4 ms·

Maybe I'm jaded or missing something obvious, but the point that seems bonkers to me is the part where the loan originator offloads 100% of the risk in the loan

Maybe I'm jaded or missing something obvious, but the point that seems bonkers to me is the part where the loan originator offloads 100% of the risk in the loans they originated. That seems like a very clear principle / agent problem where the originator no longer bears any risk for loan failure, only failure to sell the loan. That creates incentives for increasingly complicated/opaque packaging of loans that fail to sell - CDOs.

Zigurd 10y ago
Exactly. If you don't believe finanicialization is a problem, you have a tendency to believe more financial instruments are a good solution in all cases. You have only a hammer, everything looks like a nail.
prostoalex 10y ago
Having the pendulum swing to another opposite (requiring 100% of the loans to be kept on books) creates two problems I can see. Only wealthiest institutions can participate, so in good times rich get richer. It also creates a monopsony of loan buyers, likely increasing the costs of borrowing.
- atroyn 10y ago
  Both good points. I'd also note that it would be very hard if not impossible to legislate for the 'right' kinds of risk arbitrage and against the 'wrong' ones.
  - donw 10y ago
    I suspect that legislation will never be able to run ahead of the human capacity to rapidly and efficiently paint oneself into a corner. Rather than trying to prevent the resulting busts at all costs, it seems that it would be more effective to work towards building support systems that are antifragile in the face of economic downturns. Or have I totally missed the point here?
  - ScottBurson 10y ago
    So the best plan seems to be just to break the banks up to the point where they can be allowed to fail; be sure to allow them to fail when the time comes; and let natural selection do its thing.
- ak217 10y ago
  Fundamentally, the problem with loan writers unloading the loans is that it decouples their incentives. You end up with a fundamentally unstable system, where the loan writers are incentivized to further increase the spread between what the loans say and what the collateral or debtor is capable of, while offloading their liability so that it's evenly spread among the entire financial system. It doesn't matter that it makes loans more accessible (in fact to some degree that's part of the problem); it doesn't matter that it makes the market more efficient when the market is up. The decoupled incentives make the system prone to extremely painful crashes that are unfair to everyone.
  - nickff 10y ago
    I think you are getting to the core of the issue, which is that when the underwriter is decoupled from the result, they must either be regulated or their customers (the real creditors) must have skin in the game. The regulations have been ineffective (so far), and the creditors have always been bailed out; we should not be surprised that creditors are unscrupulous about lending to questionable borrowers.
    - josho 10y ago
      Or you know we could enforce our laws. Many of those loans were fraudulent and outright criminal to grant. The threat of years in jail is a pretty good way to keep people honest.
- s_kilk 10y ago
  > so in good times rich get richer. And then in the bad times... the rich get richer again. Christ, this stuff turns my stomach.
  - roflc0ptic 10y ago
    Mostly by accident I am reading "Capital in the 21st Century" by Thomas Piketty and "Debt" by David Graeber. Piketty is a liberal economist who is writing about the nature of income inequality. His thesis is that income inequality is basically inevitable without political intervention. Graeber is an anarchist anthropologist exploring the history of debt, and its relationship to social control. They are both very interesting in their own right, and they provide interesting counterpoint to each other. Using the framework of economics, Piketty sort of lays bare some serious structural problems. Graeber steps outside of that framework and challenges it. Highly recommend both of these to anyone interested in these things.
    - ionised 10y ago
      Just ordered these two, thanks. Any other texts you can recommend for someone who wants to know more about how this arcane world of economics and flow of captial actually works? Financial education is one aspect of my life I've always neglected and I wish to change that.
- dageshi 10y ago
  Perhaps having a rule where the originator must keep some meaningful percentage of the loan on its books would help, say 30%? Then the originator always has skin in the game.
  - josho 10y ago
    Or simply require verification of income. In Canada if you want a mortgage loan you are required to show proof of income, ie. a gov tax return showing your income. My understanding is that in the US verification of income was often waived making it possible to grant bad loans.

Zigurd 10y ago

Exactly. If you don't believe finanicialization is a problem, you have a tendency to believe more financial instruments are a good solution in all cases. You have only a hammer, everything looks like a nail.

prostoalex 10y ago

Having the pendulum swing to another opposite (requiring 100% of the loans to be kept on books) creates two problems I can see. Only wealthiest institutions can participate, so in good times rich get richer. It also creates a monopsony of loan buyers, likely increasing the costs of borrowing.

atroyn 10y ago
Both good points. I'd also note that it would be very hard if not impossible to legislate for the 'right' kinds of risk arbitrage and against the 'wrong' ones.
- donw 10y ago
  I suspect that legislation will never be able to run ahead of the human capacity to rapidly and efficiently paint oneself into a corner. Rather than trying to prevent the resulting busts at all costs, it seems that it would be more effective to work towards building support systems that are antifragile in the face of economic downturns. Or have I totally missed the point here?
- ScottBurson 10y ago
  So the best plan seems to be just to break the banks up to the point where they can be allowed to fail; be sure to allow them to fail when the time comes; and let natural selection do its thing.
ak217 10y ago
Fundamentally, the problem with loan writers unloading the loans is that it decouples their incentives. You end up with a fundamentally unstable system, where the loan writers are incentivized to further increase the spread between what the loans say and what the collateral or debtor is capable of, while offloading their liability so that it's evenly spread among the entire financial system. It doesn't matter that it makes loans more accessible (in fact to some degree that's part of the problem); it doesn't matter that it makes the market more efficient when the market is up. The decoupled incentives make the system prone to extremely painful crashes that are unfair to everyone.
- nickff 10y ago
  I think you are getting to the core of the issue, which is that when the underwriter is decoupled from the result, they must either be regulated or their customers (the real creditors) must have skin in the game. The regulations have been ineffective (so far), and the creditors have always been bailed out; we should not be surprised that creditors are unscrupulous about lending to questionable borrowers.
  - josho 10y ago
    Or you know we could enforce our laws. Many of those loans were fraudulent and outright criminal to grant. The threat of years in jail is a pretty good way to keep people honest.
s_kilk 10y ago
> so in good times rich get richer. And then in the bad times... the rich get richer again. Christ, this stuff turns my stomach.
- roflc0ptic 10y ago
  Mostly by accident I am reading "Capital in the 21st Century" by Thomas Piketty and "Debt" by David Graeber. Piketty is a liberal economist who is writing about the nature of income inequality. His thesis is that income inequality is basically inevitable without political intervention. Graeber is an anarchist anthropologist exploring the history of debt, and its relationship to social control. They are both very interesting in their own right, and they provide interesting counterpoint to each other. Using the framework of economics, Piketty sort of lays bare some serious structural problems. Graeber steps outside of that framework and challenges it. Highly recommend both of these to anyone interested in these things.
  - ionised 10y ago
    Just ordered these two, thanks. Any other texts you can recommend for someone who wants to know more about how this arcane world of economics and flow of captial actually works? Financial education is one aspect of my life I've always neglected and I wish to change that.
dageshi 10y ago
Perhaps having a rule where the originator must keep some meaningful percentage of the loan on its books would help, say 30%? Then the originator always has skin in the game.
- josho 10y ago
  Or simply require verification of income. In Canada if you want a mortgage loan you are required to show proof of income, ie. a gov tax return showing your income. My understanding is that in the US verification of income was often waived making it possible to grant bad loans.