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Except that derivatives were not the cause of the financial crisis. Over-enthusiastic mortgage lending to poor borrowers caused the financial crisis.

by retube 11y ago

RobertoG 11y ago
Over-enthusiastic mortgage lending to poor borrowers without risk, because the risk was wisely managed and diversified through perfectly designed, financial, innovative products that covered all the bases (for a nice commission, of course).
- retube 11y ago
  Yes but those products (Mortgage backed Securities) are cash products, like a bond or equity, NOT a derivative.
  - RobertoG 11y ago
    Depends on the definition. The wikipedia editors think it is: https://en.wikipedia.org/wiki/Derivative_%28finance%29#Mortgage-backed_securities https://en.wikipedia.org/wiki/Derivative_%28finance%29#Mortg...
- skylan_q 11y ago
  The mortgages everything was based on were junk, because they were guaranteed by the GSEs that couldn't handle the rate and size of the defaults on junk mortgages. Everything based on junk mortgages were junk.
daveguy 11y ago
That is one part of it. Those mortgages could be blended into derivatives, which could then be run up in a speculative bubble. Pretending there was a single cause for the financial crisis is a little disingenuous on both our parts.
- retube 11y ago
  what does "blended into derivatives" mean? Yes mortgages were sold on a packaged up into MBS (Mortgage back securities), but these are cash products, like a bond or equity, NOT a derivative.
  - maxerickson 11y ago
    There were MBSs built by splitting bundles of other MBSs into various tranches. Those certainly seem to be derivatives. What would they be called if they aren't derivatives?
    - JumpCrisscross 11y ago
      Portfolios. There are synthetic MBSs, too. Those are derivatives. They were also relatively uncommon.
    - retube 11y ago
      > What would they be called if they aren't derivatives? Securitised bonds, which is a cash product. The distinction between a cash & derivative product is really simple - one is leveraged the other isn't. E.g if I buy 100m of MBS I actually have to cough up 100m in cash - I am buying both the interest and principal repayments of the underlying mortgages. On the other hand if I enter into an interest rate swap with 100m notional I don't pay anything at all (assuming traded at spot market levels, and ignoring initial margin). The risk, or sensitivity, to interest rates is the same on both, but am only paying out cash for the securitised bond. Hence the bond, or MBS is "cash" and the swap is "derivative".
  - deleted 11y ago
    [deleted]
  - daveguy 11y ago
    Ahh. I stand corrected. Looking at your later post (which for some reason I can't respond to directly): so the derivatives are just what amplified the MBS crash with leverage -- allowed organizations to put more money into toxic MBS assets than they would normally be able to with cash? All the splitting and recombining of MBS does that not act as a vehicle for laundering or coverup? I mean it wasn't technically laundering because it was completely legal to offer mortgages to people who couldn't afford them. But didn't the MBS allow banks to resell those poor assets which normally wouldn't have been sought after as investments? And the investments were leveraged through derivatives so that crashing of the poor quality assets were amplified? So it seems that there was a complex interaction of unregulated financial vehicles that caused the crisis and not simply "bad mortgages" or simply "derivatives" or simply "MBS". Any one of those alone would not have caused a huge bubble and crash, right? I do not have a background in finance, but I think it is important for a layperson to understand what happened.
jackcosgrove 11y ago
Derivatives did exacerbate the unwinding of the mortgage mess, because the chain of title was so convoluted. I've read reports of people who were given homes in south Florida because the owners of mortgage debt were unable to finish foreclosure proceedings before the statute of limitations ran out. That is an extreme case, but the milder case of banks being landlords when that's not what they're good at, plus borrowers being stuck in foreclosure limbo longer than should be necessary, introduces unnecessary friction in the economy that wastes time and money. This could be the self-regulating limit for derivatives - the legal time required to unwind them in the case of mass redemptions, bounded by the business cycle length and statute of limitations for a locality.
mullingitover 11y ago
Weren't the banks selling each other credit default swaps they couldn't cover, such that the moment a single bank went under it triggered the collapse of the entire banking system? Blaming the mortgage lending is like saying, "I didn't blow up the neighborhood with my unsupervised warehouse full of explosives, it was those damn kids playing with matches!"
sxcurry 11y ago
Some economists call this view "The Big Lie". See Krugman's column today: https://www.nytimes.com/2015/12/18/opinion/the-big-short-housing-bubbles-and-retold-lies.html https://www.nytimes.com/2015/12/18/opinion/the-big-short-hou...

