The Big Short

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Sunday, December 27. 2015

I found the movie tedious. In addition, it ignored obvious factors which were crucial to the story:

For starters, everybody knew there was a US housing bubble and a mortgage bubble. Dr. Burry was not the only one, but the credit default swaps was a brilliant approach to shorting what was bound to fall sooner or later.

Everybody knew that a large number of mortgages were junk. You could read about it on the internets every day.

Everybody knew that, since Clinton, banks were required to expand mortgage availability to high credit risks. This was not voluntary.

Naturally, banks did not want to keep that junk on their books. They packaged them and sold them to sophisticated willing institutional buyers around the world, same as any other asset a bank did not wish to hold. Can't blame the bankers for doing that. It's their job to sell stuff. It's common sense.

One good thing was included: the slipperiness of the debt rating agencies.

In Honor Of "The Big Short", Here Is Michael Burry's Historic Commencement Speech - it's a dynamite speech

Everybody likes to find a scapegoat. Moral of the story, in my view: Bubbles happen, and always burst. Shorting bubbles makes sense. It just takes balls. Other morals: Abolish Freddie Mac And Fannie Mae - and the Fed. And the notion of "too big to fail."

Posted by Bird Dog in Hot News & Misc. Short Subjects at 08:34 | Comments (46) | Trackbacks (0)

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Margin Call, appearing a few years ago, was a brilliant slice-of-life film about the life and near death experience of a major NY financial firm. Recommended.

But to get to the root of the problem requires a lot of research perhaps aided by a few of the better documentaries.

#1 Ten on 2015-12-27 09:05 (Reply)

It's not a problem. It's just real life and distorted markets.

#1.1 Bird Dog on 2015-12-27 09:06 (Reply)

You couldn't be more wrong. It is a problem and it is both foreshadowed and preventable. Ostensible conservatives worship at it, is why it's not revealed.

Burry strongly alludes to it in the linked speech.

#1.1.1 Ten on 2015-12-27 09:19 (Reply)

Bubbles always happen, even in free markets.

#1.1.1.1 Bird Dog on 2015-12-27 09:41 (Reply)

Why bubbles happen is the thing. Look at the long term S&P, for example. Of the seven major events you see - of the seven major bubbles - can you point to the origins six of them share?

Be complete before taking a swing at the problem.

#1.1.1.1.1 Ten on 2015-12-27 11:30 (Reply)

I agree with you and Bird Dog. There is a 'problem', but it may not be what you think it is.

Bird Dog is correct - bubbles will always occur. They don't tend to keep expanding in free markets the way they do in rigged markets, though. When markets are rigged, the moral hazard is 'rewarded' until it can no longer be rewarded, but in being rewarded, the bubble keeps growing to disproportionate levels.

While you're also correct that there are methods to measure and manage these things (I've read Didier Sornette's work and it's here at a TED talk: https://www.ted.com/talks/didier_sornette_how_we_can_predict_the_next_financial_crisis?language=en

However, the idea that anyone has the political will to actually WANT to manage these things is another question altogether. In free markets, bubbles do not tend to get too large before they burst, some people get hurt, but the market readjusts rapidly. We have very few (if any) examples of this, however, because there is always a desire to want to 'play a role' in fixing things. Perhaps the closest we have is the depression of 1920-1921, though even that was manipulated, to an extent.

Still, Bird Dog's essential point is that eliminating incentives which distort markets and promote moral hazard is better than keeping these incentives and requesting a political agency or agencies from overseeing and managing these situations. Invariably, the agencies in question fall victim to the one thing hated by the people who fought for the agencies - corruption, which is then misconstrued to be a 'problem of capital' rather than a 'problem of politics and bureaucracy'.

Eliminating the Fed, eliminating "TBTF", and spinning off Fannie and Freddie as full-fledged private institutions (rather than the quasi-public institutions they are) and cut all ties to taxpayer support.

The fact of the matter is that bubbles will happen, because truly free markets rarely occur. Humans love to dip their fingers into anything they think they can control in some way (which is why I usually use the word 'manage' because you can't control anything except yourself). But even in trying to 'manage' markets, you really have very little control at all and very little influence when markets are as big as they are.

Which is why Hayek's speech on the "Pretence of Knowledge" is critical. http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1974/hayek-lecture.html

We can't assume to have impacts or control in situations where we lack information or scale, yet we do. It's a fool's errand.

#1.2 Bulldog on 2015-12-27 10:10 (Reply)

I grasp your explanation of our compadre's short original post (although he's edited it to be somewhat more expansive.) It's just less than concise as far as our broader reality and situation. I don't disagree with either of you except, ironically to BD's original point, for the incompleteness.

***

FWIW, I also question in a general sense how playing the market casino is referred to as investing or putting your money work. It's neither, of course. It's gambling, which means it's skimming losses in the rapid, short term as the result of a clever, effortful striving to do so. It was elevated to a science and an institution and a faintly honored endeavor only when the technical means and the social acceptance permitted it. Naming the resulting actions "bubbles" in the natural sense is a fallacy. I think that's denial.

