there and sell baby!)

Mate, the Steel deal died long ago. Waiting, I moved on mate. And while I am unmoved by your bleating as such, it is worth noting that I was in my blog writing against simplistic liberalisation in Iraq right from 03, without the hysterics or lies of say a Naomi Klein, I would add.

Smear away, but get your smears right idiot boy.

alex, I take your point although the high prices from which NASDAQ stocks fell were real purchases of stock. Turnover in the NASDAQ was killer so to think that all holders of stock that split etc, etc and then dropped lost only paper is not at all the case. People, funds, IRAs didn't lose paper, they lost money.