Politics, Politics, PoliticsWell talking politics didn't exactly work out for Comicus and probably won't work out here either.
A reader left a comment asking for my opinion about systemic risk and what might happen if the government tried to regulate sub-prime lending and credit card lending.
I should preface my thoughts here by saying I tend to have more questions than I do answers and I find I have very little sympathy for people who don't really do for themselves on matters which we debate about whether government should have an increased role or not.
Generally speaking, adults know they have to pay their bills and they should know what they can afford but by the same token the bank should know what a prospective borrower can afford.
A guy I worked with in 1998 had bad credit and I was astounded to learn that he was paying 23% on a car loan for an old crappy econobox vehicle. My wife and I used to have friends whose family business was selling cars to people like my former co-worker. He had a lot full of old cars not worth much and really the sales price meant very little given how much interest he was making.
I had no idea that anyone paid that kind of interest for anything.
It is not intuitive to me that I can buy a car at 7% while the guy next to me, making the same money would have to pay three times as much for the same car. Bad credit has a price I'm not sure the likelihood of default corresponds with the price being so high.
WRT to the subprime mortgages, I don't think too many people disagree that in this recent era of liquidity there were many loans that were written that should never have been written. Lenders who wrote too many crappy loans will probably pay a price as will the borrowers in question. I am inclined to place more blame on the lender who puts a 25 year old couple into a loan with a payment that went up by 30% a year or two later but I realize the inconsistency of this notion.
Both of the above types of lending are examples of free market capitalism but reveal some of the warts inherent where selling money in concerned.
Based on track record, the notion that government regulation could magically fix predatory lending and while we are at health care and social security is nothing but a fantasy. More inconsistency; it would be great if the government could fix things with out leaving a sea of unintended consequences, failed strategies and lazy bureaucrats. But I believe I might be describing wishes granted by a genie and not a realistic expectation of what regulation could do for anyone or anything.
I certainly do not have any solutions which might mean I have nothing constructive to say. As a matter of philosophy I tend to think that something run privately with the hope and incentive for making money has a better chance of success than something state run where there is no do for yourself principle motivating success.
To be clear both private and public have conflicts that get in the way of the desired outcome.
As far as systemic risk; that is a tough one too. I am in the camp that thinks social security is a problem and that Medicare is a bigger problem. I do not think subprime (the context of the question) poses a systemic risk. Something akin to a recession is not my idea of systemic risk.
The more immediate risk along these lines is the simultaneous drying up of many sources of global liquidity which could include subprime which is different than being caused by subprime. However real this is or is not I do not think the threat of regulation plays any role in this. More disruption from the yen combined with money generally becoming more expensive or difficult to access is the systemic threat I see.
While these threats are real, global markets are always threatened by very dire things and very rarely in history has the result been a systemic breakdown so I tend to think the probability now is low. This would not preclude a recession of some sort but a normal recession is not a systemic breakdown.
15 comments:
"Based on track record, the notion that government regulation could magically fix predatory lending and while we are at health care and social security is nothing but a fantasy."
In large part I agree with you. But let's be clear that the public (which is government, though unrecognizable) has a right to expect and demand fair disclosures, and the financial industry has been rife with inadequacy in this area (remember APR regs?). That's not to say that the government cannot get a misguided (sometimes a little, sometimes ALOT) in those efforts.
Heck, I'd like to see the Fed say to each bank: "You ensure that you have adequate lending standards to protect your depositors' assets; otherwise you lose FDIC participation." Oh, I know that there are so many problems with that--but the point is that there seems to be so few consequences to the people who made the most money in engaging in these egregious practices except and those consequences inure to the detriment of those who may suffer them unwittingly (through lack of appropriate disclosure).
The general rule is that the more interlocked a system is the smaller the percentage chance that their will be a systemic breakdown. The problem is that the systemic breakdowns will generally be much larger if they do occur.
One area that the system is not very well interlocked is in the non-transparent non-open market nature of the securitization process - derivatives market.
So you would expect the non-interlocked parts of the system to collapse (which is happening), but the more flexible parts to hold on. Unfortunately, if a tipping point is reached the system could go down very quickly. The tipping points are often not easily defined before hand.
