[barmar]

kenberg, on 2013-July-16, 16:37, said:

I tend to at least begin with the obvious.

It is so, is it not, that in the run up to the crash loan applications were being approved that in previous times would have been rejected? If you bundle a bunch of bad loans then you have a bundle of bad loans instead of several individual bad loans, but you still have bad loans.

Let's say you have a bundle of loans, and each of them has a 10% chance of default. As long as the income from the 90% that keep paying makes up for the losses from the 10% who default, you're OK.

This expectation is reasonable if they're all independent. That's the basis behind the insurance industry, too: everyone pays their premiums, but only a few of them will make claims.

But they're not necessarily independent. The housing bubble was to the loan industry as a natural disaster is to the home insurance industry: the losses are correlated and widespread, and the income doesn't compensate for them.

Another way to look at it is this. If they're independent, the expectation is that only about 10% of the loans will default. The chance that 20% of the loans will default is only 1% , and the chance that all of them will default is 0.00000001%. At the other end of the spectrums, if the loans are perfectly correlated with each other, the chance that all of them will default is the same as the chance that any one will default: there's a 10% chance of losing everything that has been loaned out.

The flaw in their thinking was that loans were mostly independent, when there's actually a strong correlation.

[mike777]

To be fair local banks have always known there is a strong correlation. They live and die with their local community or local city and state and that is ok. Failure is ok and an accepted part of purging the system quickly to help recover and grow again.

[hrothgar]

mike777, on 2013-July-17, 10:08, said:

To be fair local banks have always known there is a strong correlation. They live and die with their local community or local city and state and that is ok. Failure is ok and an accepted part of purging the system quickly to help recover and grow again.

Aside from those cases where the local bank was investing in CDOs...
Or, worse yet, the county that the local bank was in was investing its funds in CDOs

[hrothgar]

mike777, on 2013-July-16, 17:51, said:

That is far from clear that a housing bubble caused a great recession.

It may be true that the great recession caused the real estate market to crash.

One possible theory for the cause of the recession is a decrease in the future value of labor.

Another theory is that a credit bubble, from the fed to the banks to etc, created the recession..

An open debate.
---

it may be true that the earth is a solid ellipsoid circling the sun

One possible theory is that the god Helios drives a chariot containing the sun each day.

Another theory is that the earth is solid disk sitting atop a giant turtle

An (equally) open debate

[dwar0123]

hrothgar, on 2013-July-17, 10:58, said:

it may be true that the earth is a solid ellipsoid circling the sun

One possible theory is that the god Helios drives a chariot containing the sun each day.

Another theory is that the earth is solid disk sitting atop a giant turtle

An (equally) open debate

It may be a theory to you, but tell that to the guys living on the edge of the disk dropping down under to see what they can see.

They can SEE the turtle.

And the 4 elephants too.

[barmar]

mike777, on 2013-July-17, 10:08, said:

To be fair local banks have always known there is a strong correlation.

Which is why local banks usually sell their mortgages to aggregators.

[mike777]

barmar, on 2013-July-17, 12:29, said:

Which is why local banks usually sell their mortgages to aggregators.

They may but keep in mind they still make most of their loans locally, cars, business, etc. They do live and die with their local communities.

As for the big money center bnks, they are aware that correlations change over time and that in time of great crises all correlations go to one.
----------------------------------------------------------------------
---------------------------------------------------------------------
The Possible Misdiagnosis of a CrisisFinancial Analysts Journal


Richard Roll

March/April 2011, Vol. 67, No. 2: 12–17
(doi: 10.2469/faj.v67.n2.3)


View Table of Contents

Abstract Abstract
Summary Summary
PDF PDF (267 K)
PDF Linked PDF (268 K)
Audio File Audio File (4129 K)

Abstract


Most explanations of the 2007–08 financial crisis—including excessive leverage, subprime mortgages, exotic derivatives, reckless risk taking, and easy money that spawned a housing bubble—are inconsistent with elementary principles of finance. The author explains the inconsistencies and suggests an alternative diagnosis that is fully compatible with rationality
-------------------

http://www.cfapubs.o...69/faj.v67.n2.3

[Winstonm]

barmar, on 2013-July-17, 10:00, said:

Let's say you have a bundle of loans, and each of them has a 10% chance of default. As long as the income from the 90% that keep paying makes up for the losses from the 10% who default, you're OK.

