Financial Reform

[Texas Proud]

Agree about the interest rate hedge (although the S&L crisis of the early 90's did). But this was the original reason banks started to sell their originated mortgages off. Wasn't credit risk as many of those mortgages were insured. Canadian banks generally keep their mortgages on their books and the hedging is pretty easy. Texas proud- I was trying to explain and propose changes to the US mortgage market which in my opinion would help prevent the kind of problems you have had in your financial markets. Keep in mind this was a real estate related problem that started it.

Go back and read my post... it was not directed at you... then read it again... slowly.... and you will see why I am asking

 

[Danmar]

I read it verrrrry slowly- still no idea what else you could be referring to. Help me out?

 

[IndependentlyPoor]

There are major flaws in the US mortgage market. 1) Banks can't afford to keep most mortgages on their books because they can't hedge the interest rate risk 2) They can't hedge the interest rate risk due to the imbedded option the borrower has to refinance and the term of the mortgages are so long (often 30 years)

I respectfully disagree. Assessing interest rate/inflation risk is one of the reasons these guys get paid the big bux. If this were not possible (or at least if a zillion folks didn't believe it were possible) then the treasury would never be able to sell 20 or 30 year bonds. Likewise, the refinancing option is also built into the price of the mortgage. These are some of the reasons that mortgage backed securities have historically paid higher interest rates than non-callable corporate bonds.

 

[jIMOh]

One thing I will add, PMI failed the system... anyone with less than 20% down **SHOULD** have had PMI. This was to cover the banks risk.

So PMI should be outlawed, because when we needed mortgage insurance the most, it didn't work.

 

[IndependentlyPoor]

I don't want to sound like I am ranting (although I am), but many folks don't realize that our present goofy system of bond issuers paying the rating agencies is a fairly recent innovation.

This from
Agency Problems—and Their Solution — The American, A Magazine of Ideas
a website that I admit to knowing nothing about, but this Q&A sounded reasonable.

Q. How do the rating agencies earn their living? Who pays them?
A. The original business model for the rating agencies, established when John Moody published the first publicly available ratings in 1909, was an “investor pays” model. Moody, and subsequently other rating agencies, sold thick “rating manuals” to bond investors. In the early 1970s the Big Three changed to an “issuer pays” business model, which means that an issuer of bonds pays fees to the rating agency that rates its bonds. This model continues today. The three smaller U.S. agencies, however, maintain an “investor pays” model.
Q. Why the change to the “issuer pays” business model?
A. There is no definitive answer. Here are some leading candidates: First, the early 1970s was the era when high-speed photocopying machines became commonplace, and the rating agencies may well have feared that widespread copying by bond investors of their ratings manuals would reduce their revenues. Next, the rating agencies may have belatedly realized that the issuers needed ratings in order to sell their bonds to regulated financial institutions, for the reasons mentioned above, therefore the issuers should be willing to pay for a rating (and photocopying wouldn’t interfere with fees charged to issuers). Finally, the unexpected bankruptcy of the Penn-Central Railroad rattled the bond markets and may have made bond issuers willing to pay credit rating agencies to vouch for their creditworthiness (although that bankruptcy should also have increased bond investors’ willingness to pay to discover who was more creditworthy).
Q. Doesn’t the “issuer pays” business model create a conflict of interest?
A. It certainly creates the potential for conflict of interest. If the credit rating agency is being paid by the bond issuer—and the bond issuer has the ability to “shop around” for another rating by a different rating agency—then the issuers may well have leverage with the rating agencies, and the latter may shade their ratings in favor of issuers in order to keep the engagement.
The rating agencies used to argue that they took special efforts to make sure that this potential didn’t become an actuality. They have now acknowledged that the problem is greater than they had earlier admitted and that additional steps, including greater transparency, are required to deal with the problem.
The rating agencies also argue that even an “investor pays” business model can involve some conflicts, since investors would prefer lower ratings (and thus higher yields) for newly issued bonds, as would anyone who has sold short any other security of the issuing entity. With respect to subsequent downgrades, investors who already own the bonds would disfavor them, while short sellers would welcome them. Nevertheless, the potential conflicts seem substantially less severe than for the “issuer pays” model.
Finally, the rating agencies point out that the “issuer pays” model has the advantage of rapid dissemination of ratings to the market, whereas an “investor pays” model would require some lag in general dissemination. But if the former ratings are less accurate than the latter would be, then the advantages of speedy dissemination are clearly muted.
Q. Was the “issuer pays” model even more of a potential problem in the rating of the mortgage-related securities?
A. Yes it was. Unlike the rating of a corporate bond or a government bond, where the existing structure of the entity that is to be rated is largely a given (although judgments about future prospects can clearly be more subjective), the underlying mortgage (and other) collateral and the payment structures of the mortgage-related securities were largely malleable. Thus the rating agencies worked closely with the packagers/issuers to determine collateral requirements and payment structures, which—at a minimum—heightened the appearance problems of the “issuer pays” model.

