Questions for our American friends

[deepsepia]

Originally Posted by Brian249x

It seems to me that the basic mechanism of packaging ARMs made to folks with poor credit ratings into bonds and selling those bonds is pretty fraudulent. Weren't the bonds structured by packaging quality loans in the higher tranches to conceal the extremely low quality of the lower tranches?

No, not fraudulent. The underlying idea is smart. The world has a huge demand for AAA credit, but there's actually very little of it. If I take a thousand loans bundle them, and slice them up into tranches: "first loss" -- the lowest rated, highest interest, the ones that would stop paying when, say, the first fifty mortgages went bad; second loss, all the way up to a tranche that would continue to pay until some large number of mortgages that never had been reach historically stopped paying, and that gets ranked AAA. The idea of the structure is NOT that these are great mortgages, each of AAA quality; its that if you take a thousand of them and slice up the risk by risk preference, you can engineer a very low risk senior security, because the default risk is being assumed by much higher yielding "first loss" tranches. There's nothing fraudulent about that . . . you do something like that every day in corporate finance: IBM bonds are more secure than IBM preferred stock, which is in turn more secure than IBM common; slicing up risk and reward is what capital structure is all about.

Additionally, a buyer of a senior tranche would get geographic diversification, eg your Senior Tranche represented mortgages from San Diego, Phoenix, Chicago, Richmond and El Paso. The folks who were putting these things together were looking at historical data showing that these real estate markets were uncorrelated that they _never_ would all decline by %10 at the same time.

That was true . . . until it wasn't. And the simultaneous declines across previously uncorrelated markets, far more than lousy underwriting, is what sunk the AAA tranches.

Originally Posted by xyzde69

I don't know what is your definition of fraud. But it was a MASSIVE fraud.

Nope. This is an error, and its an important error.

If you make the mistake of believing "financial crises happen because of crooks" -- you'll miss the point and you'll fail to take the correct steps to prevent future crises.

Financial markets have cycles . . . when times are good, people get more aggressive. That's not criminal, that's just the way it goes-- after year after year of gains, all you've got left are aggressive people, the conservative folks have been lapped long ago, and been bought out by the more aggressive. See the economist Hyman Minsky for analysis of why risk appetites will inevitably increase as good times go on longer.
https://www.economist.com/news/econo...-hyman-minskys

So that's what happened, not just in the US. Look at Iceland: Iceland melted down before the US crisis, and was unrelated. Same with housing finance in the UK, the Northern Rock failure was a local failure. And in France, banks have been blowing up and been bailed out more or less forever.

Here's the important lesson: if you think these things happen because of "greedy bad criminal people" -- you'll get it all wrong. This is the naive and popular narrative, but its wrong. The notion "this would have all worked out fine if these people hadn't been crooks" is demonstrably wrong, and it leads to bad policy.

What "works" is appropriate structure and regulation, not a reliance on "virtue". Are there some folks who commit fraud? Sure. That is clearly NOT the source of systemic failure, rather its system design.

Consider national banking systems that made it through the Financial Crisis with no meltdowns-- Australia, Canada, New Zealand. All of these nations have lots of speculative mortgages, quite high levels of consumer mortgage debt, but they also have much tighter regulations on bank finance. None of them had to do banking bailouts. Are Australian bankers magically "more honest" than Icelandic bankers?

Nope.

Its that Australia's banking system was better designed and regulated than Iceland's . . .

The Reserve Bank of New Zealand has a very nice paper which describes just how New Zealand got through the Financial Crisis without any collapses:
"Banking crises in New Zealand – an historical perspective"

Its a really nice paper that gives a good background on the systemic component to banking crises, its here: https://www.rbnz.govt.nz/-/media/Res...ec72-4hunt.pdf

[b1gt1t]

Best doc I've seen about the greedy cokehead Wall St fuckers...

http://www.sonyclassics.com/insidejob/

[deepsepia]

Originally Posted by b1gt1t

Best doc I've seen about the greedy cokehead Wall St fuckers...

http://www.sonyclassics.com/insidejob/

Its an anecdote, not an explanation.

No banker in history was in it for the poetry of banking . . .

[Roubignol]

Originally Posted by deepsepia

Nope. This is an error, and its an important error.

