Tuesday Morning Rant

[Rudyard K]

The problem for the regulators under our attempt at new regulations. First a little history.

There have always been subprime loans. However, prior to 2000 or the mid 1990’s, that amount of subprime loans in a given pool probably didn’t exceed 5% of the total pool. As such, the total pool was fairly risk adverse because it was 95% prime loans. When reviewed on a historical basis (i.e. the previous 5-10 years), the default rate on subprime loans was really not much higher than the default rate on prime loans. However, an improper application of logic (now that we sit here today knowing the outcome) then occurred.

That improper application of logic said…If the default rate is no higher on subprime loans, and I make a pool of loans that is made up of 100% of those “5% subprime groupings” of other portfolios, I have spread the risk across some twenty “5% subprime groupings”, where each of those groupings historically did not have a higher default rate than the prime loans, and being subprime they already have a higher interest rate, I ought to be able to get a credit rating on that pool of loans that is comparable with a pool of prime loans. That logic did have some merit at the time it was being utilized to gain the credit rating.

But once that occurred, it was “Katie, bar the door”. Where previously, the total subprime market was perhaps 5% of the total mortgage loan market, and the default rate on those subprime loans was comparable with the default rate of the prime loans. There now has been created a methodology to group subprime loans into one basket, and expand that basket exponentially. I don’t know what the subprime market had grown to, as compared to the total mortgage loan market, but my guess is that it approached some 20% of the total market. Previously it had only been able to grow in the same proportion (i.e. +/- 5%) to the total mortgage loan market. But not anymore.

While I am certain there are some who understood the fallacy in this logical argument, it is my opinion that most did not…and IMHO it was less than 1% of the people who were promoting these things who really understood the ramifications of what they were doing. The rest were just normal folks, opining like they really knew something, in an attempt to get us to buy it, and they got paid big money for getting us to do so. That is not nefarious…that is stupidity…on both our parts.

It became the perfect storm. 1) An evaluation of mortgage loans and loan portfolios based on the previous 5-10 years without a recognition that those 5-10 years had really been a pretty good economic boom, 2) A methodology to expand the subprime market without a recognition that an increase in the total mortgage loan market needed to keep the subprime market in proportion to the total mortgage loan market, 3) An enjoyment by us all of an expanding economy and finally 4) A government motivation to help everyone acquire the American Dream (a home of their own) and to keep the economy growing, so they could continue to get elected.

So, if you were sitting back there in the 1995, what should we (government and industry) have done different? If we put some regulation in place that kept this subprime bubble from occurring, we would not have had the boom economy. We would not have had the American Dream occur to a lot of folks. We would also, not have had the terrible slide we’ve had over the course of the last couple of years. Not as big of a peak…not as big of a valley. If you pissed off all you winnings from the last 10-20 years then you feel like “woe is me” today. But if you were frugal and saving over the course of last 10-20 years, then you are much better off than you would be otherwise. Which is better?

These are the problems the regulators are having to deal with. Every action has a ramification…some good…some bad. We can look at history to try and not repeat the bad…but we have to deal with the world as it is today…and the ramifications of our actions today.

I’m sure WTF will say that the Fat Cats took more than their share from the table…and to some extent I agree. Why shouldn’t they? They were (for the most part) stupidly selling a product to us that they really didn’t understand, and we were stupidly buying it, and paying them big money to do so. But limiting their ability to do so in the future?...has ramifications also. The demeanor in DC seems to be that we need regulations and restrictions to protect us from the Fat Cats. My personal belief is that we need regulations and restrictions upon ourselves to protect us from ourselves. That will serve to keep the Fat Cats from preying on us. But such restrictions will restrict our own flexibility. You want flexibility?...you take responsibility. You want security?...you give up flexibility. Take your pick.

Like Hitler did in the 30’s with the Jews, our government points at Fat Cats and says they are responsible for our plight in life. And there is enough truth in that for us to buy into it. But the biggest cause of our problems stares back at us every morning when we shave.