It's investing when you front a productive enterprise to share in its eventual profits and even then I'd remain skeptical of the ethics. Meanwhile, it's morally beneath usury when it's not and it's beneath even contempt when it's systemic. It's a shame the ostensible right worship at that altar as though it were free market enterprise. It isn't and it has no more to to do with Hayek or Friedman than it does Keynes.

A broker can't insulate one from the ethics. Neither can a vague religious sensibility. Remember Jesus in the temple; He wasn't throwing out parishioners or old ladies with mites or even establishment priests. Camels and needles.

And we still haven't touched on the practical systemics...

#1.2.1 Ten on 2015-12-27 11:55 (Reply)

The stock market is not gambling in a true market. It is now because it is not a true market, but a rigged one.
That said, even a rigged market isn't pure gambling. Let's give some perspective:

1 - a pure market isn't gambling because you benefit from network effects. I suppose you could say it's a gamble if you choose your investment poorly (shorting a strong firm or investing in a dying industry), but if you do your homework, you reduce the potential for loss substantially. There can be more winners than losers in a pure market, whereas gambling implies fewer winners with more losers. (Think of it in these terms - if 2 firms move proportionately, but in different directions, and I invest $1000 in each, one doubles while the other halves, I still earn $500. It doesn't always work that way, but that's as good an example I can provide in short space. I can elaborate, if necessary, in a longer post.)

2. A rigged market isn't pure gambling. Some will win because they know how it's rigged, others will win by sheer luck, while many others will lose because they were designed to lose. In this situation, there can still be many more winners than losers, but it's not gambling if you know the right direction, or do your homework and have some insights. It can become gambling as the rigging reaches that point where the market can no longer reward the riggers (discussed in previous comment). At that point, there may be many more losers than winners as a bubble bursts.

3. Differentiating gambling from investing means you have to have substantial useful information to guide your choices, which you have in markets. Compare this to blackjack, where the cards have 'memory' - you can count the cards and improve your chances of winning. This is still not investing, but if you are good enough, it isn't gambling, either. Read "Bringing Down The House". Taking it a step further, poker is closer to gambling because the cards dealt can't tell you as much as they can in blackjack, but the information you collect from betting action can help inform you about what your competitors hold. I tell my friends who invest that poker is a natural game of "Alpha" - how to take the most out of the money that happens to be in the market at a given point in time. "Alpha", in market terms, isn't investing. "Alpha" is what short-term traders try to maximize (which is probably why so many play poker, and usually play quite well). Investing focuses more on "Beta", which is trying to determine the systemic risk involved in a market - or figuring out where more money may come from or why it may be taken out. Finally, you have pure chance - roulette, craps, etc. The ability to glean information and improve your chances is vastly less than blackjack or poker and you're playing almost pure odds. I consider those pure luck and the only pure luck gambling I do is craps, and I don't do it that often - only because it's rather exciting if you have a good table.

All in all, if I compare the money I've put into stocks, poker, blackjack, craps, horse racing or the lottery - I've basically listed them in order of success taking more money out than putting in. I've lost money in the market, but over time I've made much, much more than I've lost. I've lost money at poker, but I've made more than I've put up. I have counted cards and made money at blackjack (let me tell you - it is incredibly difficult to do this in Vegas, but I did it successfully over a 3 days visit and walked out with over $1,000 more than I went in with...but I am much better when I play single deck, though you can't make as much), but it's so hard, I usually don't bother. My two single biggest payouts gambling came at craps and horse racing. But I've put more in than I've gotten out, so I just do those for entertainment.

Investing is very different than gambling, though I can see how people can confuse them.

#1.2.1.1 Bulldog on 2015-12-27 13:32 (Reply)

That's a nice long rationalization but all you've done is address the function and outcomes, not the ethics. You're justifying taking profits from a morally depraved system. You cannot.

You're earning nothing; you're taking calculated risks, which is indistinguishable from playing the house and winning on average.

#1.2.1.1.1 Ten on 2015-12-27 15:25 (Reply)

All life is calculated risk. There is no sure thing unless you're doing the rigging - and that is partially why rigging a system is immoral.

On the other hand, anyone else playing in the rigged system, not knowing it is rigged (or how rigged it may be) is not engaging in ethically questionable behavior at all. Only those taking part in the 'guaranteed outcome' are ethically unsound.

That said, you said it's investing if you take part in a productive enterprise to take a share of the profit, and even then you question the ethics. Why would you question those ethics? What other enterprise should an owner enter into? Nowhere in the Bible does God outlaw earning a profit, nor does He specifically say that being wealthy is wrong. In fact, after testing Job, He then rewards Job for proving his faith.

