Tattered Standard of Duty on Wall Street

Not entirely true, as the banks had developed their hedging strategies, risk and return models, and such, based on older data from the world of good-credit borrowers and collateralized (10-20% down) loans, where those who originated the loans had to hold them on their books until they were paid off. They then sold combinations (tranches) of loans originated under entirely different circumstances, and did not price in the additional risk; and furthermore did not tell anybody.

You can't be serious. Banks "did not tell anybody" that subprime, Alt-A etc. loans existed and were being securitized? Was this some sort of big secret? Give me a break.

The collateral behind these securities is disclosed. Anyone buying them can look at the makeup. Yes there are ways to hide bad loans in there and other shenanigans, etc., but on the macroscopic level if the collateral for a bond has an average 100% LTV or 590 FICO this is a fact completely known to whoever's buying that bond - or, it should be. If it's not, then the buyer has screwed up.

It's simply not true that the buyers of the tranches to which you refer were somehow kept completely in the dark as to the nature of the collateral behind them because the banks "did not tell them".

As for whether banks "priced in additional risk", I'm sure that banks priced these things as high as they could and still clear the market to the extent they wanted to. That's how what we call "the market" works. If this resulted in spreads that you consider too low for the risk that was involved, that's the result of buyers not pricing in the risk. In short, we had a bubble market. What were banks supposed to do about that? "you guys are spending too much, we're going to lower the price voluntarily"?

What other business is expected to do anything remotely resembling that?

Uh-oh. Something tells me Ben’s not going to get the usual FR love-fest for this one.

Any business relies on the mutual trust of those it does business with. On Wall Street especially (when I say WS I mean the major firms, household names) there has to be trust.

We are in agreement here, where I think disagreement may remain is in the remedy. Stein seems to imply a legal remedy involving jail, punishment etc.

Seems to me that the real remedy for a business that loses customer trust is...a loss of business. Like I've already stated, certainly something will have to change for the market to become interested in many of these instruments again. What I disagree about is that all this constitutes a proof of fraud or similar.

That's probably because these people are (were) employees of private companies, not elected public servants; this was an issue between them and their firms (and stockholders). Why would there be a "public accounting"? What would that even mean? These firms are involved in risky businesses, these guys had positions of high responsibility, and the firms lost money, ipso facto these guys failed. So, they were fired. What else is supposed to happen?

Not much of an issue between them and the stockholders, who have--effectively no say in the matter. The firms are, for all intents and purposes, the "employees," or to be more exact the officers of the company, the generals in these private armies of mercenaries, who have a license to steal. To speak of them as 'private" is ironical since it required the intervention of the government to prevent them from collapsing and taking much of the economy down with them.

The firms are, for all intents and purposes, the "employees," or to be more exact the officers of the company, the generals in these private armies of mercenaries, who have a license to steal.

Suddenly Stein's commentary is beginning to sound much more informed to me.

To speak of them as 'private" is ironical since it required the intervention of the government to prevent them from collapsing and taking much of the economy down with them.

When was this?

The collateral behind these securities is disclosed. Anyone buying them can look at the makeup. Yes there are ways to hide bad loans in there and other shenanigans, etc., but on the macroscopic level if the collateral for a bond has an average 100% LTV or 590 FICO this is a fact completely known to whoever's buying that bond - or, it should be. If it's not, then the buyer has screwed up.

The problem is not that 'there are ways to hide bad loans' as the above states.

The problem is that the bad loans were 'hidden in plain sight', i.e. the slicing and dicing of the tranches implied the risks were known and contained, whereas in fact they were NOT, due to the factors I mentioned earlier.

It's simply not true that the buyers of the tranches to which you refer were somehow kept completely in the dark as to the nature of the collateral behind them because the banks "did not tell them".

You're right, the banks did something worse. They believed their own hype (to start); and after the ball got rolling there was enormous pressure to continue, since the banks could make far more money (higher turnover, not -- until now -- holding the bag when loans went bust, etc.)

Cheers!

...oh, and Merry Christmas.

If this resulted in spreads that you consider too low for the risk that was involved, that's the result of buyers not pricing in the risk.

This is true; but they had been assured by the banks and the rating agencies that the risks really were understood and contained.

The problem is that the bad loans were 'hidden in plain sight', i.e. the slicing and dicing of the tranches implied the risks were known and contained, whereas in fact they were NOT, due to the factors I mentioned earlier.

You lost me. For one thing, the risks are and always have been known. It is known that MBS have prepayment risk, interest rate risk, and (for non-agency loans), credit risk. What we are seeing now is a result of the credit risk. Nobody "didn't know" that these bonds involved credit risk, and slicing them up into tranches didn't somehow hide the credit risk.