[CajunGent]

Good post/rant. I went back and took a look at the disclosure documents on a few pooled funds, that I invested in. And, in my opinion, the level of disclosure was less than what should have been required under the SEC disclosure requirements (pertaining to risk) in effect at the time. I never did have enough invested in the "pooled" funds to matter, but the lack of disclosure, especially on the subject of related party transactions is disturbing.

[terbul]

First, I personally believe most in the industry understood the fragile nature of the direction and choose to ignore it while the money rolled in. I know I was in many discussions during the subprime growth and I never met anyone who didn’t see it as a bubble that would burst.
I’m interested as to where the limits are.
Should Ponzi schemes be legal? Buyer beware and all.
How about the other way? If I can convince the bank to lend me a bunch of money based on some misinformation and I walk. Does the bank suck it up, or should there be laws; regulations?

[discreetgent]

Originally Posted by Rudyard K

Like Hitler did in the 30’s with the Jews, our government points at Fat Cats and says they are responsible for our plight in life. And there is enough truth in that for us to buy into it. But the biggest cause of our problems stares back at us every morning when we shave.

The rest of what you said was well said. I am sure you didn't mean it this way but your statement implies that there was some truth in what Hitler was saying about the Jews in the 1930's and I find that to be quite disturbing and offensive.

[Rudyard K]

Originally Posted by discreetgent

The rest of what you said was well said. I am sure you didn't mean it this way but your statement implies that there was some truth in what Hitler was saying about the Jews in the 1930's and I find that to be quite disturbing and offensive.

Point taken DG. It didn't hit me that way when I wrote it...but I can certainly see how you can ascribe that conclusion. Not my intent...or even close. Apologies!!

[atlcomedy]

Well, the text books we had when I was going to school blamed the Jews for everything
























Kidding....

Actually I didn't read RK's remarks to imply the Jews actually were responsible, just that Hitler claimed they were

And RK....haven't you been around the interwebs long enough to know any reference to Hitler, innocent as it may be, is recipe for disaster?

[ForumPoster]

Here is a main problem with out society in general and reason why we have arrived to current state of affairs.

FEELING OF ENTITLEMENT.

All humans are created equal, we all come to the world pretty much the same way, but then we travel different paths.

Who said that everyone has to own a house? Who said that everyone has a right to live beyond their means?

There are basic needs that we as developed society have to satisfy for all members.

Everyone has to have access to education and health care. Everyone has a right to have shelter and not go to bed hungry. Everyone has a right to be be safe.

But does everyone has a right to drive Rolls Royce? Or live in 10 bedroom home?

[Rudyard K]

Originally Posted by atlcomedy

And RK....haven't you been around the interwebs long enough to know any reference to Hitler, innocent as it may be, is recipe for disaster?

You would think I'd know better.

Actually, there are a lot of things I will rip DG a new a**hole about...but that for sure ain't one of them.

[atlcomedy]

Back to your original rant: Why?

A whole lot of people were making a whole lot of money. It didn't pay to ask questions.

[discreetgent]

Originally Posted by Rudyard K

You would think I'd know better.

Actually, there are a lot of things I will rip DG a new a**hole about...but that for sure ain't one of them.

lol

[Rudyard K]

Originally Posted by atlcomedy

Back to your original rant: Why?

A whole lot of people were making a whole lot of money. It didn't pay to ask questions.

Actually ATL, I don't ask why. I think that is a given. Like asking why a thirsty man drinks a glass of water.

The question is "What do we do now?"

Let's use Las Vegas as an example. I love to visit LV. I love the action, the sights and the fun. But I very seldom gamble. I'm not good at it. I really don't enjoy it that much. I don't know the odds. All in all, I guess I figure I gamble enough in my endeavors, I am pretty good at it, and that gives me all the thrill I need.

I understand though, that betting on things like "8 the hard way" or insurance at black jack or most of the roulette bets are pretty poor odds bets. Should the casino be required to ascertain that the gambler has the sophistication, the cash reserves and the requisite knowledge before they allow him to make a bet? Should the casino be telling him that a pass/don't pass bet is appropriate for someone of your economic level, but you can't make the "field" bet.

Would that be cheating the guy who has spent time studying the odds, and wants to make a bet, even though he may not have the money that a lot of the other players do?