It should be noted that the securitization market completely seized up in 1994 (remember the Orange County BK?). The tipping for that seize up was Greenspan's surprise pre-emptory interest rate hike.
Re subprime failures vs systemic risk I think Roger began to frame this nicely...if i follow him...and that we are going hear about this quite a bit next week. Bottom line: does it affect liquidity. Still there's just that uncertainty factor.
As a huge aside, three generations ago, a direct forbearer, was a bank president during an early 1900 bank collapse. In order to pay back creditors he left the country with his son to sell assets. When he returned, mission accomplished so the very hushed up story goes,Fed regulators imprisoned him for six months at which time his health failed.
"I am in the camp that thinks social security is a problem and that Medicare is a bigger problem."
Roger, did you watch 60 Minutes (March 4) last week with the Comptroller General of the United States? If not, you can get the podcast on ITMS. His comments are startling, especially for the younger generations.
There are several reports on the GAO website which give the facts on the budget imbalance created by Medicare and Social Security.
Sub-prime seems much less significant considering the long-term implications of the current demographic shift. Sub-prime is more like the media's flavor-of-the-moment.
I may be an unusual person. I believe Government should be in charge of defense, law&order, justice, foreign relations and very little more if anything. The rest can be perfectly run by the private sector. As for systemic risk, it is difficult but possible. With the appreciation of the JPY the carry trade has started to unwind. Not only in the USA but everywhere. The CHF has not appreciated yet, but if it does (like it would if the US enters a recession and the Fed lowers rates), then that carry trade will also start to unwind in the US. If the whole mortgage sector collapses and spills over to other sectors (which is not only possible but probable) the US will face a systemic banking crisis. If you don't like government to interfere in any economic activity (save giving the most basic regulatory rules), in the next presidential elections you should vote for Ron Paul. He doesn't have the slightest probability of getting elected, but a good voting will make people aware that we are tired of Big Brother taking care of you. Here is a statement by this guy:
http://www.house.gov/paul/congrec/congrec2000/cr020200.htm
Ernst
I wrote this morning about the risk associated with high expectations for the big money banks. They have been turning in record profits due, in no small part, to the shear volume of bond underwriting they have been performing. Credit spreads are rising - whether this leads to a tightening remains to be seen. If it does (or just the perception grows that it could), a reduction in underwriting fees could certainly impact the big banks, which would, in turn, impact both the S&P 500 and the Dow 30 indexes.
Speaking of Comicus...I am wondering if he would have done a better job of coaching my Pitt Panthers last night than Jamie Dixon. (or playing center for that matter)
I know that Pitt likes to recruit in the New York area, but they have to stop getting players from The Bronx School for the Blind.
Here is some information that you need to know before making out your NCAA bracket:
http://www.pittsburghlive.com/x/tribunereview/sports/s_497175.html
I must say that throughout the 90s and into the beginning of this decade I paid no attention whatsoever to the markets. The bull market of the 90s came and went and I had not the slightest idea.
In the 3 years or so since I started following things a little, the market, the stock market, has been impressive.
But over the long term, how can the evolution be interpreted?
The Dow is at its all time highs. Up around 20% since it's lows of July, up 50-60% from its lows of 2002. That seems like a right nice rate of return. Grossly put, you put money in and let it grow, through the ups and downs of the indexes.
But go a few years further back. From the lows of 98 and highs of 97, we have a much more modest return. If the bull doesn't re-take things in hand, I'm not sure that you're better off than if you had the money in a savings account over the last 10 years. If you "bail out" when the dow passes below its 200 day ma, you will have gone effectively nowhere in a decade.
Looking at the Russell2000, the "crash" of the end of the 90s seems like a blip in a 20 year bull market, a volatile period of distribution.
But the S&P is another story. It's still only approaching the highs of nearly a decade ago.
And of course the Nasdaq ...
I must suppose that the components of these indexes have changed substantially over these years. Also, I'm curious as to how to explain the difference in the result between, say, the S&P and the Russell. Also, the placement of money is not limited to the stock market indexes, evidently.
