Thursday, October 30, 2008
I wanted to let all of the readers of this space know that I have things in the works for election night.
Yes, I may be delving into the realm of live, real-time blogging.
It all depends on the computer hook-up wherever I am watching the election results.
If we go live, great. If not, I will let you know. I may set up a separate blog and link to it for election night purposes.
As you all know, however, I have expressed my opinions about voting and elections before. Why all the fuss on election night?
Think of the combination: I will be all boozed up, full of opinions and ichor and I will have an electronic mouthpiece.
Frankly, I don't see how you could miss it.
Friday, October 24, 2008
(NOTE: I realize that this series is going on a bit long. Well, what can I say? The situation is complex. Given all of the bluster and spewing of the twenty-four hour news cycle, though, I think I am doing pretty fair, no? If no, let me know and I will change directions)
When we last left our story, there were loads of people clamoring for cheap credit in the form of residential mortgages. As with any resource, when it is cheap, people use more of it and the demand skyrockets. No problem...just supply the credit to the people who want it, all while making sure that they are a good risk and that you will get your money back, right?
Well, that's not exactly how it happened. Remember the stringent process for issuing home loans described last time? That didn't exactly hold up too well. Because all of the people who were qualified to get mortgages already had them, mortgage companies had to look for new customers. They found these new customers, all right, but to do so, they had to change the general profile of who they considered "mortgage-worthy."
This definition went from "person with good credit, assets and a job" to "pretty much fucking anybody." Why? The lenders, for their part, had to deal in volume because the margin of profits on their loans were so low in the interest rate regime that was in place between 2001 and 2007 (more on this later, in the blame section).
The borrowers, on the other hand, were motivated either by the potential for profit on their investment or the desire (NOT right...this will be important later) to own a home. This desire, it seems, outpaced the realistic expectation that these people would ever be able to pay the debt back. Already, I'm sure, you can see where problems might arise.
So, where are we? We have lots of unworthy people with loads of debt lent to them by people who were eager to lend to anybody who could reasonably operate a pen to sign the promissory note. How, you ask, did this situation lead to a financial crisis with global implications?
Well, the mortgage companies were not the only ones looking for a way to make a profit in a bad environment. The investment banks were out there as well, so to speak. They, too, had been hit by the bursting of the tech bubble in 2000-2001 and were searching around for somewhere to put the money they had (for themselves and their clients). They decided that residential mortgages were the way to go.
Now, this was not the first time that investment banks dabbled in mortgages. Far from it. Investment banks and their fixed-income (read=not stocks or commodities) trading departments had dabbled in mortgage debt since at least the 1970's. This is where mortgage-backed securities (MBS) come into the picture.
MBS are basically an investment vehicle that are composed of many individual mortages bundled together and traded as one unit. Like other forms of debt securities (bonds, mostly), they bore a period of maturity and an interest rate. When an MBS is sold, the buyer becomes the holder of the mortgage or, in other words, the receiver of the payments from the borrower. MBS's are attractive because they allow investment banks and financial institutions access to another credit market.
This form of debt, like all forms today, are rated by the major rating agencies (Standard and Poor's, Moody's and Fitch). These agencies assess the structure and composition of assets and issue ratings that tell anyone interested how "good" a particular debt is. Here, "good" is defined as "likely to be paid back with interest."
Sounds fine, right? The investment banks, paying attention to the rating agencies, would not take on bad debts and the rating agencies would not recommend unsound investments to their clients (that being the investing public as a whole).
Well, there was a problem. A big problem. The MBS that were being sold were more complex than anyone was willing to admit. Put simply, there were wolves among the sheep. Not all of the MBS were composed of the same classes of debt. They were, in large part, composed of some good debt, some moderate-risk debt and a lot of bad debt.
The problem came when the rating agencies rated these individual MBS highly, as all good debt, when they were anything but. These MBS, or a lot of them, contained ticking time bombs, thousands of mortgages that were risky (at best) and downright suicidal (at worst).
What's more, to further complicate the situation, the MBS were themselves pooled into collateralized debt obligations (CDO) and these were traded just like the MBS were. These CDO's are divided into "tranches," which is just the French word for slice. Each tranche is supposed to be made up of a certain class of debt, which makes managing the risk easier because the relative "goodness" of the debt is a known thing. But here, this was not necessarily so.
Risk has been mentioned before, but it is at this stage (right before we get to the meltdown...don't worry, it is coming) when the idea of risk management comes into the picture. Investment banks (and smart investors in general) never expose themselves to more risk than they feel they can handle.
To do this, they try and offset the risk with other financial instruments. In options trading (what I used to do for a living), for example, there are many spreading strategies to offset the risk of any one contract and insure a profit or at least limit a loss. Those of you who are familiar with the world of sports betting (which I am not...officially) will see some similarities here. In our present case, the buyers of MBS's and CDO's used credit-default swaps (CDS) to manage risk.
Here again, what was usually done does not apply here. CDS's, basically guarantees against another party defaulting on a loan, help to manage risk by passing it along, so to speak, to other parties until many people hold small parts of the risk and no one body is fully exposed. What was different with our persent case is that the investment banks and other entities bought these MBS's and CDO's on leverage (read=credit). So, basically, they were buying huge pools of debt by taking on huge amounts of debt themselves. This is what is called leverage.
