4 ms·

The AAA rating for the senior tranches was perfectly correct assuming the risk of the underlying mortgages was properly estimated. The bulk of the buyers of th

The AAA rating for the senior tranches was perfectly correct assuming the risk of the underlying mortgages was properly estimated. The bulk of the buyers of the AAA tranches were other banks, and the reason was satisfying requirements for capital reserves. If bank A and B both have portfolios of mortgages worth $1B, they are treated as having $1B of risky assets and do not satisfy capitalization requirements. If they securitize the portfolios and sell each other a $700M senior tranch (while holding the equity tranches themselves), bank A and B are both considered to have $700M in cash-like reserves. This does reduce the risk caused by regional house price decreases which is why regulators wanted banks to do it. (No one, including regulators, expected a national/global drop in real estate values.) Also, the idea that the mispricing was intentional is silly. The issuing banks mostly held onto the equity tranches and suffered as a result - not the actions one would take if you knew things would tank.

wheaties 11y ago
No, they sold those too. Look up CDO and CDO squared to see where those things went. That said, super senior subprime mortgage binds did exceptionally well as investments. It was the BBB stuff which had near 100% loss.
- yummyfajitas 11y ago
  CDO^2 was a minor part of the market, and again is also a valid thing to do provided the assumptions are right. According to the "evil actor/information assymmetry" theory, the people closest to the mortgage issuance should have been the ones who survived the crisis best (since their information was the most accurate). In contrast, the dumb investment banks back in NY should have been hurt the worst. That's the exact opposite of what happened.
  - crdoconnor 11y ago
    >According to the "evil actor/information assymmetry" theory, the people closest to the mortgage issuance Several thousand appraisers actually wrote a letter to Congress complaining that they were being pressured to inflate their home appraisals or face blacklisting. This went back to 1999.
    - yummyfajitas 11y ago
      What, exactly, do you believe this proves?
Retric 11y ago
Raiting agency's are paid by security seller, and have huge financial incentives not to look to closely at any one deal. So sure, you can pretend that all risks are independent, but this was a clear case of corruption not incompetence. Note: Many people brought up how crap these models where both in and outside of these raiting agency's.
- yummyfajitas 11y ago
  Rating a CDO AAA is beneficial for regulatory purposes - it allows banks to use a senior tranche as a capital reserve. This does not change the fact that everyone else - banks, hedge fund buyers, mortgage issuers, regulators - made the same assumptions. Even if everyone independently made the same wrong assumptions, rather than one possibly corrupt party doing it for them, the result would be the same.
  - Retric 11y ago
    Sure, AAA really was more about the label than actual benefit. Still, I think it's important to understand most of these people where not idiots. There incentives just got wacky. I spoke with a few Mortgage issuers in this time period they could generally resell the whole mortgage fairly easily so throughput quickly became more important than quality because they where just selling them to someone else. And often wondering who the bleep would buy this crap. The buyers where often working with other peoples money, sure it might tank in a few years but they had little exposure to the downside. Making a few years of slightly above average returns worth it. Finally, I am not sure US regulators dropped to ball on this one as much as you might think. A huge chunk of these security's where sold outside of the US, so over a 20 year period this extracted a lot of foreign money 'for free'. As in we sold paper and got paid for it.
    - crdoconnor 11y ago
      >Sure, AAA really was more about the label than actual benefit. AAA is not just a label. It's about being allowed to sell to unsophisticated buyers who can't tell that you're taking them for a ride. It's also about being able to use the asset to count towards your capital reserves, so you can take more risk (as a bank) and get higher profits.
crdoconnor 11y ago
>Also, the idea that the mispricing was intentional is silly. The issuing banks mostly held onto the equity tranches and suffered as a result - not the actions one would take if you knew things would tank. We've been over this before. Banks are not people. The people in the banks were trying to sell these things so that they could collect commissions. They didn't give a shit if the bank suffered. I suggest you read this: https://en.wikipedia.org/wiki/Control_fraud https://en.wikipedia.org/wiki/Control_fraud And then this: https://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem https://en.wikipedia.org/wiki/Principal%E2%80%93agent_proble... And then reconsider your notions of what is 'silly'.
- yummyfajitas 11y ago
  If you want to assert that assorted bad actors screwed over the banks, by all means. I agree that many homeowners, agents and others did in fact screw over mortgage issuers - in many cases fraudulently. I'm sure various traders also marked to model in order to get a bonus this year without caring about next year (in their case not so fraudulently). You are correct that the sympathetic voters who engaged in mortgage fraud/etc are not being prosecuted, and are in fact being rewarded by craven politicians. My apologies - I misread your first comment as somehow suggesting that ratings agencies and securitizers were deliberately attempting to cause mispricing.
  - maxerickson 11y ago
    The Senate Permanent Subcommittee on Investigations believed that the banks were putting pressure on the ratings agencies to deliver good ratings: http://www.hsgac.senate.gov//imo/media/doc/Financial_Crisis/FinancialCrisisReport.pdf http://www.hsgac.senate.gov//imo/media/doc/Financial_Crisis/... It's a huge document, V.D, pdf page 274, document page 267, doesn't really dance around the issue: The Subcommittee’s investigation uncovered a host of factors responsible for the inaccurate credit ratings assigned by Moody’s and S&P to RMBS and CDO securities. Those factors include the drive for market share, pressure from investment banks to inflate ratings, inaccurate rating models, and in adequate rating and surveillance resources. In addition, federal regulations that limited certain financial institutions to the purchase of investment grade financial instruments encouraged investment banks and investors to pursue and credit rating agencies to provide those top ratings. All these factors played out against the backdrop of an ongoing conflict of interest that arose from how the credit rating agencies earned their income. If the credit rating agencies had issued ratings that accurately exposed the increasing risk in the RMBS and CDO markets, they may have discouraged investors from purchasing those securities, slowed the pace of securitizations, and as a result reduced their own profits. It was not in the short term economic self-interest of either Moody’s or S&P to provide accurate credit risk ratings for high risk RMBS and CDO securities. (But I agree that there were 2 parties involved in each of the bad loans, the evil bank story is an appealing populist narrative, but not at all the full story.)