The SEC effectively granted monopolies to the big agencies, implicitly accepting their inherently conflicted business model.
Concept Release: Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws; Release Nos. 33-8236; 34-47972; IC-26066; File No. S7-12-03

[FONT=Verdana,Arial,Helvetica]Since 1975, the Commission has relied on credit ratings from market-recognized credible rating agencies for distinguishing among grades of creditworthiness in various regulations under the federal securities laws. These credit rating agencies, known as "nationally recognized statistical rating organizations," or "NRSROs," are recognized as such by Commission staff through the no-action letter process. There currently are four NRSROs3 — Moody's Investors Service, Inc.; Fitch, Inc.; Standard & Poor's, a division of The McGraw-Hill Companies, Inc.; and Dominion Bond Rating Service Limited ("DBRS").4 Although the Commission originated the use of the term "NRSRO" for a narrow purpose in its own regulations, ratings by NRSROs today are widely used as benchmarks in federal and state legislation, rules issued by financial and other regulators, foreign regulatory schemes, and private financial contracts.[/FONT]

in fact, these agencies seem to be protected from civil liabilities
The Harvard Law School Forum on Corporate Governance and Financial Regulation » SEC Amends Rules Related to Credit Rating Agencies

[the] Securities Act Rule 436(g), which currently exempts NRSROs (but not other credit rating agencies) from liability as “experts” under Section 11 of that Act.

There is a whole bunch out there about new SEC regulations, both proposed and recently enacted, but they seem pretty lily-levered to me. Instead of preventing bond issuers from paying for ratings, they simply required disclosure. Whoopde-effing-do.
op-cit:

In brief, the amendments would require such issuers to describe in their registration statements:
...the identity of the person who paid for the credit rating, and whether the rating agency or its affiliates provided other services to the registrant or its affiliates over a specified period of time (as well as any related fees); and
any final ratings not used by a registrant, as well as whether any “preliminary ratings” were obtained from rating agencies in a practice known as “ratings shopping.”

So here we are. Bond issuers work hand-in-glove to get tranches AAA ratings in return for big fees, perfectly legal and nothing under the table you understand, but wink-wink-nudge-nudge.

 

[chinaco]

What is this

"No optinion"

Oops.

 

[Texas Proud]

I read it verrrrry slowly- still no idea what else you could be referring to. Help me out?

It is misspelled... so am asking what it is... I guess the joke was lost if others did not see it...

 

[Danmar]

OK I get it. I failed to go back to OP. Cheers.

 

[Danmar]

I respectfully disagree. Assessing interest rate/inflation risk is one of the reasons these guys get paid the big bux. If this were not possible (or at least if a zillion folks didn't believe it were possible) then the treasury would never be able to sell 20 or 30 year bonds. Likewise, the refinancing option is also built into the price of the mortgage. These are some of the reasons that mortgage backed securities have historically paid higher interest rates than non-callable corporate bonds.

You make good points but pricing a security is quite different then hedging one. The hedges and underlying can often diverge in price in unexpected ways. I once studied the financial statements of WAMU. I defy anyone to understand how their mortgage hedges worked. I doubt they did at least not very well.

 

[IndependentlyPoor]

You make good points but pricing a security is quite different then hedging one. The hedges and underlying can often diverge in price in unexpected ways. I once studied the financial statements of WAMU. I defy anyone to understand how their mortgage hedges worked. I doubt they did at least not very well.

I suspect that you know much more than I about this, so I will tiptoe out of this conversation.
Well, maybe one last word...
I believe that WaMu very much wanted to obscure what they were doing. They didn't want anyone to understand those hedges. The reason? They were trying to conceal the fact that they were up to their ears in "liar loans", "sub-prime loans" and other creepy "creative financing". (This is from my admittedly faulty memory. Please correct me if I am wrong.)

Do plain-Jane 20% down, verified income, verified disposable income mortgages really required elaborate hedging?