With all of this complex debt, leverage, credit and the attempt to manage risk, it is not hard to imagine that something could happen that would destabilize this arrangement. This is so because so much of the arrangement was based on credit and promises, not on real assets and complete assessments of the risks involved.
This brings us to the so-called tipping point. Next time: the tipping, falling and blaming.
Tuesday, October 14, 2008
Now, the shocking news:
- Is British Prime Minister Gordon Brown the Allmighty, The Savior of World Finance? Recent Nobel Laureate Economist Paul Krugman seems to think so. I personally think this is a case of Krugman, swollen with victory and the notion that his view of the world is coming to pass, throwing kudos to Brown for something that, well, I guess he did. I actually think (along with this really smart guy) that the Irish Government strong-armed Europe into intervention and they, in turn, strong-armed the USA into following suit. Sort of a "play by the new rules or don't play at all" sort of thing. Will this help Brown's generally sinking political fortunes? For a time, maybe. Long-term? No.
- Is Will Shannon a Deadhead? Well, yes, I am. I does not seem to fit with my business casual dress or my generally sour demeanor about the world or my on-and-off hatred of mirth, whimsy, wonder and that sort of rot. The fact remains, however, that I have been a fan of San Fransisco's eternal house band for some years. Maybe it is their lyrical intricacy (piloted mainly by Robert Hunter/Jerry Garcia and John Perry Barlow/Bob Weir). Maybe it is their jazz-like devotion to improvisation. Or maybe, just maybe, it is because they were not really political, prefering to leave the politics and shouting out and concentrate on the music. Well, the upshot of this revelation was a great piece in Reason from a few years back. Read it here. It brings together, in the form of a review of this book, a lot of what makes the Dead attractive to me. Boy, if anyone could make something like "hippie capitalism" work, it was them.
Actually, in closing and in considering the state of finance today, perhaps a quote from the Dead is apropos:
"The wheel is turning and you can't slow down,
You can't let go and you can't hold on,
You can't go back and you can't stand still,
If the thunder don't get you, then the lightning will."
Wednesday, October 08, 2008
I wanted to post about and expound upon a fascinating idea in Tyler Cowen's great book Discover Your Inner Economist.
In this season of campaign donations and with the charitable onslaught of the holidays just around the corner, I got to thinking about the effect of charitable giving and what giving to charity means to people.
In a certain sense, charity is like any other sort of spending: resources are allocated to a particular purpose and in doing so, people show their preferences. There is more at work, it seems, when it comes to charity.
There is a moral dimension in giving to charity that is not present in other forms of exchange. When you buy (fill in your favorite good here), you are showing that you have a preference for that item at the price you paid for it and in the quantity you bought it in.
When you give to charity, you also do this, but you are trying to show that you are a certain sort of person...namely, the sort of person who gives to charity. It would seem that these sorts of people are good (or at least do one good thing) and that this is the sort of behavior that we all should engage in.
While I am not sure about making these moral judgements (I think that it is a strictly personal matter), I was curious about one assumption of everything said above. That is the assertion that all charity and donations should be given to someone or something that one supports.
Let's play the contrarian, I thought, and see where this goes...
Could there be value to giving to a cause or a person with whom you disagree? It seems at first blush to be, well, a really stupid idea. If I support gun control (which for the record, I don't; this is just an example), it would not seem to follow that I would donate money to the NRA.
Or does it?
Think about what happens when you send a donation to a charity or a political candidate. That entity takes your money, puts your name on a mailing list and proceeds to barrage you with direct mail solicitations. You showed your preference, all right. You let people who are asking for money know that you are the sort of person who gives it away.
The mail keeps pouring in and you begin to wonder about the prudence of your donation. Yeah, you are keen on nature, but c'mon Sierra Club...when does it end?
Have you figured it out yet? Has it dawned on you why "reverse charity" might be a good thing for you?
You gave a cause or person an amount of money. This action caused that party to send you, at their expense, more entreaties for cash. They put your name on a mailing list which may be exchanged with other groups, incurring more expense. It only seems when you have ignored them for a good long time that they finally get the hint.
Do you realize what you have just done? You have, though out of your best intentinos, made a cause that you wanted to support spend perhaps more than you gave. In other words, your donation made your charity of choice lose money.
You should realize what the next step is (and therefore the meaning of the title of this post).
Hate Barack Obama? Donate money to his campaign.
Think Greeenpeace nods at environmental terrorism? Cut them a check.
Think a particular charity/church/aid drive is particularly unseemly? Pass the plate and dig deep, brothers and sisters.
Your one-time donation, though it goes against your preferences (and thus could be called "strategic charity"), could end up helping you by weakening a cause or person with whom you disagree. Yes, it may feel off-putting holding these two contradictory ideas at once, but trust me: every time you get another piece of mail from your "target," consider it a small victory.
Have I ever actually done this? Yes, but it was without knowing the full implications of the situation. In college, we put one of our friends on this guy's mailing list and he got deliveries and calls for donations for years afterwards.
So go out there, think like a contrarian and show your enemies your contempt by showing your "support." While you are doing it, think about all the little interactions, exchanges and incentives that we respond to everyday and in turn show our preferences and, really, little pieces of ourselves.
It is fascinating ideas like these that make people (me included) think deeper and desire to know more about the world around them. I hope they make you think, too.