wheaties 11y ago

No, they sold those too. Look up CDO and CDO squared to see where those things went. That said, super senior subprime mortgage binds did exceptionally well as investments. It was the BBB stuff which had near 100% loss.

yummyfajitas 11y ago
CDO^2 was a minor part of the market, and again is also a valid thing to do provided the assumptions are right. According to the "evil actor/information assymmetry" theory, the people closest to the mortgage issuance should have been the ones who survived the crisis best (since their information was the most accurate). In contrast, the dumb investment banks back in NY should have been hurt the worst. That's the exact opposite of what happened.
- crdoconnor 11y ago
  >According to the "evil actor/information assymmetry" theory, the people closest to the mortgage issuance Several thousand appraisers actually wrote a letter to Congress complaining that they were being pressured to inflate their home appraisals or face blacklisting. This went back to 1999.
  - yummyfajitas 11y ago
    What, exactly, do you believe this proves?

Retric 11y ago

Raiting agency's are paid by security seller, and have huge financial incentives not to look to closely at any one deal. So sure, you can pretend that all risks are independent, but this was a clear case of corruption not incompetence. Note: Many people brought up how crap these models where both in and outside of these raiting agency's.

yummyfajitas 11y ago
Rating a CDO AAA is beneficial for regulatory purposes - it allows banks to use a senior tranche as a capital reserve. This does not change the fact that everyone else - banks, hedge fund buyers, mortgage issuers, regulators - made the same assumptions. Even if everyone independently made the same wrong assumptions, rather than one possibly corrupt party doing it for them, the result would be the same.
- Retric 11y ago
  Sure, AAA really was more about the label than actual benefit. Still, I think it's important to understand most of these people where not idiots. There incentives just got wacky. I spoke with a few Mortgage issuers in this time period they could generally resell the whole mortgage fairly easily so throughput quickly became more important than quality because they where just selling them to someone else. And often wondering who the bleep would buy this crap. The buyers where often working with other peoples money, sure it might tank in a few years but they had little exposure to the downside. Making a few years of slightly above average returns worth it. Finally, I am not sure US regulators dropped to ball on this one as much as you might think. A huge chunk of these security's where sold outside of the US, so over a 20 year period this extracted a lot of foreign money 'for free'. As in we sold paper and got paid for it.
  - crdoconnor 11y ago
    >Sure, AAA really was more about the label than actual benefit. AAA is not just a label. It's about being allowed to sell to unsophisticated buyers who can't tell that you're taking them for a ride. It's also about being able to use the asset to count towards your capital reserves, so you can take more risk (as a bank) and get higher profits.

crdoconnor 11y ago

>Also, the idea that the mispricing was intentional is silly. The issuing banks mostly held onto the equity tranches and suffered as a result - not the actions one would take if you knew things would tank. We've been over this before. Banks are not people. The people in the banks were trying to sell these things so that they could collect commissions. They didn't give a shit if the bank suffered. I suggest you read this: https://en.wikipedia.org/wiki/Control_fraud https://en.wikipedia.org/wiki/Control_fraud And then this: https://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem https://en.wikipedia.org/wiki/Principal%E2%80%93agent_proble... And then reconsider your notions of what is 'silly'.

yummyfajitas 11y ago
If you want to assert that assorted bad actors screwed over the banks, by all means. I agree that many homeowners, agents and others did in fact screw over mortgage issuers - in many cases fraudulently. I'm sure various traders also marked to model in order to get a bonus this year without caring about next year (in their case not so fraudulently). You are correct that the sympathetic voters who engaged in mortgage fraud/etc are not being prosecuted, and are in fact being rewarded by craven politicians. My apologies - I misread your first comment as somehow suggesting that ratings agencies and securitizers were deliberately attempting to cause mispricing.
- maxerickson 11y ago
  The Senate Permanent Subcommittee on Investigations believed that the banks were putting pressure on the ratings agencies to deliver good ratings: http://www.hsgac.senate.gov//imo/media/doc/Financial_Crisis/FinancialCrisisReport.pdf http://www.hsgac.senate.gov//imo/media/doc/Financial_Crisis/... It's a huge document, V.D, pdf page 274, document page 267, doesn't really dance around the issue: The Subcommittee’s investigation uncovered a host of factors responsible for the inaccurate credit ratings assigned by Moody’s and S&P to RMBS and CDO securities. Those factors include the drive for market share, pressure from investment banks to inflate ratings, inaccurate rating models, and in adequate rating and surveillance resources. In addition, federal regulations that limited certain financial institutions to the purchase of investment grade financial instruments encouraged investment banks and investors to pursue and credit rating agencies to provide those top ratings. All these factors played out against the backdrop of an ongoing conflict of interest that arose from how the credit rating agencies earned their income. If the credit rating agencies had issued ratings that accurately exposed the increasing risk in the RMBS and CDO markets, they may have discouraged investors from purchasing those securities, slowed the pace of securitizations, and as a result reduced their own profits. It was not in the short term economic self-interest of either Moody’s or S&P to provide accurate credit risk ratings for high risk RMBS and CDO securities. (But I agree that there were 2 parties involved in each of the bad loans, the evil bank story is an appealing populist narrative, but not at all the full story.)