Quote of the Day: Alan Greenspan on SubPrime, I/O and other exotic mortgages

is greenspan saying anything wrong? there will always be marginal borrowers but financial innovation does indeed push the frontier of that marginal borrower. yesterday’s marginal borowwer is a safe credit borrower in part because of the reasons greenspan mentions.

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“is greenspan saying anything wrong?”

Yes. The part that is underlined on lenders correctly evaluating risk. That is why he underlined it.

Ah, yes, that would be our new ‘future-predicting’ technology… the same one we use to reliably predict such things as the weather, the stock markets, political elections and other things far into the future.

I’m with sa and see nothing wrong with what he said. “lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately” is quite rational and led to the highest level of home ownership we ever had in this country. The problem was the bubble era, when lenders judged the risk by holding a mirror to the applicant’s mouth and if it fogged a little the applicant passed. Having the ability to judge, and actually bothering to judge are two completely different camps. No matter what improvements you make to a free market economic system, you can only make it fool proof, you can never make it “damn fool” proof.

Actually heard one of the “damn fools” on NPR this morning, explaining that China was in trouble because it had “too much money”, especially in reserves. “Too much money”= problem? Nearly split a gut laughing at him.

I think any of these that I have heard lately – “too much money”, “prudent subprime lender”, “conservative San Francisco politician”, or “inexpensive Starbucks latte” can send me into gales of laughter.

The issue as I see it, isn’t necessarily that financial institutions have extended credit to the sub prime market, it’s that some lenders didn’t practice strong risk management practices. ie, Their loan portfolios are too concentrated in risky loans.

So, to take the flip side of the argument, would a company like Citi or B of A as an example, who might have practiced stronger lending practices, ultimately make money by including sub prime lending in their portfolio? I suspect the answer is yes. So, technically, Greenspan may have a point. And, he may be referring to such practices in the overall context of his statement to give him the benefit of the doubt. (Which I’m not saying he deserves.) But, for those who left their brain at the door, well, they will suffer the consequences.

His other profoundly bad call was when he encouraged people to take ARMs right as interest rates were clearly near a several decade long bottom.

What a great idea, take on an ARM when you know the future holds higher rates.

Just goes to show you can be as academically qualified as you like but common sense is a rare, soon to be priceless quality.

**”With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . “**

Honestly, advances in technology? Yeah its called a cheap, crappy, badly thought out loan.

everything that’s wrong is Greenspan’s fault ….. the lending practices of those lenders is his fault …. the sell-off is his fault … the sun spots are his fault … global warming’s his fault …. the Iraq war’s his fault …. AIDS is his fault…….

tt,
A lot of those things are George Bush’s fault. Just kidding.

I remember sitting there listening to him talk when he gave that speech. It was unbelievable. He was telling the lenders and the borrowers to go ahead and take on a lot more risk. It will be ok. Because I do not plan to raise rates much.

1) The lenders and the borrowers went on a spree not seen ever before at very low rates, and
2) He ended up raising rates far more than probably he believed at the time.

So is it his fault? Overseeing bank lending practices is the Fed’s job, isn’t it? He also presided over the biggest bad corporate investment cycle in god knows how long in the 90s.
He is bright enough to know what incentives they were putting in place for the housing market. The market never priced in hikes all the way to 5.25% because of his musings. So he definitely shares the blame.

It is quite amazing (or disgusting or amusing or heroic..depending on your point of view) to see the folks on CNBC try to blame the problems now on “a couple of twenty year old mortgage brokers” and “dishonest borrowers”.

tt-
AIDS is Greenie’s fault? Boy, that old dude really gets around!

‘Teddy’ posted:

“These surpluses were suppose to be off budget and sacred, but I believe it was the Clinton administration that first started using them to ‘balance’ the budget.”

A)You are only off by more than a decade. The Reagan administration “unified” the federal budget in the early 1980s, utilizing the Social Security, Medicare, and other trust funds to mask the exploding size of the federal budget deficits, in a desperate attempt to make it appear their failed economic policies were succeeding.

B) After the federal budget reversed and went into surplus during the Clinton administration, it was the Republican Majority controlled Congress that demanded that the administration report the budget with the trust funds off-budget, in a desperate attempt to make it appear the administration’s economic policies were failing, but to their dismay, the surpluses continued anyway. Of course, this administration returned to masking their exploding deficits with the trust funds in 2001 with not a peep from the same Republican Majority controlled Congress.
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VJ, when increased FICA taxes were first approved around 1984, SS surpluses were definitely off budget and considered sacred. I think you would have to fault both parties for this problem since the surpluses were part of Clinton’s budget initially. Certainly, the capital gains taxes from stock sales during the Clinton later years helped balance the budget.