This expectation is reasonable if they're all independent. That's the basis behind the insurance industry, too: everyone pays their premiums, but only a few of them will make claims.

But they're not necessarily independent. The housing bubble was to the loan industry as a natural disaster is to the home insurance industry: the losses are correlated and widespread, and the income doesn't compensate for them.

Another way to look at it is this. If they're independent, the expectation is that only about 10% of the loans will default. The chance that 20% of the loans will default is only 1% , and the chance that all of them will default is 0.00000001%. At the other end of the spectrums, if the loans are perfectly correlated with each other, the chance that all of them will default is the same as the chance that any one will default: there's a 10% chance of losing everything that has been loaned out.

The flaw in their thinking was that loans were mostly independent, when there's actually a strong correlation.

The trouble is you are only talking about some of the loans - from around 2006-2008 the majority of loans were more like 99.9% guaranteed to default. And with no transparency no one knew which loans (and thus MBS) were toxic and which were not. This threatened a collapse of the entire MBS market, spawning credit defaut swaps which had been sold by institutions without sufficient reserves to pay those losses.

At its heart, the cause of the Great Recession was the pursuit of yield.

[Winstonm]

barmar, on 2013-July-17, 12:29, said:

Which is why local banks usually sell their mortgages to aggregators.

But local banks were simply not the problem when it comes to the Great Recession - non-bank lenders made the vast majority of loans that later defaulted, and they sold those loans to Wall Street banks who then packaged the loans into Mortgage Backed Securities. This group of mortgage lenders became known as the "shadow banking industry" because they fell outside normal regulatory channels, while the Federal Reserve, who did have the power to regulate them, chose not to do so.

[Winstonm]

mike777, on 2013-July-17, 12:36, said:

They may but keep in mind they still make most of their loans locally, cars, business, etc. They do live and die with their local communities.

As for the big money center bnks, they are aware that correlations change over time and that in time of great crises all correlations go to one.
----------------------------------------------------------------------
---------------------------------------------------------------------
The Possible Misdiagnosis of a CrisisFinancial Analysts Journal


Richard Roll

March/April 2011, Vol. 67, No. 2: 12–17
(doi: 10.2469/faj.v67.n2.3)


View Table of Contents

Abstract Abstract
Summary Summary
PDF PDF (267 K)
PDF Linked PDF (268 K)
Audio File Audio File (4129 K)

Abstract


Most explanations of the 2007–08 financial crisis—including excessive leverage, subprime mortgages, exotic derivatives, reckless risk taking, and easy money that spawned a housing bubble—are inconsistent with elementary principles of finance. The author explains the inconsistencies and suggests an alternative diagnosis that is fully compatible with rationality
-------------------

http://www.cfapubs.o...69/faj.v67.n2.3

In the first paragraph or so there is a problem with this thinking when the author correlates "easy money" with "interest rates". Such was not the case in this instance. Easy money was the easy availability of mortgage loans to non-qualified applicants and the flexible loan products developed, not just interest rates.

[blackshoe]

Winstonm, on 2013-July-17, 13:17, said:

But local banks were simply not the problem when it comes to the Great Recession - non-bank lenders made the vast majority of loans that later defaulted, and they sold those loans to Wall Street banks who then packaged the loans into Mortgage Backed Securities. This group of mortgage lenders became known as the "shadow banking industry" because they fell outside normal regulatory channels, while the Federal Reserve, who did have the power to regulate them, chose not to do so.

Interesting that a private institution should have the power to regulate anything.

[Winstonm]

blackshoe, on 2013-July-17, 16:55, said:

Interesting that a private institution should have the power to regulate anything.

