Villain 4: Disgraceful practices in subprime mortgage lending
Villain 5: Complexity Run Amok
modern finance graphic
Villain 6: The overrated Rating Agencies
Villain 7: Crazy Compensation Systems
A Fragile House of cards
if bank regulators had cracked down on the disgraceful subprime
lending practices 2000-2006 smaller bubble, less dangerous
Brooksley Born made more headway in 98 with Greenspan, Rubin,
Summers, Levit, OTC derivatives - regulated instead of free pas in 2000 but no one worried
Leadership od America's big commercial and invst banks - less
leverage, better risk mngmnt systems (smaller bubble, smaller damage)
wall street - system long on complexity and short on liquidity - if it
wasn't like that - panic might have been contained
4- When the music stopped
2006 - intricate financial house of cards, great complexity and fragility. constructed slowly and painstakingly. impressive sheer ingenuity. tumblesudden and chaotic (removal of one of its main supporting props). house P ended long ascent - after rest crumbling followed logically. . few were prepared. end of housing bubble - hardly a surprise. 2006- is there a bubble debate over, question when it will burst and how far hous e P will fall.
pessimist 20-30%; markets 6.4 % decline in the case-schiller ten city
composite idnez( too small) The Standard & Poor's CaseShiller Home Price Indices are repeat-sales house price indices for the United States. There are multiple CaseShiller home price indices: A national home price index, a 20-city composite index, a 10-city composite index, and twenty individual metro area indices. These indices are calcuated and kept monthly by Standard and Poor, with data points calculated for the time period of January 1987 through the present. The indices kept by Standard and Poor are normalized to have a value of 100 in January 2000. These Indices are based on original work by economists Karl Case and Robert Shiller, in which their team calculated the home price index back to 1890. That index is normalized to have 1890 have a value of 100. The Case-Shiller Index being kept on Robert Shillers website (http://www.econ.yale.edu/~shiller/data.htm) is updated quarterly. Due to the different set reference points, and perhaps calculation differences, the index numbers provided in each data set can be very different. For example, in 4th quarter 2013, the Standard and Poor 20 city index point was in the 160's, while the index point for 4th quarter on the Shiller data was in the 130's. Professor Robert Shiller claims in his book Irrational Exuberance that such a long series of home prices does not appear to have been published for any country.[1] Professor Shiller subsequently was one of three winners of the 2013 Nobel Memorial Prize in Economics, for his work on "empirical analysis of asset prices", which was predominantly used in macroeconomics (large-scale economics, of entities such as countries or corporations, as opposed to households or individuals). A home or other domicile, along with ownership of a car and affordable access to the purchase of educational and healthcare services, is an appreciable long-term asset. Homes (a whole and the parts) can have discrete assessed valuations, and can be bought, sold, and rent using legal contracts; other assets are bought and traded on other markets
The cards Tumble
bond bubble less visible, more complicated, appreciated by few - but
devastating effect. Bursting in stages
house P stop rising -> subprime mortgages started to default it Wasn't
too small corner to not damage overall economy
Treasury Secretary : Hank Paulson April '07 - subprime mortgage
problem largely contained
Fed Reserve Chairman Ben Bernanke may - no significant spillovers to
the rest of economy or to the financial system
huge amounts of leverage * dmage, financial executives : incentive to
continue as long as they could (regulators asleep- too far too long ride), reckoning delayed not avoided. house of cards tumble hard and fats
investment bank FIB convinces comm bank RBC that mortgage-related
securities reduced risk by pooling mortgages from diff geographical areas and selling around the globe
Truth : diversification didn't worked
national housing bubble (P go down everywhere), forgivable error no
gains from geographical diversification .MBS not diversified - Californie + sand states (arizona, nevada, florida)
no wide distribution amongst the holders! many leading financial
institutions still owned large concentrations of mortgage-related assets (toxic waste)- > much profit from selling other tranches of CDO's and MBS ( Bear Stern, Lehman Brothers, Merrill Lynch, Wachovia, Citigroup, Bank of America => excessive concentration of mortgage-related risks)
crack in the system July '07 dancing quot chuck prince; B- S to
investors that one mortgage-related fund no effective value left. music stops but wishful thinking
August 9' 07 bnp halt withdrawals on 3 subprime mortgage funds "
evaporation of liquidity in certain market segments of the US securitization market makes impossible to value assets fairl" cad no accs to money, bank don't know how much it is. suspension of specie payments * in XIXth century b4 bank run, Paribas refunsed to exchange fund shares for cash. signal to panic
interplay of falling asset values with high leverage -> solvency of
heavily exposed firms (B-S, Paribas). Market Price risk already acute gets worse -> visions of counterparts risk (default people owing money to you)
Doubts=>scramble for liquidity begins, worst case scenario markets
seize up, less severe case - flights to quality , us treasury bills. Bond bubble predicated ln blissfully ignoring risk ended on 9.08.2007
Counterparties- faith disappeared you see it i sharp rise in interbank
lending rates. LIBOR london interbank offered rate for ST lending of big boys=> risk premium of paying overnight loans reflected risk of default (30 basis points in 3 days).
Fear takds over
t the Fed's Annual Watering Hole
Late august FOMC fed open market comittee in jackson hole