Still the question seems necessary, is the average return over the years really interesting if you don't manage to get in and out at the key moments?
This question doesn't adress the theme of your poste Roger. It's in the context of the discussions of these last few weeks.
Roger how long have you been doing this, not the blog but the managing of other people's money? Have you been at it since the 90s, did you pass this difficult period? Do you have a concrete feel for how a portfolio can evolve over 15-20 years?
I’m with you, Ernesto. To paraphrase Reagan.,“Government is not the solution, government is the problem.” I like to keep that in mind when politicians look for more ways to protect us from our own free will. These lenders were providing opportunity to people who had previously proven they don’t deserve it. The rates, therefore, were high. So was the risk. All parties were privy to the terms of the deals, so all share responsibility. Profit motive will ultimately fix the mortgage industry without government intervention—turns out it’s hard to make money loaning to deadbeats unless home values are rising at a frenzied pace.
Coincidentally, I just got a mailing from the Libertarian Party stating Ron Paul will be announcing his candidacy for President on Monday. You're right, Ernesto, he's got no shot. Despite that, he's got my vote.
I am trying to make some investments from the opportunity presented by the sub prime shock. it seems to me that the good with the bad get tarred in these circumstances, so far i am thinking about washington mutual any other ideas out there.
I agree that government is usually the problem and not the answer.
Regarding financial institutions, I think that if one stays clear of the few US-based large banks and investment houses that are the final act of the sub-prime Ponzi scheme, you will do just fine.Sub-prime loans are still available but with stringent stips. That is a good thing. Why should anyone get a loan they can't, or won't, repay? Foreign banks and more conservative US banks are now shouldering recent sub-prime loans.
We had a similar problem with sub-prime credit cards in 2000-2002 culminating in some bankrupt issuers. Perhaps many do not recall the angst media had over people being led by mean-spirited bankers to spend into oblivion, and then find out they actually had to repay the money with interest.
Call me harsh, but I do not look upon anyone not reading a contract or paying back monies owed a "victim" unless there is a clear violation of the law.
Anon 8:34, you might look for bargains in some of the larger, more diversified outfits such as WFC, CFC, Chase or Wamu but take your time, this washout is not finished yet and a lot of stinky tar is going to be spread on a lot of names. As to outfits such as LEND whose central business was subprime and alt-A, might want to take an even longer time looking those over; the damage in this sector has only just begun and frankly all the players are probably better short candidates than long picks right now no matter what their prospects might be. JMO
As to systemic risks, I personally consider the risk/reward ratio to be as poor as anything I've seen in 25 years. I have no idea if any of this will end well or poorly or just sort of putter along but, as nearly as I can tell, entitlement trusts (social security, etc.) and subprime mortgages amount to a relatively small fraction of the total involved regardless.
OTOH, just as an example, the CDO and CDS markets are now reputed (no one really knows for sure) to represent nominal quantities more than an order of magnitude greater than the assets, bonds and mortgages, they were presumably derived from and a portion of those underlying assets (quantities again uncertain) are being called and/or reset now.
This is private enterprise at work, god love it, but those who recall the "portfolio insurance" failures of 1987 or the bond/currency crises of 1997-98 will understand why you might want to, um, cover your arse more and worry less. Remember it's always the junkie's fault, never the dealer, distributor, transporter or grower/manufacturer; it's just what James Thurber would call passing the universal thump, sending it down the chain until the weakest is struck and there is no one left in the chain to take the smack (until the next set of kids of course) so protect yourself (and find that bigger fool somewhere).
Remember too that from the perspective of an individual investor, big money and big government are not readily distinguishable, they can both rob and cheat you with no little or no recourse available: If in doubt recall the old African saying, "when elephants fight it is the grass that is wounded," and practice staying nimble. Oh yes, and welcome to the jungle, we missed you.
Good luck.
Thanks to all for the awsome discussion about systemic risk. What I love about this blog is that it makes me think, mostly about stuff I hadn't even thought of.
One of the movie channels has been rerunning Mels 'High Anxiety'. Now that is some funny cinema. Getting chased through a park by poopin pidgens makes me chuckle just thinking about it. Sure beats watching the evening noose. Tom in Indy
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