The only financial innovation is that the U.S. has found takers (suckers) for this paper overseas. Without Chairman Hu and the FCB gang, the low-end mortgage market and Fannie/Freddie would have circled the bowl long ago and interest rates would have been dramatically higher.

As long as the Chairman Hu’s of the world suck up the majority of the MBS paper, the mortgage market can limp along. When they decide “enough’s enough”, game over.

That’s when we’ll need some REAL financial innovation.

Actually, he says they are “able” to efficiently judge and price the risk appropriately. He doesn’t say that they have actually been doing that. Just that the technology and products exist to do so.

Speaking of Technology:

The Washington Times. “In another sign the mortgage crunch is spreading, Lehman Brothers Holdings Inc. announced it is cutting the ratings of Countrywide Financial Corp., the largest mortgage lender, and other prime lenders as defaults surge.”

“‘Prime loans will see rising default rates as subprime has, due to increasingly weak underwriting in recent vintages,’ analyst Bruce Harting said. ‘The rapidity, breadth and depth of the subprime sector meltdown has been extraordinary, even in the context of an environment in which most industry observers felt that major problems in the subprime space were inevitable and overdue.’”

“subprime sector meltdown”.
Now THAT’S what i call innovation!

New technology and repackaging debt? Every major repackaging has ended in a bust and hasn’t he ever heard of garbage in, garbage out?

Can’t believe there are some who still think one party is “good” at economics and another is “bad.” They’ve both been pretty sorry and both share plenty of blame. Say what you want about Reagan, but taking top marginal rate from 70% to around 35% was a great move–it created structural and profound positive changes in the economy. For example, many top producers, “tax-payers” who wouldn’t have bothered to work more or produce more because they were only getting to keep a fourth of their profit really changed their whole outlook and tax income went up drastically. What did not create any profound change was W. Bush moving the rate from 39.6 to 35. Does anybody really produce any more or expand more cause they get to keep an extra 4.6% of income? I highly doubt it. Highest brackets should have been left alone. Yes, tax income is up but that is also due to other govt. stimuli like very low interest and skyrocketing spending. (even non-defense discretionary) Now dems will get control back and screw up in other ways. (Clinton happened to get lucky with a massive technological upgrade business cycle. And a Congress and Treasury Sec. that restricted spending. Too bad GOP congress of this decade wasn’t like one of the last. Bottom line is they are all pretty much worthless. And don’t forget Yen carry trade didn’t help make easy AL look more responsible.

‘Teddy’ posted:

“when increased FICA taxes were first approved around 1984…”

That was 1983. Check the ‘Greenspan Commission’ and subsequent legislation.

“SS surpluses were definitely off budget and considered sacred.”

Nope. The trust funds went from off-budget in 1982 to on-budget in 1983.

“I think you would have to fault both parties for this problem since the surpluses were part of Clinton’s budget initially.”

That was only keeping in what the previous administrations had done for a decade.

“Certainly, the capital gains taxes from stock sales during the Clinton later years helped balance the budget.”

The federal budget was in net balance well before any changes to the Capital Gains tax rate.
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‘Ryan’ posted:

“Say what you want about Reagan, but taking top marginal rate from 70% to around 35% was a great move”

Only if you think massive federal deficits and debt was a “great move“.

“ For example, many top producers, ‘tax-payers’ who wouldn’t have bothered to work more or produce more because they were only getting to keep a fourth of their profit really changed their whole outlook…”

There’s no evidence to support such a theory. People invest or “produce” irrespective of the level of taxation. The two greatest periods of economic prosperity during the last century were when top tax rates were high. The late 1950s and early 1960s when the top tax rates were 90%/70%, and the late 1990s when the top tax rate was raised to 39.6%.

“and tax income went up drastically.”

To the contrary, federal income tax revenues plummeted dramatically. As David Stockman, who was Reagan’s Director of the Office of Management and Budget (1981-1985), stated:

“Ronald Reagan’s original across-the-board income tax cut would have permanently reduced the federal revenue base by 3% of GNP … the Reagan tax-rate cut alone would have strained the nation’s fiscal equation beyond the breaking point. As of August of 1981, Uncle Sam had been left to finance a 1980s-sized [federal government] and defense build-up from a general revenues base that was now smaller relative to GNP than at any time since 1940 !”

“Yes, tax income is up but that is also due to other govt. stimuli like very low interest and skyrocketing spending”

No, tax revenue is only up recently because a tax cut expired.