In the New Testament, Jesus does say it's harder for a wealthy man to enter the kingdom of heaven, but does not explicitly rule it out simply because the person is wealthy, or even specify whether certain methods of earning wealth are questionable (though we can probably figure outright theft IS morally reprehensible). Exchange of a product, for cash, at a profit, implies a fair trade or the purchaser would not make the trade (unless some form of coercion takes place - which doesn't happen in the stock market. Nobody has ever put a gun to my head and say buy something.)

Citing the Austrian School does much to explain and justify the current system. Not in the sense that it justifies it being correct or 'good' - but that even if it isn't, those taking part in it are no more or less ethically corrupt than if they weren't taking part (since they have no choice BUT to take part). The problem, of course, is that you and I probably agree the market is rigged. You and I agree that a free market is better. You and I probably agree most bubbles have external factors which have promoted and driven them. But we don't have a choice EXCEPT to take part in that system. We can't exactly step out of the system. So knowing the hows and whys of such outliers does allow us to justify our behavior within them, and does justify our positions regarding them. Hayek may not approve of our 'market' any more than he would approve of any 'market' past or present. Few, if any, have been perfectly free. One has to take that into account.

But even in the most free, bubbles have happened. Tulipmania was possibly the best example of a free market which bubbled to extraordinary levels without external manipulation. The US saw many bubbles through the 1800s and not all were generated from external influence or operation. They were, generally, much smaller bubbles and bursting was not as debilitating, because freer markets absorb the losses more effectively. You can 'see' the most recent bubbles and point to their causes today because they have simply become much larger and more dangerous due to external influence. But in the past, there were bubbles in auto stocks as well as radio stocks. Those burst without much general impact, due to the nature of markets at the time.

I'm still trying to figure out where you've drawn the line on the ethics, though. It's not clear to me, from what you've written, why you consider investing in stocks to be gambling, even in today's market.

#1.2.1.1.1.1 Bulldog on 2015-12-27 17:53 (Reply)

All life is calculated risk.

Pragmatism to the point of irrelevance. I'm making a moral distinction. I'm already aware of the faulty rationalizations.

QUOTE:

There is no sure thing unless you're doing the rigging - and that is partially why rigging a system is immoral. On the other hand, anyone else playing in the rigged system, not knowing it is rigged (or how rigged it may be) is not engaging in ethically questionable behavior at all. Only those taking part in the 'guaranteed outcome' are ethically unsound.

(My emphasis.) The drug kingpin's wife argument? Wrong on its face. Remember, the law is frequently said to be an ass.

QUOTE:

That said, you said it's investing if you take part in a productive enterprise to take a share of the profit, and even then you question the ethics. Why would you question those ethics?

Because I question usury and all forms of harm and oppression. I'm not conflating them; I'm questioning them. Or try this: Is it earning to trade for profit, leaving nothing for your gains but comparable losses elsewhere? Isn't that just the old Smith Barney jingle? In a system you have to justify by, in effect, feigning ignorance how it works?

QUOTE:

What other enterprise should an owner enter into?

What other endeavors do you think are unimpeachably moral? Then, is money-changing moral?

QUOTE:

Nowhere in the Bible does God outlaw earning a profit, nor does He specifically say that being wealthy is wrong.

How about stealing a profit by manipulation or unfairness or opportunism or association, or..., or is that a bridge too far too? Even assuming you're theologically correct, what God "says" in ancient scripture and what Jesus said in fact are two different things. Further, God never spoke to either casinos or stock markets or monetary systems - didn't much have to for want of the specific context after having done the 10 Commandments thing - though Jesus spoke to His present time, didn't he, and the whole Christian structure spoke and speaks against gambling.

QUOTE:

In fact, after testing Job, He then rewards Job for proving his faith.

Come on. That God also threw down the human race for one sin and damned homosexuality and taught a people to initiate war. But do you think

QUOTE:

God

does? In other words, I don't buy simplistic biblical appeals, partly because I know it quite a bit better than most and partly because I think I can see a distinctly different trajectory to it than the usual conventions and partly because such appeals are almost always disingenuous leverage.

QUOTE:

In the New Testament, Jesus does say it's harder for a wealthy man to enter the kingdom of heaven, but does not explicitly rule it out simply because the person is wealthy, or even specify whether certain methods of earning wealth are questionable (though we can probably figure outright theft IS morally reprehensible). Exchange of a product, for cash, at a profit, implies a fair trade or the purchaser would not make the trade (unless some form of coercion takes place - which doesn't happen in the stock market. Nobody has ever put a gun to my head and say buy something.)

You thought I forgot Solomon? Abstract wealth is obviously beside the point in an argument predicated in part on the purported ethical correctness of trading for profit in an engineered system for no productivity and against against another person or institution by simple cleverness, opportunity, manipulation, or unethical behavior itself.

The onus is on the trader to prove the honest virtue of trading or, as seems common, to sleep well having built a rationalization calling on professed ignorance. I'm not here to reform thought but to challenge it and see how it holds up. Not well so far.

QUOTE:

Citing the Austrian School does much to explain and justify the current system.