It is surprising to me that someone with your background and obvious intelligence continues seemingly to fail to grasp that not every situation can be simplified to binary equation - the federal reserve is a classic example.

The Federal Reserve is a system, not a single entity, and that system has components that are both public and private. Regardless, the federal reserve was created by an act of Congress, it is still answerable to Congress, and it turns over its profits each year to the U.S. Treasury.

Hardly a scary monster from Spooky Island.

[y66]

onoway, on 2013-July-16, 21:20, said:

This may be obvious to everyone else but me, but what exactly is stopping the whole thing from going pop? It seems as though everything that had people planning for an economic doomsday - like the level of governmental debt - hasn't gone away but now people are happy and marching forward with a smile on their face and a song in their hearts, so to speak. What did I miss?

It looks like you missed Jan Hatzius' latest U.S. budget deficit estimates for 2013 - 2023 which pretty much ended the government debt = doomsday hysteria when his estimates were reported in April. The real doomsday machine is the ever growing global network of banks that are "still too big to fail, too big to manage, and too big to trust ... There are now more too-big-to-fail institutions than there were prior to the 2008 crisis -- Gretchen Morgenson May 24, 2013".

[blackshoe]

The Chairman of the Federal Reserve Board is required to appear before Congress twice a year to report what the Federal Reserve System is doing and what it plans to do in the future. I don't see anything in the law that gives Congress the authority to tell the Board "No. Don't do that." I suppose they could pass a law abolishing the institution, but somehow I don't see that happening. So while there is "oversight", there's certainly no control. Congress gave up that control when they established — at the behest of bankers — the system. Also, while the GAO is tasked to audit the system, its authority in what to audit is severely limited. So it doesn't seem to me the government has much to say about the day to day operations or long term policies of the Fed.

The Federal Reserve System is in practice an independent entity with control over the monetary policy of the United States. While it was "established by law", I'm not at all convinced that Congress has, or ever did have, the power Constitutional authority to pass those laws. I must correct myself — Congress passed the laws, so they certainly had the power to do so.

The top level members of the FRB are paid by the Federal government. The rest of its employees are paid from the system's own revenues, which if I read it right amounted to about $5 billion in 2010.

[mike777]

blackshoe, on 2013-July-17, 21:33, said:

The Chairman of the Federal Reserve Board is required to appear before Congress twice a year to report what the Federal Reserve System is doing and what it plans to do in the future. I don't see anything in the law that gives Congress the authority to tell the Board "No. Don't do that." I suppose they could pass a law abolishing the institution, but somehow I don't see that happening. So while there is "oversight", there's certainly no control. Congress gave up that control when they established — at the behest of bankers — the system. Also, while the GAO is tasked to audit the system, its authority in what to audit is severely limited. So it doesn't seem to me the government has much to say about the day to day operations or long term policies of the Fed.

The Federal Reserve System is in practice an independent entity with control over the monetary policy of the United States. While it was "established by law", I'm not at all convinced that Congress has, or ever did have, the power Constitutional authority to pass those laws. I must correct myself — Congress passed the laws, so they certainly had the power to do so.

The top level members of the FRB are paid by the Federal government. The rest of its employees are paid from the system's own revenues, which if I read it right amounted to about $5 billion in 2010.

If we agree(for the sake of this discussion) all of the above is fact and agree that the fed leadership including the current chairman is as much to blame for the crises(credit bubble) in 2008 then what?

fwiw my take is domain dependence make the issue difficult to understand but you =may have other issues?


"For an initial-value problem for a partial differential equation, a portion of the range such that the initial values on this portion determine the solution over the entire range"

[kenberg]

y66, on 2013-July-17, 20:45, said:

It looks like you missed Jan Hatzius' latest U.S. budget deficit estimates for 2013 - 2023 which pretty much ended the government debt = doomsday hysteria when his estimates were reported in April. The real doomsday machine is the ever growing global network of banks that are "still too big to fail, too big to manage, and too big to trust ... There are now more too-big-to-fail institutions than there were prior to the 2008 crisis -- Gretchen Morgenson May 24, 2013".

