Michael Osinski - How One Man Broke the US Economy

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http://nymag.com/news/business/55687/

[WVUFootball29]

http://nymag.com/news/business/55687/

 

Long, but absolutely a great read

[Sanners]

http://nymag.com/news/business/55687/

 

Great read. But, I thought conservative wisdom states that it was all Clinton's fault!

[DC Tom]

Great read. But, I thought conservative wisdom states that it was all Clinton's fault!

 

Nope. Carter's. Or Reagan's, maybe.

 

 

Actually, Osinski describes the root cause quite nicely and subtlely: the cavalier and sometimes non-existent approach to risk management that the mortgage bond desks at many of the major commercial and investment banks.

[Magox]

Very interesting read. Something new that I never knew. Once again, great read.

 

No doubt that he wasn't the cause of the financial debacle, if he didn't provide the software then someone else would of. Where there is a demand for a product or service, there will be a supplier of it.

 

Let's not kid ourselves. The Repeal of the Glass-Steagall act played a much much bigger role.

 

http://en.wikipedia.org/wiki/Glass-Steagall_Act

 

The legislation was signed into law by President Bill Clinton on November 12, 1999.

 

The banking industry had been seeking the repeal of Glass-Steagall since at least the 1980s. In 1987 the Congressional Research Service prepared a report which explored the case for preserving Glass-Steagall and the case against preserving the act

 

The argument for preserving Glass-Steagall (as written in 1987):

 

1. Conflicts of interest characterize the granting of credit -- lending -- and the use of credit -- investing -- by the same entity, which led to abuses that originally produced the Act.

 

2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

 

3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

 

4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

 

The argument against preserving the Act (as written in 1987):

 

1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.

 

2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.

 

3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them -- by diversification.

 

4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.[7]

 

 

Financial events following the repeal

The repeal enabled commercial lenders such as Citigroup, which was in 1999 the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities.[15] It is believed by some including Elizabeth Warren[16], one of the five outside experts who constitute the Congressional Oversight Panel of the Troubled Asset Relief Program, that the repeal of this act contributed to the Global financial crisis of 2008–2009[17] [18], although some maintain that the increased flexibility allowed by the repeal of Glass-Steagall mitigated or prevented the failure of some American banks.[19]

 

The year before the repeal, sub-prime loans were just 5% of all mortgage lending. By the time the credit crisis peaked in 2008, they were approaching 30%.

 

 

 

Now tell me that the repeal of the Glass-Steagall act wasn't the biggest influence that opened up the gates to the financial crisis that we are in.

 

Back to the article, I thought the very last paragraph was simple and insightful from his old professor buddy.

 

 

He mused that the U.S. government would, like Poland’s, make the currency worthless. What do we have, I wonder, that like the vodka in communist Poland, can be counted on to hold its value in this age?

[GG]

Now tell me that the repeal of the Glass-Steagall act wasn't the biggest influence that opened up the gates to the financial crisis that we are in.

 

Alrighty then, how do you explain foreign institutions who weren't subject to GS that got into trouble? GS didn't have jurisdiction over the types of products that got Lehman, Bear & AIG in trouble. Origination and selling of mortgages and then packaging them into securitizations to be sold to investors was not covered under GS.

 

Other than that, you may be on to something.

[Magox]

Alrighty then, how do you explain foreign institutions who weren't subject to GS that got into trouble? GS didn't have jurisdiction over the types of products that got Lehman, Bear & AIG in trouble. Origination and selling of mortgages and then packaging them into securitizations to be sold to investors was not covered under GS.

 

Other than that, you may be on to something.

You are misinformed and you sound like an apologist. The repeal of GS did enable large commercial banks to underwrite and trade mortgage backed securities, SIV's and CDO's. Many of these instruments were backed by sub prime mortgages, which consists of high risk of loan defaults, just as the article we read so eliquently had mentioned. The fact of the matter is that the year before the repeal of GS, only 5% of all mortgage lending were sub-prime loans, and by 2008 it reached 30%. Now if you think that there isn't a direct correlation between the two, then you are fooling yourself. You can't possibly think that the liquidity provided by these financial instruments didn't play a role in all this. Without the liquidity, the money would of never have been available for all the subprime lending. The repeal of the GS allowed tremendous liquidity to the markets, which were provided by these financial instruments of mass destruction. (which was one of the arguments for the repeal of GS, Greenspan fought with fervor to repeal the act, which he later confessed that he miscalculated the risk).

 

Couple this massive liquidity for subprime lending, greed, and the federal government pushing companies like Fannie Mae and Freddy Mac to lend more freely to people who should of never have gotten loans in the first place. You have yourself a recipe to disaster.

 

When the subprime mortgage markets fell apart, and btw I loved how both Secretary Treasury Paulson and Bernanke both said "the subprime mortgage markets are contained" when the liquidity dried up in these markets, then the rest of the SIV's, CDO's were inversely affected as a result. Liquidity dried up, and there were no more buyers to step in. With the mark to market accounting, these assets had to be marked down, credit ratings dropped like a rock, interest payments went through the roof, massive amount of collateral had to be put up, and as a result, everything fell apart. great institutions like Bear Stearns and Lehman collapsed.