Fill me in if my ignorance is showing.

 

[Danmar]

No problem. I agree with your basic conclusion and you may be right about them near the end. I met with several of their senior execs on a tangential issue in mid 2002. They seemed honest, sincere, and did try to explain the hedges to me. But I still didn't really understand it.

 

[chinaco]

Interesting poll.


ABC News Poll: Two-Thirds Back Financial Reform - ABC News

 

[Gone4Good]

So 63% support reform but only 43% think derivatives should be regulated (with 41% saying no). I don't get it.

 

[Gone4Good]

What I find stunning in this whole debate is the lack of actual debate. Here we have one of the most sweeping pieces of financial legislation since the 1930s. We have two bills printed in black and white (one House and one Senate) so there is no mystery about what they're trying to do. We have one party uniformly saying "No", but offering only the vaguest explanations of why. And no real explanation of how they would do things differently, or what they would change. Even on this forum, we have no real back and forth, and I'm guessing people here are somewhat more financially savvy than the average American. Heck, nearly the whole board was expert on health insurance earlier this year, but when it comes to finance . . . nary a peep. What gives?

 

[REWahoo]

What I find stunning in this whole debate is the lack of actual debate. Here we have one of the most sweeping pieces of financial legislation since the 1930s. We have two bills printed in black and white (one House and one Senate) so there is no mystery about what they're trying to do. We have one party uniformly saying "No", but offering only the vaguest explanations of why. We have no real back and forth on this forum, where I'm guessing people are somewhat more financially savvy than the average American. Heck, nearly the whole board was expert on health insurance earlier this year, but when it comes to finance . . . nary a peep. What gives?

Your comment above takes a very clear political position, inviting a response from the other side which, if history repeats itself, will quickly degrade into personal attacks resulting in closing this thread. I am of the opinion the posters eager to "debate" matters here are simply seeking a way to espouse their political philosophy, thus antagonizing those who differ. In almost every case it ends as a hog calling contest.

 

[Gone4Good]

Your comment above takes a very clear political position, inviting a response from the other side which, if history repeats itself, will quickly degrade into personal attacks resulting in closing this thread. I am of the opinion the posters eager to "debate" matters here are simply seeking a way to espouse their political philosophy, thus antagonizing those who differ. In almost every case it ends as a hog calling contest.

I'm not asking for a debate. I'm just asking why there is no debate when everything else generates such heated opinions (even for such objective facts as whether GM actually repaid a loan). I find the silence interesting.

 

[Gone4Good]

I'm not asking for a debate. I'm just asking why there is no debate when everything else generates such heated opinions (even for such objective facts as whether GM actually repaid a loan). I find the silence interesting.

BTW, I say this now because apparently nobody knows what to think. But rumor has it that Republicans are going to introduce their own legislation after which I'm sure everyone will have an opinion.

 

[haha]

I would start with reform to the mortgage market (make it look more like Canada), phase out the deduction of mortgage interest for tax purposes.

In the US anyway there is a very powerful Realtors' lobby, not to mention all the middle class people who do not want to lose their cherished deduction. It is stupid to encourage overinvestment in housing at the expense of power plants, nuclear research, manufacturing industries, rapid transit, etc.

However, if there is a stupid way to do something we will always find it even if it is hidden under a lot of good alternatives.

__________________________________
News Alert
from The Wall Street Journal


Senate Republicans successfully blocked lawmakers from moving ahead with sweeping legislation to overhaul U.S. financial markets, a stumble for the Obama administration that likely represents only a temporary setback for Senate progress on the overhaul legislation.

The Senate voted 57-41 on a procedural measure allowing lawmakers to move toward debate on financial regulatory overhaul legislation, falling short of the 60 votes needed. All GOP senators present voted against invoking cloture, joined by at least one Democrat, Sen. Ben Nelson.

http://online.wsj.com/article/SB10001424052748703465204575207960621725650.html?mod=djemalertNEWS

The above mentioned Nebraska Senator Nelson is Warren's boy. Apparently Warren hates derivatives, other than the ones Berkshire owns.


Ha

 

[Gone4Good]

Apparently Warren hates derivatives, other than the ones Berkshire owns.