Except that derivatives were not the cause of the financial crisis. Over-enthusiastic mortgage lending to poor borrowers caused the financial crisis.

by retube 11y ago

Except that derivatives were not the cause of the financial crisis. Over-enthusiastic mortgage lending to poor borrowers caused the financial crisis.

RobertoG 11y ago

Over-enthusiastic mortgage lending to poor borrowers without risk, because the risk was wisely managed and diversified through perfectly designed, financial, innovative products that covered all the bases (for a nice commission, of course).

retube 11y ago
Yes but those products (Mortgage backed Securities) are cash products, like a bond or equity, NOT a derivative.
- RobertoG 11y ago
  Depends on the definition. The wikipedia editors think it is: https://en.wikipedia.org/wiki/Derivative_%28finance%29#Mortgage-backed_securities https://en.wikipedia.org/wiki/Derivative_%28finance%29#Mortg...
skylan_q 11y ago
The mortgages everything was based on were junk, because they were guaranteed by the GSEs that couldn't handle the rate and size of the defaults on junk mortgages. Everything based on junk mortgages were junk.

daveguy 11y ago

That is one part of it. Those mortgages could be blended into derivatives, which could then be run up in a speculative bubble. Pretending there was a single cause for the financial crisis is a little disingenuous on both our parts.

retube 11y ago
what does "blended into derivatives" mean? Yes mortgages were sold on a packaged up into MBS (Mortgage back securities), but these are cash products, like a bond or equity, NOT a derivative.
- maxerickson 11y ago
  There were MBSs built by splitting bundles of other MBSs into various tranches. Those certainly seem to be derivatives. What would they be called if they aren't derivatives?
  - JumpCrisscross 11y ago
    Portfolios. There are synthetic MBSs, too. Those are derivatives. They were also relatively uncommon.
  - retube 11y ago
    > What would they be called if they aren't derivatives? Securitised bonds, which is a cash product. The distinction between a cash & derivative product is really simple - one is leveraged the other isn't. E.g if I buy 100m of MBS I actually have to cough up 100m in cash - I am buying both the interest and principal repayments of the underlying mortgages. On the other hand if I enter into an interest rate swap with 100m notional I don't pay anything at all (assuming traded at spot market levels, and ignoring initial margin). The risk, or sensitivity, to interest rates is the same on both, but am only paying out cash for the securitised bond. Hence the bond, or MBS is "cash" and the swap is "derivative".
- deleted 11y ago
  [deleted]
- daveguy 11y ago
  Ahh. I stand corrected. Looking at your later post (which for some reason I can't respond to directly): so the derivatives are just what amplified the MBS crash with leverage -- allowed organizations to put more money into toxic MBS assets than they would normally be able to with cash? All the splitting and recombining of MBS does that not act as a vehicle for laundering or coverup? I mean it wasn't technically laundering because it was completely legal to offer mortgages to people who couldn't afford them. But didn't the MBS allow banks to resell those poor assets which normally wouldn't have been sought after as investments? And the investments were leveraged through derivatives so that crashing of the poor quality assets were amplified? So it seems that there was a complex interaction of unregulated financial vehicles that caused the crisis and not simply "bad mortgages" or simply "derivatives" or simply "MBS". Any one of those alone would not have caused a huge bubble and crash, right? I do not have a background in finance, but I think it is important for a layperson to understand what happened.

jackcosgrove 11y ago

Derivatives did exacerbate the unwinding of the mortgage mess, because the chain of title was so convoluted. I've read reports of people who were given homes in south Florida because the owners of mortgage debt were unable to finish foreclosure proceedings before the statute of limitations ran out. That is an extreme case, but the milder case of banks being landlords when that's not what they're good at, plus borrowers being stuck in foreclosure limbo longer than should be necessary, introduces unnecessary friction in the economy that wastes time and money. This could be the self-regulating limit for derivatives - the legal time required to unwind them in the case of mass redemptions, bounded by the business cycle length and statute of limitations for a locality.

mullingitover 11y ago

Weren't the banks selling each other credit default swaps they couldn't cover, such that the moment a single bank went under it triggered the collapse of the entire banking system? Blaming the mortgage lending is like saying, "I didn't blow up the neighborhood with my unsupervised warehouse full of explosives, it was those damn kids playing with matches!"

sxcurry 11y ago

Some economists call this view "The Big Lie". See Krugman's column today: https://www.nytimes.com/2015/12/18/opinion/the-big-short-housing-bubbles-and-retold-lies.html https://www.nytimes.com/2015/12/18/opinion/the-big-short-hou...