“Clinton happened to get lucky with a massive technological upgrade business cycle.”

Which did not even begin until well after the fact.

“And a Congress and Treasury Sec. that restricted spending.”

Putting aside the fact that a Treasury Secretary cannot enact any “restricted spending“, the Republican takeover of Congress did not occur until January of 1995 and no major budget legislation was signed into law by the President until February of 1996, after the Congress shut down the federal government for the second time, at which point all the economic reversals had already occurred.
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Funny how the Republicans always pair tax cuts with a huge deficit stimulus; almost like they don’t believe their own BS about the magic of tax cuts.

“I believe I can flap my arms and fly; this F-22 I got strapped to my back has nothing to do with it.”

pd130,

Yes, yes… my son. Thank you for your kindness. And, let’s close out this bible class with a review of:

The Sermon on the Mount, or possibly we can rename it the epistle,

“First Kudlownians.”
—
Quoting from the first link in my prior post, from remarks by Alan Greenspan given: To the Conference on Housing, Mortgage Finance, and the Macroeconomy, Federal Reserve Bank of Atlanta, Atlanta, Georgia
(via satellite) on May 19, 2005:

“The [strong belief of investors in the implicit government backing of the GSEs] does not by itself create problems of safety and soundness for the GSEs, but it does create systemic risks for the U.S. financial system as the GSEs become very large. As I have recently testified before the Banking Committee of the U.S. Senate, systemic risks are difficult to address through the normal course of financial institution regulation alone. But in the case of the GSEs, these risks can be effectively handled by limiting their investment portfolios, which are funded by implicitly subsidized debt.” …end quote [brackets added]
—
Now, let’s ratchet forward in time to just recently when Ben Bernanke gave the following remarks: Before the Independent Community Bankers of America’s Annual Convention and Techworld, Honolulu, Hawaii
(via satellite) March 6, 2007, ‘GSE Portfolios, Systemic Risk, and Affordable Housing.’

Linked here (sorry, but my prior link to these remarks brought up the footnotes section of the remarks first rather than the heading):

http://tinyurl.com/2esj2n

I’ll have several exact quotes from it [indicated with brackets] and **followed by my (Eclectic) comments, so let’s get started.

[The GSEs’ second line of business is the main focus of my remarks today. It involves the purchase of mortgage-backed securities and other types of assets for their own investment portfolios. This line of business has raised public concern because its fundamental source of profitability is the widespread perception by investors that the U.S. government would not allow a GSE to fail, notwithstanding the fact that–as numerous government officials have asserted–the government has given no such guarantees.]

**to be fair to Mr. Greenspan, much of this message is the same as the one delivered by Greenspan on May 19, 2005. Go back and read that 2005 linked piece by Greenspan in its entirety to gain the context you’ll need to decide if you agree with me. What’s happened in the meantime is that near two long years have now passed and the housing environment is finally (as anyone with any sense back then knew) coming into focus as marginal lenders are beginning to hit the tripwires that were inevitable to be hit. Tripwires are sometimes hidden in an unfolding “Greatest Story Never Told;” that is, when some of the story that hasn’t been told finally does get told.

[The GSE portfolios have been the subject of much controversy. First, analysts disagree about whether the GSE portfolios serve any public purpose. The GSEs themselves argue that their purchases of MBS provide additional support to the mortgage market, particularly during periods of financial stress. In contrast, research at the Federal Reserve Board and elsewhere has found that the GSE portfolios appear to have no material effect on the cost or availability of residential mortgages.]

**it sound like in plain speak from Bernanke that the Fed’s research considers that the second line of business of the GSEs, that Bernanke has already said “is the main focus of my remarks today,” doesn’t appear to contribute any material effect on the cost or availability of residential mortgages. Thus, the implication is that the credit enhancements given to the GSEs, for which they are in part using for building these investment portfolios (of Bernanke’s focus), are evidently being given to the GSEs without any return benefit to the taxpayers that stand behind the credit enhancements.