You can make the casino post the odds on each and every bet right above the table. And 99% of the folks will never even look at it. Then those players will walk out of the casino thinking they got cheated by the casino.

We can put all the regulations we want on the casino. We can make them post all the warnings we want for the players. But we can't make the casino owners change the odds. If we do, they will lock the doors and go do something else. Because overall, they need those odds to be successful. I once saw a Pharo table in an old saloon. The description above it said the odds were not sufficiently in favor of the house in Pharo, and too many casinos went broke. Hence they don't play it anymore.

At the end of the day, about the only thing that will be effective is to not let people play who aren't qualified to play. Unfortunately that tends to keeps rich people rich, and poor people poor.

PJ makes the comment all the time about personal responsibility. Unfortunately, in a free society, there is no way around it.

[pjorourke]

Originally Posted by Rudyard K

PJ makes the comment all the time about personal responsibility. Unfortunately, in a free society, there is no way around it.

"There is only one basic human right, the right to do as you damn well please. And with it comes the only basic human duty, the duty to take the consequences."

[WTF]

Originally Posted by Rudyard K

I’m sure WTF will say that the Fat Cats took more than their share from the table…and to some extent I agree. Why shouldn’t they? They were (for the most part) stupidly selling a product to us that they really didn’t understand, and we were stupidly buying it, and paying them big money to do so. But limiting their ability to do so in the future?....

Why shouldn't they? Is that what you asked? Why shouldn't the snake oil salesman take all your money? Why shouldn't the bank robber take all your money. Hell I reckon they should if there is no ramifications for them doing so.

Why shouldn't the poor people vote to take all the fat cats money?

Damn what you smoking up there in Dallas?

I get personal responsibility...but it cuts both ways.

What you are asking it seems is "Is it ok to steal if nobody knows you are stealing?" Is ignorance a defense? Good question but I say no.

The bigger picture is how do people want to be governed. Do they want security over freedom. Believe it or not I want freedom. I do not want borders or price controls. If I live in Az. I do not want some law where some government worker can demand my papers. I'd show him some lead and tell him to move on. I'm an anchrist. Problem is we half ass things.

[atlcomedy]

Originally Posted by WTF

. I'm an anchrist. .

A what?

[Sydneyb]

Originally Posted by Rudyard K

At the end of the day, about the only thing that will be effective is to not let people play who aren't qualified to play. Unfortunately that tends to keeps rich people rich, and poor people poor.

PJ makes the comment all the time about personal responsibility. Unfortunately, in a free society, there is no way around it.

It seems to me that the biggest problem regarding the concept that in a free society, idiots are free to make bad decisions is that people made decisions based on bad information from Moody's.

Typically people of all levels of sophistication depend on hiring people to do work that they are not qualified to do. I can't lay tile - its way outside my skillset. But I know enough to know what to look for in a qualified tile guy; as a result, I got some good work goin' on in the tile department.

Because Moody's is responsible for 40% of the rating market and BRK had a financial stake in it (I totally trust Buffett to know who to hire), the expectation is that Moody's ratings were to be trusted.

Instead there was a recalibration of credit ratings on these subprime loans. I forget the term - I read about it back when it happened; a term that implied they were shortening the period of evaluation to make these triple A paper. Some kind of manipulation of the historicals by not going back far enough. Dammit - I know it has a technical term, but can't remember it.

Anyway, I don't believe its coincience that Moody's stock was at its highest in 2005 to 2007, while they were supporting wallstreet - actually PAID by wallstreet FOR the ratings - definitely a conflict of interest there...

In addition to the recalibration of ratings based on faulty historical analysis, some of the loan rating was increased as a result of being protected via credit default insurance - so bad paper was insured, therefore it was protected in case of default. But the insurance companies were so over leveraged they couldn't pay out when the going got rough -hence the fall of AIG when it all went to crap.

This is not (only) a matter of unsophisticated people drinking the koolaid. We depended on agencies to be telling the truth about the credit ratings when we made what should have been informed decisions. Those agencies had other incentives and were not working for the people buying, but the people selling.