Wrong. Co-opting it, however, historically serves to justify the odd "conservative" ethic that a wholly manipulated market represents some bizarre form of 'Mericun capitalism. Also not hardly, Bulldog. The Austrian School I know wants no part of any of it. Try the Mises Institute for one.

QUOTE:

Not in the sense that it justifies it being correct or 'good' - but that even if it isn't, those taking part in it are no more or less ethically corrupt than if they weren't taking part (since they have no choice BUT to take part).

(My emphasis.) And this is your take on a constitutional democracy? That this issue is unique among all other conservative issues up for vote? And in order to, ahem, rationalize virtue?

QUOTE:

The problem, of course, is that you and I probably agree the market is rigged. You and I agree that a free market is better. You and I probably agree most bubbles have external factors which have promoted and driven them. But we don't have a choice EXCEPT to take part in that system. We can't exactly step out of the system. So knowing the hows and whys of such outliers does allow us to justify our behavior within them, and does justify our positions regarding them. Hayek may not approve of our 'market' any more than he would approve of any 'market' past or present. Few, if any, have been perfectly free. One has to take that into account.

You don't have a choice but to trade equities?

I'll let your paragraph just stand there. It seems you've struck on the core of it, but took a subtle detour around complicity and back into profits.

QUOTE:

But even in the most free, bubbles have happened.

[Etc., etc., etc., excess snipped] All irrelevant, obviously. That bubbles occur is not the question.

QUOTE:

I'm still trying to figure out where you've drawn the line on the ethics, though. It's not clear to me, from what you've written, why you consider investing in stocks to be gambling, even in today's market.

Obviously, there are libraries on how and why. I wonder who has the will to seek them out.

#1.2.1.1.1.1.1 Ten on 2015-12-27 19:24 (Reply)

As for the morality of investing in the stock market, everyone is going to have a different point of view on this issue.

I'm not in agreement with your view. I believe we all take risk in life, including taking our own money, investing in a business and trying to be productive to earn a profit. More businesses fail than succeed, so isn't that gambling? I'd say it isn't, you've basically done the same thing that a stock investor did - you took your money, did some homework, and decided to try and make more by investing it in something you think will do well. The only difference is that in owning your business you put in some sweat equity. I hardly think that makes a difference in moral terms, though others may think so. Whatever floats your boat.

The reason Hayek IS important, and worth reading, is because he does make the moral case for letting markets work their magic rather than trying to rig them (and having them only benefit the chosen few).

#1.2.1.2 Bulldog on 2015-12-27 13:40 (Reply)

I didn't say Hayek wasn't important; quite the contrary. I'm saying that citing the Austrian school isn't even remotely a justification for the present system. They're quite the opposite. Even Keynes would reject it.

#1.2.1.2.1 Ten on 2015-12-27 15:27 (Reply)

For the sake of beating a dead horse, let me ask a question.

Let's say it's 1890. There are two investors and two companies to invest in. One is a blacksmith company, the largest in the nation. The other is an auto company, a new technology and slow to catch on.

One investor says "smithing will always be a big business, people always need farriers, and this is the biggest one in the U.S. I will invest in them, even though this other company is making a horseless carriage. My investment can help this company remain relevant and maybe even grow."

The other says "I like this auto thing. If they get some investment, they can bring down the cost and could undercut the cost of owning a horse, and people could even travel faster. It's a good long term investment."

Both are 'gambles', though both are working on information which, at the time, puts both firms on an unequal footing. As we know, one will eventually shrink and possibly fail, while the other will grow and thrive. Is it morally wrong to invest in the belief that you can help a company progress to give great gains to all people? Rather than 'gamble' - if you invested an equal amount in both, you'd still come out ahead over time. So I'm having a hard time making the connection between morality and investing...if you define investing as gambling.

#1.2.1.3 Bulldog on 2015-12-27 13:56 (Reply)

That's an obvious excluded middle.

This is not a question of viewpoints, of pragmatic outcomes in various places, or even of honest investment in functional going concerns, should you be able to isolate either. It's a question of taking profit in a system.

Upthread I asked BD if he could isolate bubbles in the long term S&P. It's a whole thing and you have it on you when you walk in the doors and start pulling the handles.

#1.2.1.3.1 Ten on 2015-12-27 15:38 (Reply)

That makes absolutely no sense at all. It's great broad generalization but says nothing of use, sorry.

You differentiate between 'honest investment' and all other kinds. But earlier you even question whether 'honest investment' is ethical at all. So I'm curious where you're drawing the line?

Is it 'honest investment' to simply labor and earn income from the investment of time and effort? If so, then you 'profit' from the exchange of your service to those you labor for.

Is it 'honest investment' to labor for someone who runs a enterprise that benefits from rigged markets (and since most have a level of rigging today, that's almost every enterprise)?

Is it 'honest investment' to put money into a company and try to run it profitably? What if it is profitable to benefit from the rigged market?

Is it 'honest investment' to buy stocks in a totally free market? Given few markets are totally free, is that still honest?