I'm sorry deepsepia. But if it's only a financial mistake (numbers written on papers or on digital supports), the banks and the US state had to give more time to the American people who get into debts to buy their house, to repay their loans and our states had to request to the banks to refund the integrality of the toxic investements to the old retired people.
It was easy to fix this mess without stealing money of honest people.

It's not what happened.
They threw away people from "their" house, banks took the money from investors and never refund the totality of the protected capital.

I'll explain the story in other words, why I really do not agree with you and why I believe it was a massive fraud.

When a person that you trust (a banker), call you and tell you: "Hey deepsepia, lend me 50'000$ and I'll give you an interest of 0 to 10% depending the year... but I promise, your 50'000$ will NEVER be lost."

What do you think if one day that person tells you: "Hey, deep... Sorry, but I've lost your 50'000$."

-"That's impossible, you told me that my capital was in security."
-"Yep... but sorry, I lose it."
-"But can you give me this money back one day?"
-"No, I lose it."

What will you think?

And then... 3 years later you read in newspaper, that the guy who has lost your money, still do the same business, makes 2 billions benefits per year and shares this benefits with his clients, pays himself 20 millions per year and will NEVER give you back your "protected" 50'000$.

That's exactly what happened.

If for you that's not a fraud... for me (and probably millions of people) it is.

And you didn't answer to my final question: In which pocket is the money?
Because according to the contract, the money existed and still exists.

[deepsepia]

Originally Posted by xyzde69

And you didn't answer to my final question: In which pocket is the money?
Because according to the contract, the money existed and still exists.

What money? From bust mortgages?

No equity still exists in most cases where the bank sells the house.

What "zero equity" means is that essentially that although their name was on the title, the "owners" had no effective ownership interest the moment they stopped paying their mortgage. There was an often heard line during the Crisis:
"A Home Without Equity Is Just a Rental With Debt."

You have to think about that one. What does it mean, when you buy a house for $300,000; put $15,000 down, and the price of the home declines by %10?

Well it means
At purchase:
House value $300K
Mortgage $285K
Your equity $15K

Now:
House value $270K
Mortgage $285K
Your equity ($15K) = negative $15,000, you're "upside down", your mortgage is greater than the house is worth.

Huge numbers of homes were in this position in 2008-2011; a rough estimate is that about %25 of homes had negative equity in 2009, the deepest part of the financial crisis.

Your name may still be on the title, and you might still make mortgage payments and keep it there, but if the house is sold, you get nothing.

In such a scenario, many people walk away, because its economically rational. If your paying, say $3000 a month in mortgage payments on a house in which you have no equity, and you can rent an equivalent house for $2K, why pay the extra $1K a month?

The bank then seizes the house, sells it for $270K and records a $15K loss on the mortgage.

There's no money there for you. Whatever proceeds there are go to the folks who own the mortgage, whoever they may be (typically not the bank who repossessed it; in the US banks hold very few mortgages themselves, they just service them, meaning handling all the legal work-- they pass on the principal and interest payments to whoever might have bought them).

Who made money in this? Not the original mortgage holder. Not the bank, which typically would get hit by part of the loss, if the loan went bad quickly. So where did your $15K of equity, and $15K of the mortgage write down go?

The guy who sold you the house got $300K, for property which is now worth $270K; that is the only account that's in the black in this scenario.

Originally Posted by xyzde69

They threw away people from "their" house, banks took the money from investors and never refund the integrality of the protected capital.

There's no such thing as protected capital, not sure what is meant there.

Bank depositors didn't lose money in the Crisis, even when banks went bust-- US bank accounts were guaranteed up to $250,000 in deposits; there were a few people with larger accounts at one or two banks that may have lost money if they had larger amounts on deposit, but that was very rare (I'm only aware of one bank where that happened).

But buying a mortgage comes with no guarantee. Your security isn't a promise by the bank, its the value of the collateral, the house. When the house declines in value, there's no promise by anyone to make up that loss . . . that's on you, the guy who bought the mortgage.

The basic feature of the story is: housing is a our most highly leveraged asset. Between 2006 and 2012, the total market value of US housing declined by roughly $6.5 Trillion (with a T); that was a massive loss. When you have a massive loss in value of an asset, and folks have borrowed a lot against that asset, you'll have a lot of losses. That's just math.

[Roubignol]

Originally Posted by deepsepia

What money? From bust mortgages?

In my example your 50'000$ protected capital investment...
In which pocket is this money?
Why didn't the banks pay back the totality of the guaranteed capital?