So, what is the size of this secondary business Mr. Bernanke is referring to? He goes on and tells us…

[Both of these conditions apply to the current situation of Fannie Mae and Freddie Mac (Eisenbeis, Frame, and Wall, forthcoming). The two GSEs are certainly large, having a dominant presence in U.S. mortgage markets and a substantial role in other financial markets, particularly in public debt and derivatives markets. Beginning in the mid-1990s, the GSEs began to rapidly increase the quantity of mortgages and other assets that they purchased and retained in their portfolios. From the end of 1990 until the end of 2003, the combined portfolios of Fannie Mae and Freddie Mac grew more than tenfold, from $135 billion to $1.56 trillion, and the share they hold of outstanding residential mortgages increased from less than 5 percent to more than 20 percent.5 Moreover, to finance their own holdings of MBS and other assets, in 2005 the two GSEs together issued almost $3 trillion in debt. Today, the two companies have $5.2 trillion of debt and MBS obligations outstanding, exceeding the $4.9 trillion of publicly held debt of the U.S. government (Lockhart, 2007). The activities of the GSEs are not confined to debt markets; because the GSEs engage in extensive hedging activities, these companies are among the most active users of derivative instruments. Thus, by any measure, the GSEs have a significant presence in U.S. financial markets.6] (all footnotes available in appropriate links already provided)

**no comments necessary here.

So, what does he think are the implications of this discussion so far?

[In most situations, policymakers can rely on market forces to constrain the risk-taking behavior of privately owned financial organizations. Market discipline is effective because, normally, the creditors of private firms have powerful incentives to monitor the risk-taking and risk-management activities conducted by these organizations. In particular, if creditors believe that an organization is taking on increased risk, they will reduce their exposure to the organization or demand greater compensation for bearing the additional risk. These market responses act as a brake on an organization’s risk-taking behavior and consequently reduce the likelihood that the company will fail.
-paragraph break-
Unlike other private firms, however, the GSEs face little or no market discipline from their senior debt holders because of the belief among market participants that the U.S. government will back these institutions under almost any circumstances. As a result, increased risk-taking by the GSEs does not significantly increase their cost of funding or reduce their access to credit, as it would for other private firms. Indeed, as I have already noted, GSE debt trades at a narrow spread over U.S. Treasury debt and at spreads below those of other highly rated financial institutions, including the largest U.S. bank holding companies.7 Moreover, the spread of GSE debt over Treasuries has been remarkably unresponsive to the recent problems of the GSEs (including the turnover of senior management and the inability of either company to provide current financial statements), suggesting that investors’ faith in an implicit government guarantee remains unshaken.]

**in other words, the market forces that ordinarily might constrain the excessive build-up of secondary investment portfolios of GSEs are de-linked from effectiveness because of the assumed status of GSE debt being guaranteed by the government.

What does Bernanke recommend in regards to these issues he is raising (and, frankly, the same generalized issues that Greenspan should be credited with posing in May 2005)? Well, Bernanke is being given some credit in the press for being more of a direct speaker and able to come to a direct point in simple language…

[Measures to Reduce the Systemic Risk of GSE Portfolios
-header break-
I have argued today that the size and the potentially rapid growth of GSE portfolios, combined with the lack of market discipline faced by GSEs, raise substantial systemic risk concerns. How should this issue be addressed? In recent years, the Federal Reserve Board has laid out three essential elements for the effective regulation of the GSEs that we believe would mitigate those concerns while promoting more effectively the important public purposes that they serve (Greenspan 2004; 2005b; 2006). First, the GSE regulator should have the broad authority necessary to set and adjust GSE capital requirements in line with the risks posed by the GSEs. Second, the GSEs should be subject to a clear and credible receivership process, a process that would establish that both shareholders and debt holders of a failed GSE would suffer financial losses. Third, the GSEs’ portfolios should be anchored firmly to a well-understood public purpose approved by the Congress.]

**Bernanke is actively of the opinion, stated very clearly here, that a clearly defined procedure for establishing receivership of failed GSEs should be in place, and that in the event of failure that “both shareholders and debt holders of a failed GSE would suffer financial losses.” That is, not the government as is the erroneous assumption still within the market today, but the equity and debt holders themselves.

You cant make this stuff up

File this under: Truth is stranger than fiction!
The link below will take you to Barry Ritholtz fabulous blog The Big Picture (see blogroll in the sidebar also). Barrys blog is the best of its type on the internet, in my opinion.
This post, the …

‘Ryan’ posted:

“Reagan’s moving down the top marginal rate was a great move…”

For the wealthy.

It was a bad move for everyone else and the nation as a whole. The Standard of Living of the vast majority of Americans went backwards, Poverty increased, federal deficits and debt ballooned, etc.

“and helped turn around the mess that others before him had made”

Hardly.

The economy grew faster and created more jobs during Carter’s term than during Reagan’s.

“If you want to try to influence people to hate republicans…”

???

You must be projecting. I can’t help it if you cannot deal with reality.
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Did you know that ebay now sells body parts? This is wrong on so many levels.
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