 

This all would of never of happened without the repeal of the GS. That's the bottom line.

[Acantha]

Nope. Carter's. Or Reagan's, maybe.

Actually, Osinski describes the root cause quite nicely and subtlely: the cavalier and sometimes non-existent approach to risk management that the mortgage bond desks at many of the major commercial and investment banks.

 

"George Bush, in one of his speaches, said that Wall Street got drunk. And he was right, they were drunk. But so was main street--the whole country was drunk. But what he doesn't point out, is where did they get the alcohol? - Peter Schiff

 

From the article:

Now, an investor does not want a single person’s mortgage, much the same as you may not want to underwrite your sibling’s purchase of an overpriced McMansion. But when 1,000 similar loans are combined, and the U.S. government, through Freddie Mac and Fannie Mae, absorbs the default risk, you now have a nifty little AAA-rated piece of paper paying one or two points above Treasury bills.

[GG]

You are misinformed and you sound like an apologist.

 

OK, assuming your supposition is correct, and you're the expert, you should have no problems answering some Qs

 

The repeal of GS did enable large commercial banks to underwrite and trade mortgage backed securities, SIV's and CDO's.

 

What was the share of RMBS underwriting by financials who were previously subject to GS vs those that weren't?

 

Many of these instruments were backed by sub prime mortgages, which consists of high risk of loan defaults, just as the article we read so eliquently had mentioned. The fact of the matter is that the year before the repeal of GS, only 5% of all mortgage lending were sub-prime loans, and by 2008 it reached 30%.

 

Did anything else happen in the economy, technology or in financial markets at that time? Or was the repeal of GS the only thing? You are talking about an 11-yr time frame.

 

Now if you think that there isn't a direct correlation between the two, then you are fooling yourself. You can't possibly think that the liquidity provided by these financial instruments didn't play a role in all this. Without the liquidity, the money would of never have been available for all the subprime lending. The repeal of the GS allowed tremendous liquidity to the markets, which were provided by these financial instruments of mass destruction.

 

What is liquidity?

 

(which was one of the arguments for the repeal of GS, Greenspan fought with fervor to repeal the act, which he later confessed that he miscalculated the risk).

 

Which risk was he referring to?

 

Couple this massive liquidity for subprime lending, greed, and the federal government pushing companies like Fannie Mae and Freddy Mac to lend more freely to people who should of never have gotten loans in the first place. You have yourself a recipe to disaster.

 

Were FanFred covered by GS? If not, why bring them into the discussion?

 

Did GS govern banks' credit standards? If not, why bring them into the discussion?

 

When the subprime mortgage markets fell apart, and btw I loved how both Secretary Treasury Paulson and Bernanke both said "the subprime mortgage markets are contained" when the liquidity dried up in these markets, then the rest of the SIV's, CDO's were inversely affected as a result. Liquidity dried up, and there were no more buyers to step in. With the mark to market accounting, these assets had to be marked down, credit ratings dropped like a rock, interest payments went through the roof, massive amount of collateral had to be put up, and as a result, everything fell apart. great institutions like Bear Stearns and Lehman collapsed.

 

This all would of never of happened without the repeal of the GS. That's the bottom line.

 

Did SIVs, CDOs & other securitizations exist before GS was repealed? If they did, why bring them into the discussion?

[EZC-Boston]

I'm not all the educated on this topic but I believe someone here will offer up a lengthy and knowledgeable reply to GG and I look forward to reading it.

 

my $.02, i worked for a mortgage insurance company about 10 years ago and boy was greed the driving factor. My role was to research new markets for home ownership, focusing mainly on the spanish speaking population, basically we wanted to get as many people into houses as possible. i don't want to say they didn't care if people could afford to live there, i think they did, but they wanted to make is as cheap as possible for people to get into homes (a good thing, until things go south)

 

i remember my boss at the time telling me to buy stock in Fannie and Freddie, "they're supported by the government, if they fail, you'll still get your money"

[DC Tom]

"George Bush, in one of his speaches, said that Wall Street got drunk. And he was right, they were drunk. But so was main street--the whole country was drunk. But what he doesn't point out, is where did they get the alcohol? - Peter Schiff

 

From the article:

 

Yes, and that is a result of a many-decades US policy, across at least four and maybe five administrations and many Congresses, of promoting homeownership as a right rather than a responsibility; and relying on market forces to provide the brake on excessive risk while simultaneously promoting risk-taking in that market. The government laid the foundation for this house of cards by playing roulette (pardon the mixed metaphor) with taxpayer money, through Fannie and Freddie.

 

Don't believe it? Then explain why Fannie and Freddie are insolvent after years of relaxing standards, whereas Ginnie - which only backs loans that meet strict HUD and VA mortgage requirements - is not just solvent, but one of the few government programs that actually makes money?

[Chef Jim]

I'm not all the educated on this topic but I believe someone here will offer up a lengthy and knowledgeable reply to GG and I look forward to reading it.