As example, Credit Suisse, as goodwill, refunded 50 to 70% of the capital (depending their own criteria) if their clients had a fortune under 500'000 CHF. But they never refund the totality.
Even worse... if their clients had more that 500'000 CHF of fortune, they did not refund them.
WTF!!!

When investors bought these toxic products, they had no idea that they were buying potential toxic products, because according to the bank officers, who advised them, their capital was... protected.

Originally Posted by deepsepia

There's no such thing as protected capital, not sure what is meant there.

Here is an article that describe the story (reading time two minutes)

google translated article

[deepsepia]

Originally Posted by xyzde69

In my example your 50'000$ protected capital investment...
In which pocket is this money?
Why didn't the banks pay back the totality of the guaranteed capital?

What you had was that Swiss banks selling a Lehman financial product to their customers with the name "%100 Principal Protection Notes" or PPN.

A PPN is, typically, a combination of some risky assets, plus a guarantee.

Unfortunately, these are only as good as the credit of the entity making the guarantee . . . and that entity was Lehman. When a bankrupt company is the one "protecting your capital" -- well, then there's no protection at all.

So what happened was that Credit Suisse and UBS sold these Lehman products, Lehman went bust, now the products have no guarantee. . . that is part of why the Lehman collapse was so devastating, because they were the counter-party, the people who'd made guarantees, to other companies and people . . . and now they were broke, which meant their guarantees weren't worth much.

[cicciobuki]

A news channel question...

Now and then (like today when something like this Vegas tragedy happens) i want to check American News Websites, and usually i turn to CNN, because it is the name that i know (back in the day that was where i followed the whole 9-11 thing).

Though here on the forum i often notice that CNN gets a lot of flak, so my question is: what is a good, reliable and fairly neutral/objective news channel (with a website, obviously) you would recommend to a foreigner?

[Roubignol]

Originally Posted by deepsepia

So what happened was that Credit Suisse and UBS sold these Lehman products, Lehman went bust, now the products have no guarantee. . .

Yep... but the bank officers never said to old retired grannies and daddies, that they could lose their funds.

There were several stories old retired people, who received a call from their bank officer. They had a small pension and a capital. The bank officers advised them to put almost all their bank capital on Capital guarantee products (because of the guarantee), but never said that was not their bank that was protected their capital. Their clients trusted them.

When you read later that the boss of the most exposed bank was an ex-chief of Lehman Brother... You begin to think that was a kind of fraud.
Because they massively sold these products just one year before the Lehman's crash.

Later CS and UBS made billions of benefits but never paid back their "lack" of informations.

If I remember well, the same stories happened all over Europa. At least in France and in Germany...

[deepsepia]

Originally Posted by xyzde69

Yep... but the bank officers never said to old retired grannies and daddies, that they could lose their funds.

There were several stories old retired people, who received a call from their bank officer. They had a small pension and a capital. The bank officers advised them to put almost all their bank capital on Capital guarantee products (because of the guarantee), but never said that was not their bank that was protected their capital. Their clients trusted them.

When you read later that the boss of the most exposed bank was an ex-chief of Lehman Brother... You begin to think that was a kind of fraud.
Because they massively sold these products just one year before the Lehman's crash.

Later CS and UBS made billions of benefits but never paid back their "lack" of informations.

If I remember well, the same stories happened all over Europa. At least in France and in Germany...

I can't speak to what might have been said by a CS or UBS banker to a customer - they might well have mislead them.

But if you look at the purchase agreement for any structured note sold by a bank, it will be explicit that this is not a bank deposit, rather it's a debt security guaranteed by some third party, not the bank.

This is why bank regulatory stuff is so important. The question of whether the bank is acting as a fiduciary- with a duty to your best interest, or whether its acting as your agent, just selling you something you want to buy- this will be lost on nearly every customer, but it's critically important in cases like PPNs (which are crappy fee machines, really shouldn't exist)

You probably didn't notice, but.one of the things the Trump Administration is doing is gutting rules which make banks more responsible for vetting stuff like this; the devil is in the details.

Never buy something that comes with some complicated contract that you have to sign without understanding; and ask whether the bank is acting as fiduciary or agent. And "get it in writing" -- "stuff someone promised" ain't worth much to signed document that says "I understand that this PPN is a debt instrument of Lehman Brothers, who are the sole guarantors and make the only market in it"