More generally, how does the mere act of slicing a risky cashflow into tranches "imply that the risks [are] contained"? It does nothing of the sort. It merely reapportions the risk that is there, and that's why they do it (because different segments of the market demand different types of risk). NOBODY involved believed that the risks were "contained" per se. I dare you to find such a person.

They believed their own hype (to start); and after the ball got rolling there was enormous pressure to continue, since the banks could make far more money (higher turnover, not -- until now -- holding the bag when loans went bust, etc.)

In other words, there was an inflated/bubble market, hype led to liquidity, and everyone hoped to be able to chase profits till the bubble burst.

Yup.

Not sure how that adds up to fraud on the banks' part, anymore than stockbrokers were guilty of fraud in the '90s days of "internet stocks" for selling an eager hobby-investor some stock in pets.com. There was a craze, lots of people made money, and then it burst, giving (some? all? we don't know) of it back, as was inevitable. Which part requires malevolence and/or criminality? I don't understand this need to "blame someone". In this case there does seem to have been some actual fraud, but that fraud we know about exists on the loan-level: people lying on their loan applications, dishonest mortgage brokers pushing loans on unqualified borrowers, etc. Again, that particular fraud cannot be laid primarily at the feet of Wall Street, because in a strange twist, Wall Street was largely the victim of this fraud.

Banks of this size are quasi-governmental, and like governmental agencies they enjoy a certain immunity to failure, or the consequences of failure. What you haven’t read the papers? If the Fed can’t mop up the spilled milk, the cash cows in Arabia will. As to a proper reward, back in 1929, lots of these guys jumped off of buildings. The least they could do would be to give back their bonuses. They remind me of the ballplayers who have been caught unsing steroids, except we don’t know what they actually did to deserve their high incomes and their awards. Anything? maybe your argument is simply this: that they really were no more than figureheads, like the pettykings of Europe.

I believe that no system of laws, government, or society can function well unless the majority of the people within it are honest.

From reading your posts, you seem to believe that everyone in the system from the original borrowers, the real estate people, the appraisers, the loan officers, the bank officials, and so on up the ladder were all dishonest. And consequently, no one was hurt. That may be true, but if so, we do not and will not have a future. That is pretty bleak.

I believe that EVERYONE within the system was hurt in one manner or another by this fiasco. The only question in my mind is apportioning the blame. No one is blameless.

I believe that no system of laws, government, or society can function well unless the majority of the people within it are honest. From reading your posts, you seem to believe that everyone in the system from the original borrowers, the real estate people, the appraisers, the loan officers, the bank officials, and so on up the ladder were all dishonest.

Well, you can breathe a sigh of relief now, because that is not what I believe at all. If you read my posts more carefully and in context it should be clear that I'm the one arguing against people who are levelling a sweeping accusation against "Wall Street" that they are exceedingly dishonest.

My main claim here is that the focus of "broken trust" (Stein's theme) in this scandal is one of borrowers violating the "trust" of banks/mortgagors by taking out loans and not paying them back.

But even in that case, I don't believe that anything approaching a majority of borrowers are dishonest. It's still a minority (with all the talk nowadays you'd never realize that a large majority of "subprime" loans are doing just fine), and most of them are probably perfect decent people who were simply (perhaps unknowingly and naively) making a "bet" on endlessly-increasing house prices, but unfortunately that minority is significant enough that it has upset the prior statistics upon which everyone was valuing securitized loans. Hence, the market has gotten spooked, or a "liquidity crisis" has ensued.

If anything, I'm blaming the situation less on "dishonesty" than any single other poster in this thread! I view it as more of a "tragically inevitable" situation, myself.

I believe that EVERYONE within the system was hurt in one manner or another by this fiasco.

How were you hurt, just out of curiosity?

Truth be told, most people probably haven't been really tangibly affected one way or the other - if they're being honest with themselves. This would include a lot of people bitching and moaning about the "fiasco" in my opinion.

There is one large class you can point to as having "been hurt": the banks, which bought up securitized-loans (which is to say: put money out there for people to buy houses) and now have seen the market value of those securities plummet. They put their money out there, it ended up in someone's house, and now the banks are left holding the cards. So if you want to shed a tear for anyone, weep for the banks. ;-)

But a lot of people haven't "been hurt" in any identifiable way. For example take the 80% (or whatever it is) of up-to-date "subprime" borrowers who were able to get loans that the same people would not have been able to get 50 or even 20 years ago. Because of freer lending practices, such people now live in nicer housing than people of similar circumstance ever have. They are making their payments, they are happy, the banks are happy (with them, anyway). How have such people "been hurt"?

if the "only question is apportioning blame" let's first at least diagnose properly (a) the problem and (b) who has been hurt. I've seen very little of either on display in this thread or the article which spawned it.