I'd say - regardless of which you choose - ALL are honest investment as long as you're not taking part in the creation of a system which does the rigging, but merely recognizing an opportunity and choosing to benefit from it.

As BD pointed out, almost everyone saw the market bubbling (if you didn't you were blind or in denial). The ONLY thing few people could tell then (or now) is when the bubble will end. IF I could figure that out, you can be darn sure I'll short it. Does that make me unethical?

Hopefully, I'll have a better understanding of where you're arguing from if you can explain the difference of 'honest investment' and all other kinds.

#1.2.1.3.1.1 Bulldog on 2015-12-27 18:04 (Reply)

QUOTE:

ALL are honest investment as long as you're not taking part in the creation of a system which does the rigging, but merely recognizing an opportunity and choosing to benefit from it.

Because God? Well then. Debate closed.

#1.2.1.3.1.1.1 Ten on 2015-12-27 19:29 (Reply)

"Oldtimers" on siliconinvestor remember his posting there from this time. Of course, he got rich and famous and the rest of us didn't. Shorting was risky and still is. I'll still stick with long term dividend growers.

#2 Bruce on 2015-12-27 09:23 (Reply)

IMHO this film is nothing more than a propaganda film to continue the rehabillitation of the Democrat party who created this problem. It was Clinton along with Dodd-Frank and other lesser known Democrat congress members who created the bubble with regulations and mandates. Most will see this movie and conclude it was 'banksters' and lenders who did this too us. That is the intent.

#3 GoneWithTheWind on 2015-12-27 10:03 (Reply)

BECAUSE PARTISAN!

How you could be so wrong and yet so emphatic is remarkable.

#3.1 Ten on 2015-12-27 12:55 (Reply)

GoneWithTheWind
You are spot on , it was the Democrat Community Reinvestment
Act that fueled the "liars loans' and the bubble.
http://www.businessinsider.com/the-cra-debate-a-users-guide-2009-6
https://en.wikipedia.org/wiki/Community_Reinvestment_Act

Started by Jimmy Carter and strengthened by Bill Clinton.

Now Hillary comes out and says no one is too big to jail.
Referring to the bankers....spin that around and it's her.

#3.2 Ron Spins (Link) on 2015-12-27 14:38 (Reply)

Thanks, ron. You saved me some time. It was a disaster from word "go" -- an extension of the War on Poverty that terrified both the S&Ls and bankers who knew what was down the road.

I could do a tome on this, but you hit the salient points: #1 you don't loan money to people who may not pay it back, #2 you check 'em out to make CERTAIN they will pay it back.

#3.2.1 jma on 2015-12-27 18:56 (Reply)

So, why did Clinton insist banks be required to offer mortgages to high credit risks?

#4 Scullman on 2015-12-27 10:13 (Reply)

Politics.

#4.1 Bird Dog on 2015-12-27 10:20 (Reply)

Why did the banks cooperate? My dad had to have 20% down and a good job to buy the house I grew up in.

Why the change? Who orchestrated it? Why the cooperation from the banks when they had everything to lose?

#5 Scullman on 2015-12-27 10:33 (Reply)

because most of it was driven in the name of diversity. Why certain populations in the US were not homeowners. The banks went along with it else they would be hit with terms like racist with the resultant consequences.

Unfortunately there is a reason the old rules existed that required your father to have 20% down and etc. So when the initial interest only (or ARMS) reset, mamy people who had been enticed to easy, out of reach homeownership found they were in serious trouble and lost their homes devestating families and whole communities.

Also, the banks used this lowering of standards across the board to talk buyers who could afford a reasonable home to apply to get a mansion and for those who owned homes to refinance and use their homes like a piggy bank. Thus this entire mess caught a large swath of Americans in one way or another.

#5.1 sunlight88 on 2015-12-27 11:29 (Reply)

Much of the change was built upon "correcting" the redlining of the Democratic administration of FDR and others. It was also a response against the break up of the Black community under the "War on Poverty" that eroded the ability of Blacks to work their way up as they had before the Civil Rights movement, although against policies that made it hard for them.

But ultimately, the change came from the wrong-headed sociology idea that homeownership, etc. were middle-class so the way to make middle-class was to promote homeownership instead of noting the governing traits of conscientiousness, saving, thrift, etc., enabled homeownership.

The banks went along with it as they are not free enterprises but highly regulated or one might say government-guided enterprises. For their subservience, they are permitted to make very good profits. In any case, they devised the credit default swaps to move the risk to sophisticated long-term investors as would be appropriate.

However, along came the marketing that cause many to believe their house was an wealth-producing asset rather than a consumable. This caused the bubble. This caused the realization of early profits in the credit default swaps. And for some reason, the banks forgot what credit default swaps did and started wanting to snag some of those early profits for themselves and thus started holding the long-term paper in their portfolios. When the bubble burst the increased debt defaulted and the churn that brought early profits at the expense of increased debt stopped. Crash.