 

[winger]

1. Borrowing money is a personal responsibility, whether it is for a new home, a college education or crystal meth. No one forced people to buy homes they couldn't afford. DW and I could qualify for a mortgage 5X what we are paying, but we know it isn't realistic. What really irks me in this whole mess is the emergence and encouragement of the victim mentality in this debacle -"it wasn't my fault, the evil bankers told me I could afford a new 300K home on $10/hour. And I needed all new furniture and jet skis, all the neighbors had them" And.... "now I expect the folks who played by the rules, lived below their means, and whose own home equity and stock portfolios I trashed when the bank foreclosed on my place next door at 50cents on the dollar to step up and pay higher taxes to bail my stupid a$$ out- it's not my fault, it was the (insert viillan of your choice here). Where's my check, I'm entitled to it... sheesh, all I did was lie about my income on my loan application? ".

Exaggerations. isn't the truth bad enough?

 

[Gone4Good]

The above mentioned Nebraska Senator Nelson is Warren's boy. Apparently Warren hates derivatives, other than the ones Berkshire owns.

It looks like Nelson's provision just got stripped out. (Democrats Deny Buffett on Key Provision) Good thing too. One of the reasons AIG was able to morph into a financial Death Star was because it could enter into derivative contracts without any need to post collateral. It's Aaa rating served as all the collateral counterparties required. Berkshire shouldn't be afforded the same luxury.

P.S. Question for the moderators . . . if I call Ben Nelson an idiot for repeatedly tying to ruin legislation for self-serving ends can it be considered non-partisan, or bi-partisan, in light of my earlier post calling Chuck Grassley an idiot for deliberately misrepresenting facts?

 

[FinanceDude]

P.S. Question for the moderators . . . if I call Ben Nelson an idiot for repeatedly tying to ruin legislation for self-serving ends can it be considered non-partisan, or bi-partisan, in light of my earlier post calling Chuck Grassley an idiot for deliberately misrepresenting facts?

You are lucky I am no longer a mod.........

US Senators, regardless of what you or I think of them, deserve the respect the office entails. Much like the President, or Vice President, or other top officials, whether you like them or not, hate them or not, they are due the respect of their office.

You just called Senator Grassley that name again..........

 

[Gone4Good]

Um, ok. Whatever. You can "respect" things like this, but I don't . . .

The relationship between Sen. Ben Nelson and Warren Buffett's Berkshire Hathaway Inc. has thrown an unexpected wrench into the White House's bid to speed an overhaul of financial regulation, as the Nebraska Democrat voted for a second time in two days with Republicans to block the bill from moving forward.

Democrats killed a provision Monday pushed by Mr. Nelson that would have helped Berkshire avoid a big financial hit related to its portfolio of derivatives. Berkshire is Mr. Nelson's biggest campaign contributor. Mr. Nelson and his wife, Diane, owned up to $6 million in the company's stock at the end of 2008, according to the latest congressional disclosure records. . . .

Mr. Dodd, appearing to contradict his colleague, said earlier the Berkshire provision was the only issue he and Sen. Harry Reid (D., Nev.) discussed with Mr. Nelson during a tense-looking huddle at the start of Monday's vote.

But I will agree that "idiot" isn't the right word to describe what's going on here.

 

[ziggy29]

It seems a little incestuous, but what Mr. Buffett suggests isn't unreasonable (though I'd add that he shouldn't have a unique exemption and Nelson has lost some credibility as the result of the Cornhusker Kickback).

Let's say you took out a mortgage for 95% loan to value a couple years ago. You can still easily afford to make the payments. Now Congress passes a law which requires that no mortgage be allowed to be over 80% LTV -- and enforces it retroactively to existing contracts. You have, let's say, 92% LTV by this time and you have to come up with 12% of the home's value in cash.... or else. That the contract you entered was fully lawful and acceptable at the time it was executed means *nothing* any more. Congress has forcibly changed the terms in a way that is financially disastrous to you (possibly).

Buffett isn't saying these laws are a bad idea moving forward -- but that you shouldn't retroactively add financially punitive terms to existing deals already in place before the law was passed. In criminal law, we have a prohibition against this sort of ex post facto law. And for a similar reason: it's unjust to move the goalposts after the ball has already been kicked.

 

[FinanceDude]

Um, ok. Whatever. You can "respect" things like this, but I don't . . .



But I will agree that "idiot" isn't the right word to describe what's going on here.

Why are we trying to give the Fed all the powers of regaulation? The Fed should control the money supply, that's IT!!!

Having a Consumer Protection Agency INSIDE the Fed? Ludicrous and stupid...........we already HAVE a Consumer Protection Agency!!!