 

my $.02, i worked for a mortgage insurance company about 10 years ago and boy was greed the driving factor. My role was to research new markets for home ownership, focusing mainly on the spanish speaking population, basically we wanted to get as many people into houses as possible. i don't want to say they didn't care if people could afford to live there, i think they did, but they wanted to make is as cheap as possible for people to get into homes (a good thing, until things go south)

 

i remember my boss at the time telling me to buy stock in Fannie and Freddie, "they're supported by the government, if they fail, you'll still get your money"

 

So what restaurant is your ex-boss bussing tables at right now?

[DC Tom]

Were FanFred covered by GS? If not, why bring them into the discussion?

 

 

And why call them lenders?

 

I've never seen a Fannie or Freddie mortgage. And I've seen a hell of a lot of loan origination information.

[Chef Jim]

Yes, and that is a result of a many-decades US policy, across at least four and maybe five administrations and many Congresses, of promoting homeownership as a right rather than a responsibility; and relying on market forces to provide the brake on excessive risk while simultaneously promoting risk-taking in that market. The government laid the foundation for this house of cards by playing roulette (pardon the mixed metaphor) with taxpayer money, through Fannie and Freddie.

 

Don't believe it? Then explain why Fannie and Freddie are insolvent after years of relaxing standards, whereas Ginnie - which only backs loans that meet strict HUD and VA mortgage requirements - is not just solvent, but one of the few government programs that actually makes money?

 

Nothing to explain, you explained it right there. We had a friend who got a VA loan last year and the hoops they had to jump through we're incredible. And they're not going anywhere, they'll probably die in that house.

[BuffaloBill]

very interesting thread. I will be returning to it after I leave the office and have time to really read for detail. Good points being expressed all around. Points to the complexity of the issues. I like the fact that generally it is recognized that several administrations and both political parties have had roles in this situation. I am surprised that nobody has mentioned the Fed's role and especially Volker and Greenspan's role in the mess. My hunch is that while Greenspan was thought of as a great Fed leader a look back from from a point further (once we have made it past the current crisis) in the future may not be so kind.

[Lurker]

To say this guy created the credit market meltdown is to say that road builders are responsible for drunk driving deaths.

 

Piss poor, if not outright fraudulent underwriting by shady mortgage originators, facilitated by 'pay me a fee and I'll give everything a triple-A' rating agencies and the equally culpable 'asleep at the switch' regulators are the real bad actors in this story, IMO. Oh yeah, don't forget the 'housing prices always go up, right?' appraisal industry as well...

[Lurker]

My hunch is that while Greenspan was thought of as a great Fed leader a look back from from a point further (once we have made it past the current crisis) in the future may not be so kind.

That's already happening. A lot of MMQBs say the Greenspan Fed kept short-term interest rates too low for too long after the 2001 recession, causing many investors to go further out on the risk curve to chase higher returns. With a AAA-rating on a RMBS or CDO, why not get a few more basis points return than what riskless treasuries were paying?

 

I think Greenspan clearly misjudged the fraud element of the subprime mortgage market, which was the 'black swan' event that made this bubble so hard to judge early in the cycle...

[Acantha]

Yes, and that is a result of a many-decades US policy, across at least four and maybe five administrations and many Congresses, of promoting homeownership as a right rather than a responsibility; and relying on market forces to provide the brake on excessive risk while simultaneously promoting risk-taking in that market. The government laid the foundation for this house of cards by playing roulette (pardon the mixed metaphor) with taxpayer money, through Fannie and Freddie.

 

Don't believe it? Then explain why Fannie and Freddie are insolvent after years of relaxing standards, whereas Ginnie - which only backs loans that meet strict HUD and VA mortgage requirements - is not just solvent, but one of the few government programs that actually makes money?

Who's arguing? I'm against all of these government policies and interventions that are common in our country today. And yes, I blame every administration, party, and organization that plays along.

[GG]

To say this guy created the credit market meltdown is to say that road builders are responsible for drunk driving deaths.

 

Piss poor, if not outright fraudulent underwriting by shady mortgage originators, facilitated by 'pay me a fee and I'll give everything a triple-A' rating agencies and the equally culpable 'asleep at the switch' regulators are the real bad actors in this story, IMO. Oh yeah, don't forget the 'housing prices always go up, right?' appraisal industry as well...

 

You forgot the willing takers of the free lunch and the gullible press praising the masters of the universe. There's enough blame to go around. And yes, it's a bit self serving to think that one programmer created the mortgage bomb. If you pick one name who started it all, then it should be Lou Ranieri.

[Lurker]

If you pick one name who started it all, then it should be Lou Ranieri.

I saw Ranieri in a video from Mike Milken's recent conference and I wouldn't pin the blame on him. That's like saying Samuel Colt was ultimately responsible for drive by shootings.

 

Securitization, in and of itself, isn't a bad innovation. It's the unscrupulous folks who took advantage of the system while the SEC twiddled its thumbs that bear the largest blame, IMO.

 

And don't get me started on the gullible fourth estate...