All in all, the banks got in trouble because they believed their own marketing and started keeping their debt.

*The only way land not being worked, i.e., static non-rental housing, can produce wealth is if a more productive use of the land comes about through the building of a factory, the division into denser lots, retail, etc. Otherwise, the average house will only accrue at the inflation rate. There is of course the value of the use of the housing-maintenance. In the resident's old age, maintenance is usually deferred and more of the house's value is consumed through use by the income-restricted resident.

#5.2 JK Brown on 2015-12-27 12:15 (Reply)

Scullman--Under the Community Reinvestment Act ("CRA"), among other things, you could not get necessary federal approval to merge with other financial institutions, open any new branches or otherwise expand your operations until you were meeting the CRA requirements for imprudent home lending or were legally committed to do so. You would get blasted by phony "community activists" at the public oversight hearings on such approvals--these were basically phony minority interest groups trying to blackmail the banking institutions in return for not opposing the banks.

The feds made it even worse for national banks by essentially requiring them to meet CRA requirements in ALL states they operated in before they they could get approvals for a specific community, even in another state. So the banks were effectively in a stranglehold being applied by the federal government. The banks tried to cover their exposure by hiding the CRA crap loans in with others in derivative packages and credit default swaps and then marketing those. Over time, the amount of crap in those packages became more and more of the whole. A lot of the bad debt was also sold to government-backed scam entities like Fannie and Freddie, which basically bought the paper with little underwriting due diligence. This is how the bubble grew, as selling prices inflated due to the availability of easy money, and an increasing belief that since housing prices continued to go up, they were covered in the case of a default situation. (I could make an allusion here to today's stock market because of the federal government artificially restricting interest rates, but I will refrain.) It then also encouraged housing developers to build lots of unnecessary housing, which folks were snapping up primarily as investments rather than as shelter, banking on future "appreciation" and pulling "equity" out of the properties through yet more loans (homeowner equity lines of credit, or "HELOCs").

Bank of America is just one example. They had to commit to tens of billion of dollars in high-risk loans in order to get federal approval to open new branches. in the 2000s, Bank of America in my state was headquartered in my office building with its main branch on the first floor. We regularly used to get rent-a-mobs of paid "community activists" picketing the bank, claiming that the bank was "racist" and "discriminatory" by not making enough CRA loans in our state. Eventually, Bank of America pulled out of our state and shut down all its branches here, because it was not willing to make the high-risk loans required in our state to meet CRA certification, and its refusal to do so was hurting its ability to get approvals to expand in other states.

The problem worsened because this was a classic example of "Gresham's Law," where "bad money drives out the good." In this case, because of bad government policies, bad mortgages and bad underwriting standards drove out the good, because they could not compete with the growing amounts of "liar" loans and "drive-by appraisal" loans. So the whole lending industry over time was getting more and more poisoned by the CRA.

CRA was the triggering cause in the 2007-08 economic collapse, although there were a number of other factors. A major one is that in some of the major "bad loan" states, such as California, borrowers were not personally liable on the bad loans. There, because of its market strength, California requires lenders to make "non-recourse" home loans to consumers. That is, if there is a default on the mortgage, your recovery is limited to the value of the home and the borrowers are not personally liable for any shortfall ("anti-deficiency protections"). So that encouraged tens of thousands of people to simply walk away from their mortgages, abandon the property, and leave the lender with now virtually worthless real estate collateral.

In those states where borrowers were also personally liable on their mortgages, the default rates were much lower. First, borrowers recognized the danger of personal liability and tended to be more conservative in getting a loan and buying a home; second, because they knew they would be personally liable, they tended to continue to pay their mortgages even though their properties were "upside down." Those states got hit a lot less hard by the collapse.

#5.3 Jim on 2015-12-27 16:54 (Reply)

Outstanding summary, Jim. May I use it to explain to my younger family members that the goose is not yet cooked?

The banks are bigger and fewer. The junk loans are junkier. The credit card debt has reached new heights. China is broke and we won't even address Europe and South America. The venture capital markets are taking larger and larger sums over shorter time. The ratings agencies have NO idea what or how they are evaluating risk. Goldman Sachs peeps still have their fingers in every pie. In short, the best laid plans of mice and men can be imploded by lobbyist and campaign contributors designing regulations that have huge consequences -- and our congress critters simply comply. Shall I continue?

We need some people running this country who know how to read a balance sheet and less about manipulating the media and public's mind; i.e. fewer professional politicians.

#5.3.1 jma on 2015-12-27 19:13 (Reply)

Here's an article written in 2001 that foreshadows how the CRA would become a club to force financial institutions to make bad loans in order to continue to operate or expand:

http://www.svb.com/pdfs/cra/AdvocatesGuidetoCRA.pdf

(This article originally appeared in 27 N.Y.L. Sch. J. Hum. Rts. 129 (2001). It is reprinted with permission of the New
York Law School Journal of Human Rights.
Copyright New York Law School Journal of Human Rights (2001).)