I don't think that concern about debt should be discarded as doomsday hysteria. I favor addressing the problem, and I do think that it is a problem, realistically. I am not hysterical.

But this quibble aside, I do worry (although I still resist hysteria) about international financial entities that seem to be a law onto themselves. It seems to me that progress is often fueled by some mix of self interest and idealism. I am not so sure idealism has any office space in these large enterprises.

I had never heard of Jan Hatzius but the Wik tells me "he is a two-time winner of the Lawrence R. Klein Award for the most accurate US economic forecast over the prior four years.". I would say that entitles him to some of my listening time.

[y66]

kenberg, on 2013-July-18, 05:19, said:

I don't think that concern about debt should be discarded as doomsday hysteria. I favor addressing the problem, and I do think that it is a problem, realistically. I am not hysterical.

But this quibble aside, I do worry (although I still resist hysteria) about international financial entities that seem to be a law onto themselves. It seems to me that progress is often fueled by some mix of self interest and idealism. I am not so sure idealism has any office space in these large enterprises.

I had never heard of Jan Hatzius but the Wik tells me "he is a two-time winner of the Lawrence R. Klein Award for the most accurate US economic forecast over the prior four years.". I would say that entitles him to some of my listening time.

Nobody is saying that "concern about the debt" = "doomsday hysteria".

If Medicare and Medicaid spending are not addressed between now and 2020, U.S. government debt will become a serious problem. U.S. government debt is not a serious problem now.

We can address the long term debt problem by tackling the healthcare spending problem as has been proposed by sensible forum mates on a different thread.

Unemployment is a serious problem now and has been a serious problem for almost 5 years.

We can address the unemployment problem by getting the economy going again and keeping it going. The best tool for this, according to people who study this problem, is short term government spending aka stimulus spending. Yes, short term government spending increases debt but there are other effects. Getting the economy going again decreases debt by decreasing unemployment costs and by increasing tax revenue. We're already seeing the effects of increasing tax revenues in new debt estimates from Hatzius and CBO.

[Winstonm]

onoway, on 2013-July-16, 21:20, said:

This may be obvious to everyone else but me, but what exactly is stopping the whole thing from going pop? It seems as though everything that had people planning for an economic doomsday - like the level of governmental debt - hasn't gone away but now people are happy and marching forward with a smile on their face and a song in their hearts, so to speak. What did I miss?

Mainly, the reason is that those people were wrong, spectacularly so.

[Winstonm]

blackshoe, on 2013-July-17, 21:33, said:

The Chairman of the Federal Reserve Board is required to appear before Congress twice a year to report what the Federal Reserve System is doing and what it plans to do in the future. I don't see anything in the law that gives Congress the authority to tell the Board "No. Don't do that." I suppose they could pass a law abolishing the institution, but somehow I don't see that happening. So while there is "oversight", there's certainly no control. Congress gave up that control when they established — at the behest of bankers — the system. Also, while the GAO is tasked to audit the system, its authority in what to audit is severely limited. So it doesn't seem to me the government has much to say about the day to day operations or long term policies of the Fed.

The Federal Reserve System is in practice an independent entity with control over the monetary policy of the United States. While it was "established by law", I'm not at all convinced that Congress has, or ever did have, the power Constitutional authority to pass those laws. I must correct myself — Congress passed the laws, so they certainly had the power to do so.

The top level members of the FRB are paid by the Federal government. The rest of its employees are paid from the system's own revenues, which if I read it right amounted to about $5 billion in 2010.

Yes, to manage and pay for the banking system the Fed is allowed to keep 6% of their earnings - they turned over about $80 billion to the US Treasury.

[onoway]

Winstonm, on 2013-July-18, 10:15, said:

Mainly, the reason is that those people were wrong, spectacularly so.

Well, maybe not. Detroit declaring bankruptcy can't be seen as a good sign. What does that even mean, a city declaring bankruptcy? How does that even work?