From Liar's Loans to Liar's Ratings?
The subprime mortgage meltdown and the ancillary predictions about whether it will drag the economy directly into a recession are headline news. But I'm losing sleep over a very different concern: What if there's no recession because the rating agencies don't tell the truth?
The emblem of the subprime mortgage meltdown has been Liar's Loans--high-interest mortgage loans for which the borrowers could fill in any numbers, and the mortgage companies wouldn't check. In other words, bad information. Now, from Gretchen Morgenson at the New York Times, comes a paragraph that makes me wonder if Liar's Ratings are coming next:
Nevertheless, some investors wonder whether the rating agencies have the stomach to downgrade these securities because of the selling stampede that would follow. Many mortgage buyers cannot hold securities that are rated below investment grade — insurance companies are an example. So if the securities were downgraded, forced selling would ensue, further pressuring an already beleaguered market.
I get the part about the stampede, but I'm enough of a market purist to believe that when quality fails, the rating agencies MUST downgrade. If they do not, then ratings are not giving a genuine mark of the quality of securities. At that point, all confidence in the American markets will dissolve.
A piece in the Wall Street Journal last week (no link) suggested that hedge funds that had big exposures in the subprime markets were delaying their regular reports while they went shopping for more favorable valuations of the subprime portion of their portfolios. More bad data coming up?
My friends from Japan tell me that one reason the Japanese recession of the 90s lasted so long (a decade) was that the banks were loathe to write down the value of their assets. They just kept carrying over-valued property on their books. By refusing to take the hit on bad loans, they make their own reports useless and investors stayed away. Only after they admitted the problem and wiped out some companies and investors, could they move forward again.
Good data are essential to make markets work, and ratings are the gold standard. If Morgenson is right, then we may not see a recession this spring, but the long term effects for the economy would be a disaster.
Comments (6)
You mean to tell that ratings agencies might have certain conflicts of interest? Well, I never!
March 17, 2007 6:59 PM | Reply | Permalink
thanks for such a great posting! I think it's right on! there's a mismatch between wages and what people pay for things and a gap between the rich and poor.
I forget where I read it, but when this situation occurs, societies apparently crumble.
Forbes had a similar quote to the one you posted:
Quote 1: In reality, the problem goes way beyond housing. Nearly every big-ticket item that Americans consume is paid for with borrowed money, with foreign lenders supplying the credit. Without access to low-cost credit, the spending stops."
Quote 2: "The fix now being suggested by some members of the U.S. Congress demonstrates how Washington completely misunderstands market dynamics. Their legislative proposals will require that lenders make potential borrowers verify their incomes and restrict credit only to those who can afford the payments after the teaser periods end. Washington fails to grasp that a return to traditional lending standards would precipitate a return to traditional prices, which are way below current levels.
Where I found it: The Housing Bubble Blog
Original Source: Forbes: From Subprime To The Ridiculous
What makes all this "scarey" is that real-estate is apparently 75% of "our investments" but what makes it "bearable" is that perhaps the arabs will bail out the "foreclosure bomb" to save the economy. (source: KPFA, "Pacifica Radio," Guns And Butter
March 18, 2007 3:45 AM | Reply | Permalink
Good data are essential to make markets work, and ratings are the gold standard.
I think it was in the book Deflation: What happens when prices fall that talked about regulation being the key to going off the gold standard because, otherwise, people would lose faith and that's why the IMF, for example, was created.
Thus, it scares the hell out of me when our politicians say that we need to deregulate our financial markets to keep them competitive. It seems like they want us to go back to the "wild west" days...
I don't do economic modeling but I was wondering out loud last week, after reading a bit of the book above, if "interest paid" was the deflated price and "the capitol" was the protected price which nobody can afford to pay off. I think we're in for some interesting times...
March 18, 2007 3:56 AM | Reply | Permalink
Well, hmm, do you want a recession? That would worsen all the problems that are discussed on this blog, and affect people who might not otherwise be affected by a bunch of already bad loans going bad. There are situations when telling the truth can be worse than not telling it, or when things said become a self-fulfilling prophesy. A doctor, for example, ought not harp on the worst case prognosis when a patient is receiving the bad news about cancer or HIV, even if he feels that the worst case is more likely than not. The psychsomatic effect is real enough in medicine and I believe it holds good elsewhere in life, anywhere that attitude and emotion have power to influence reality. By all means prosecute deliberate fraud and tighten up standards (but smartly, not stupidly) but crashing the market to make a point seems like a classic case of cutting off one's nose to spite one's face.
March 19, 2007 6:30 PM | Reply | Permalink
CERTAIN parties have stood by for a long time, like about the last, hmm, 12 YEARS or so, and allowed certain goings-on. Well, the GOP racketeers no longer 'own' Congress, and some of em ended up doing hard time. Good riddance, there, hopefully the consumer, er, CITIZEN advocates will step forward and jump up and down on the table until someone listens up about the legitimized loan-sharking that's been permitted to go on in our country all these years, and put a stop to a fair amount of it. Be it a car loan, a mortgage, or just a credit card, there's reasonable, and there's unreasonable. Since the last few years have gotten really unreasonable, I used it as MY reason to stop buying things on credit. Now, I pay NO interest. Ahhhhh....well, there's one little one left out there, but next month, it's history. In God we trust, all others pay cash...
March 25, 2007 7:24 AM | Reply | Permalink
Bravo!! Congradulations! Welcome to greater financial security! Don't ever go back, it will always be a trap.
Jim Anderson
The Truth About Credit
Facebook ProfileApril 2, 2007 8:16 AM | Reply | Permalink