ENFORCING THE COMMUNITY REINVESTMENT ACT: AN ADVOCATE'S GUIDE TO MAKING THE CRA WORK FOR COMMUNITIES

Excerpt:

"As part of their regulatory function, the federal banking agencies periodically send examiners to a bank to determine whether it is in compliance with the banking laws, including the CRA. At the end of the CRA examination, the agency issues a written report describing its findings and containing one of four ratings: outstanding record of meeting community credit needs; satisfactory record; needs to improve; and substantial non-compliance. In addition to these periodic examinations, the federal banking agencies also evaluate certain bank expansion applications to ensure that the bank is capable of expanding and qualified to do so. One of the issues the agencies consider when a bank applies to expand its business is the bank's CRA record. An agency may deny an application if a bank has a poor CRA record or condition approval on improved performance."

Another excerpt about how "community organizations" were used to extort financial institutions:

"Community groups are the most effective enforcers of the CRA. The federal banking agencies have been unwilling to enforce the CRA aggressively or hold banks to strict lending standards. In their place, community groups have taken up the slack. They have carefully scrutinized bank lending records, urged banks to adopt lending programs designed to meet the needs of LMI communities, assisted banks in marketing the lending programs, participated in banks' CRA exams, filed written challenges opposing bank mergers with the bank's regulatory agencies, and negotiated lending agreements with banks."

#5.3.2 Jim on 2015-12-28 20:11 (Reply)

What makes anyone think the bubble is over? It was only bailed out for a short time...and look at its cost in our current national debt. Does anyone think this can continue?

#6 indyjonesouthere on 2015-12-27 14:40 (Reply)

Blaming diversity mandates is simply not tenable. The housing bubble was fueled by the bubble in the shadow market for securities, which was not constrained by banking laws. Trillions poured into the housing market through mortgages because of the corruption of the ratings system, and the widespread belief that the U.S. real estate market would continue to grow.

#7 Zachriel on 2015-12-27 15:24 (Reply)

Zach you got it exactly right!! That is the exact left wing propaganda. It's almost as though you got the memo.

Bill Clinton and Frank & Dodd set this up with their legislation in the late 90's. During the Bush II presidency he sent his people to congress to try to stop pushing for zero down loans and no legitimate proof of ability to pay and he warned congress that it was causing a bubble. The congressional Democrats were vicious to Bush's people and played the predictable race card. So for their part the congress of the early 2000's were also complicit in this debacle. There were videos on Youtube of the Democrats yelling and demeaning the administrations people for daring to warn them they were making a mistake.

#7.1 GoneWithTheWind on 2015-12-27 16:03 (Reply)

Here are the links:
https://www.youtube.com/watch?v=cMnSp4qEXNM
https://www.youtube.com/watch?v=IyqYY72PeRM
https://www.youtube.com/watch?v=Lr1M1T2Y314
https://www.youtube.com/watch?v=x0k2PmF-o5Q
https://www.youtube.com/watch?v=iW5qKYfqALE

#7.1.1 GoneWithTheWind on 2015-12-27 16:17 (Reply)

GoneWithTheWind: Bill Clinton and Frank & Dodd set this up with their legislation in the late 90's.

The problem with that argument is that it doesn't explain why trillions poured into the shadow markets fueling the bubble. Government regulation can't force international investors to buy toxic securities. They did so willingly, enthusiastically.

#7.1.2 Zachriel on 2015-12-28 09:11 (Reply)

Zach your argument is specious. It is like blaming Christmas for children wanting to eat candy. The 'markets' or 'shadow markets' as you like to call them to infer something distasteful is in the business of buying debt/notes/investments. That's what they do just as a dog chews a bone. Fannie and Freddy were selling bundled mortgages by the trillions and they all had the federal imprimatur of the federal government; an implied as well as a explicit guarantee. Why wouldn't they invest in them?

The whole purpose of the propaganda was to make us all believe that it was the tail wagging the dog. That mortgage companies were accosting innocent 'poor' people in alleys and forcing them to buy homes they couldn't afford. It was a classic case of the magician (Democrats in congress) distracting attention from their sleight of hand to keep the rubes from knowing how the trick was done. No one likes the 'banksters' so it was an easy sell and the MSM embraced it and the rubes bought it. Now it is simply a matter of keeping anyone with common sense fromm exposing the whole story. Just like the warmies the left must shut down anyone who disagrees with the meme. There is after all a 97% consensus that indeed morygage brokers did force people to accept sub-prime mortgages.

#7.1.2.1 GoneWithTheWind on 2015-12-28 10:46 (Reply)

GoneWithTheWind: The 'markets' or 'shadow markets' as you like to call them to infer something distasteful is in the business of buying debt/notes/investments.

It's called the Shadow Market because it is largely outside the regulated banking system.

GoneWithTheWind: That's what they do just as a dog chews a bone.

They only buy investments that they think will result in profit.

