On 2/7/2011 11:31 AM, Doug Henwood wrote:
>> It was the hysterical forecast of price appreciation, not the "hiding" of risk
> Not exactly. Goldman and the rest packaged dud securities and sold them to clients at the same time they were shorting the crap. They even shorted Bear Stearns' stock after Bear bought one of those turkeys. Also, in a bubble, people often can't see what should be obvious - that the forecasts were insane. Something like a negative amortization loan with low introductory teaser rates - in which the first few years of payments don't even cover the interest bill, much less reduce premium, only to be followed by a sharp rise in the interest rate - is clearly lunatic, but supposedly sophisticated people shoveled cash into them anyway. There are none so blind...
It sounds like Goldman was making a contrarian bet on the correct house-price forecast, and taking advantage of Bear's non-contrarian (crazy) house-price forecast. It's true - the craziest loans, like the one you mention, were obviously heading for non-payment. But if you believed that by that time the house would have gained 20% additional equity from price appreciation, then it's not a disaster - the owner just refinances or moves. That's obviously pushing the envelope to the extreme, but most loans weren't so extreme.
This Brookings paper by Fed economists examines the data systematically:
> In this paper, we explore why market participants did not anticipate the
> major increase in foreclosures. We first argue that the loans
> themselves were
> not ex ante unreasonable. Loans made in 2005–2006 were not that different
> from loans made earlier, which, in turn had performed well, despite
> carrying a
> variety of serious risk factors....
>
> We then focus on what we think, and a wealth of other research shows, is
> the source of the crisis: the collapse in house price appreciation
> (HPA) that
> started in the spring of 2006. 1 Lenders must either have expected HPA to
> remain high (or at least not collapse) or have expected subprime
> defaults not
> to be particularly sensitive to a big drop in HPA. ...
>
> Thus, market participants could have failed in two ways: either they
> failed
> to estimate df/dp [the sensitivity of foreclosures to price declines]
> accurately
> (despite having the proper tools and data), or
> were far too sanguine about the trajectory of house prices, dp/dt. In
> the last
> section of the paper, we discuss what analysts of the mortgage market
> said in
> 2004, 2005 and 2006 about the loans that eventually got into trouble. Our
> conclusion is that investment analysts had a good sense of df/dp but
> basically
> got dp/dt wrong. As an illustrative example, consider a 2005 analyst
> report
> published be Lehman Brothers: it analyzed a representative deal
> composed of
> 2005 vintage loans and argued it would face 17 percent cumulative
> losses in a
> “meltdown” scenario where house prices fell five percent over the life
> of the deal.
> Their analysis is prescient: the ABX index currently implies that such
> a deal
> will actually face losses of 18.3 percent over its life. The problem
> was that the
> report only assigned a 5 percent probability to the meltdown scenario
> whereas
> it assigned 15 percent to a scenario of 11 percent HPA for the life of
> the deal.
>> an ongoing housing bubble "from below" to invest in.
> It could never have happened had the credit not been available.
>
> You're also underestimating the degree to which mortgage bankers hawked their products. It was an extremely aggressive sales effort, involving all the blandishments of American life - seduction, temptation, lies.
Absolutely. When I say the bubble was "from below," I just mean it first represented the percolation of an idea - huge HPA forever - in the minds of people, from home-buyers to Wall St. analysts, etc. Once it became clear you could make money off the hysteria, a whole industry grew up to do so - but that industry wasn't so much based on hiding risk as on the bedrock belief in price appreciation.
And you're right that the bubble could never have happened without credit availability. But I still see that as institutional, and I'm suspicious of the "weight of money" story.
SA