Friday, August 17, 2007

Money for Nothing and Checks for Free

If you want to understand a bit more about what is happening in the markets, I highly recommend the IMF working paper "Money for Nothing and Checks for Free". If you are pressed for time, take a look at the graphic summaries throughout the paper.

Two things strike me in all of this:

1) The leveraged positions on some of these investments (in particular in hedge funds) on securities is almost an inversion of the historical norm of banks with required asset reserves for loans. The fact that these securities were not only over-valued but in some cases are unable to be valued is alarming

2) The subprime loan segment just blossomed a few years back as the economy was coming out of a recession via a major injection of money for the central bank (of course depressing interest rates); after today's rate cut, it's unclear that what Fed policy is going to look like. Could this mean things are really that bad? Obviously the equity markets didn't think so.

PS: Mauro Guillen of the Wharton School pointed me to this paper.


Richard Friedman said...

Hey Greg,

Good paper, good read.

What I learned...

Same as your point 1, the backing of loans has been farmed out. It's been marketized. And note the legality behind it has been sheltered. Currently you can not legally go after the market for selling hyped up offers (predatory). And those companies which originate the loans have the good old chapter 11 of their own.

And note the folks impacted by this are those that stretched themselves beyond means and those doing so in the latter half of the real estate rally. (They bought high and forced to sell low). Kind of castle-in-the-air of the real estate market.

I don't think the US real estate market boom was as great as the Japanese boom. And I do contend (but don't have all the facts needed) that housing prices have flattened because they have about reached an inflation adjusted price. Look at average home prices from 1980 and compare to today. Has real estate boomed or has inflation caught up.

I think the paper makes a case that the infrastructure to support mortgages has increased stability by moving to a decentralized market(platform) approach. Though not all regulations are in place to protect consumers and investors from the middleman trying to squeeze the margins and sell pipe dreams.

Greg Pavlik said...

Well, the theory was that risk diversification would be a good thing. Now that a lot of securities are turning out to be extraordinarily difficult to value and the effects are multiplied by leveraged positions, we're getting a lot less stability than we'd see if the positions were maintained in a traditional manner.