GoneWithTheWind: Fannie and Freddy were selling bundled mortgages by the trillions and they all had the federal imprimatur of the federal government; an implied as well as a explicit guarantee. Why wouldn't they invest in them?

Private firms, not subject to the CRA, dominated the market boom of 2004-2006. Freddie and Fannie were late to the game. They were the Greater Fools.
http://s3.mediamattersaction.org.s3.amazonaws.com/static/images/krugfc2.png

#7.1.2.1.1 Zachriel on 2015-12-28 11:29 (Reply)

I may have to quit commenting here if you continue to prove my case for me.

I mean, seriously, you cite media matters as 'proof' that the Dems, Fannie & Freddie did nothing wrong. Duh! That is the meme, the propaganda I was talking about that you and the left wing MSM are pushing. Did you even bother to look at the videos where those Democrat congress members explicitly connected the dots for you. That says soooo much more than some after the fact smoke screen by media matters.
The admitted it!!! They passed the legislation to force banks to make sub-prime loans and they created and commanded Fannie and Freddie to funnel the money into the system and to sell off the debt instruments to the world market with promise that it was all 'insured' by the full faith and credit of the American taxpayers. It's all right there!! They did it. They were proud they did it. They were really really pissed that some administration economist dare testify before congress and the American people that if we continued down this road and created a bubble it would eventually burst and harm the American people. THEY DID IT! They admitted that they did it. It was only after the bubble burst that they scrambled to find someone to blame, some 'shadow market'. Why do you think Dodd and Frank both left congress??? They didn't want to run on their record and they would be an a embarrassment to other Democrats who needed to distance themselves from this disaster and blame it all on Bush.

#7.1.2.1.1.1 GoneWithTheWind on 2015-12-28 17:53 (Reply)

GoneWithTheWind: I mean, seriously, you cite media matters as 'proof' that the Dems, Fannie & Freddie did nothing wrong.

Are you disputing the data because of the source? Or are you simply waving your hands?
http://econlog.econlib.org/Jones/FannieFreddieRit.JPG

#7.1.2.1.1.1.1 Zachriel on 2015-12-28 18:19 (Reply)

GoneWithTheWind: I mean, seriously, you cite media matters as 'proof' that the Dems, Fannie & Freddie did nothing wrong.

Fannie and Freddie were the Bigger Fools.

#7.1.2.1.1.1.2 Zachriel on 2015-12-28 18:21 (Reply)

The initial source of the crash was the mandate to sell houses to people with no verifiable ability to pay. The securitization of those mortgages was as much defensive as opportunistic. The bank, Fannie, or Freddie had to figure a way not to get left holding the bag.

You're right that there was a prevailing assumption that housing values in general would only go up which was obviously both wrong and a warning sign (when everybody believes that something will forever go only one way, it is likely to go the other soon). Another problem is that those CDSs, nor were their derivatives, traded on an exchange so there was little transparency.

#7.2 mudbug on 2015-12-27 16:28 (Reply)

QUOTE:

The initial source of the crash was the mandate to sell houses to people with no verifiable ability to pay.

No it wasn't, anymore than than lug nuts make the wheels go around. Correlation, as they say, is simply not causation.

Gang of Z's is actually far closer to the mark than either of you. If you and Windy would only see the bigger picture...

#7.2.1 Ten on 2015-12-27 16:42 (Reply)

Sorry. If the underlying mortgages that those securities were built on were solvent, there would be no need for the complex CDSs and related derivatives needed to sell and hedge them. They would not have had massive defaults and the downturn would have been less sever and contained.

As I said, the fact that too many worthless CDSs were being created, bought and sold was only part of the problem, but it was the central one.

#7.2.1.1 mudbug on 2015-12-27 17:12 (Reply)

mudbug: The bank, Fannie, or Freddie had to figure a way not to get left holding the bag.

Fannie and Freddie were late to the party. They were the ones left holding the bag.

#7.2.2 Zachriel on 2015-12-28 09:12 (Reply)

What is sobering is that the Crash of 2007-08 and the subsequent Depression from 2008 on (now heading into the eighth year) were ENTIRELY the result of bad government policies. The destruction they have done to our country is incalculable, and will cripple any future our grandchildren will have.

#8 Jim on 2015-12-27 15:38 (Reply)

What I would hope this post would do is encourage people to be more discriminating in personal and political decisions while encouraging an investment in our country that carries few risks if one sticks to a longer picture. You can't sit with your money in your mattress and presume you'll be able to afford the necessities in ten to twenty years.

All my grandparents and series of great-grands found it a privilege to invest in the expertise of others as such was not easily available in their native lands. They taught me early on ab out due diligence, diversification beyond our family businesses, and paying attention to why companies succeeded.

Real estate should first provide a home for your family, no matter how large or filled with toys. Renting is always an option if you move regularly or are more knowledgeable about other areas for investing. K.I.S.S.

#9 jma on 2015-12-27 19:46 (Reply)

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Sunday, December 27. 2015

The Big Short