Letters to the Editor
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Dispersed risk
IMO, the problem with this is that only the risk gets dispersed. The profits, when there are any, stay in the hands of the few.
I'm having a hard time understanding why Wall Street's activities are considered so beneficial that they deserve to be encouraged by hefty tax incentives.
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I'd have used the Black Plague
The analogy was good, but having the disease spread by rats and fleas seems more appropriate under the circimstances.
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Oh! Oh! I can hide my loss!
Perhaps the real silver lining is the opportunity to dump one's non-performing, loss laden assets at this time and blame it on the sub-prime wave. This way one can deflect scrutiny for bad decisions and sweep them under the sub-prime rug.
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Libertarians would find it hard ...
... to admit that their favorite philospher, Greenspan/Rand, could fail intellectually. Don't hold your breath for them to change their minds.
Yes, socialize the risk, privatize the profits! These episodes only show how our private appropriation system is not theoretically (let alone practically) working in a mass, interconnected world, in which the public is affected by every 'private' decision ... the contradiction is glaring. Just like oil or water being 'owned.' There is no clean line anymore, if there ever was one.
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From the Dead Horse Spanking Dept.
Spreading risk as wide as possible is a sound idea and works just fine, Andrew--so long as the risks insured are understood well and priced properly. The idea really is like ebola when that risk is poorly understood and underpriced. This is why life insurance companies, who have been working with mortality for 100+ years very closely, consistently make money in life insurance. Mortality among a general population sector is very well understood as a risk.
Again, hundreds of billions of dollars worth of subprime loan products were underpriced with no track record of performance. However they were priced, the results were badly out of joint with the prospectus. When that bad risk is spread throughout the investment world, it really does--and scientifically, should--act like a plague virus.
Look at it this way: arguing AGAINST spreading the risks goes against the mathematical principle of the law of large numbers. Make the argument if you please, but you're arguing against math. Now, if you don't believe in math, I can put you in touch with the local Flat Earth Society people in your area.
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Spread risk? Spread massively increased risk is more apt.
Hi Andrew,
It seems to me that the issue you're skirting with your zinger ("spread contagion faster than the Ebola virus") is that the US housing bubble could not have gone on for as long as it did without a worldwide credit market. The reason is that any given institution will accept as much perceived risk as it's comfortable with, and no more.
Had there been the same amount of regulation but only a national credit market, the US credit market would probably still be hurting, but investment losses might have been limited to US companies. Once the US got saturated with MBSs, however, its mortgages got sold 'round the world, and this is why we're playing international whack-a-mole with banks, and any institutions that had excess cash to invest during the last decade or so.
Without all of that "extra credit" (contrast the term with the high school definition), the US housing bubble would have popped long ago due to lack of mortgage credit. The economic situation facing the US wouldn't be as bad (as the bubble would have been much smaller), though I'm not sure that the US credit markets would be any better off. Maybe, since the lack of available mortgages might have encouraged lending institutions to avoid making "Liar's Loans."
-Wil
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@alkaline
When risk is dispersed in mortgages, profits are actually reduced because the issuing lender either a) buys insurance for the mortgage paid annually; or, more often since insurance is less available, transfer ownership and/or servicing rights to one of two different organizations.
For example, the issuing lender might only make a one time fee of 1-2% origination. The purchasing lender makes the interest on the loan, from which they pay a servicing company a fee to send the bill out every month and collect. The holding lender then might package the loan with thousands of others like it and register them as MBS with a commercial underwriter, spreading risk around the system like a spoonful of peanut butter over a giant cracker (say, a matzoh). The problem comes in when a) the peanut butter has biotoxins in it, and b) so many of these loans have been issued that the peanut butter is now an inch thick, guaranteeing that every bite is covered in poison. Yumm.
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Looking Ahead
The Dot Com bubble burst about seven years before the Housing Bubble burst. So now? We have about five years to jump into the Alternative Fuels Bubble, and get back out before it bursts, I guess.
Then what bubble? The Bartering Scrap Metal For Food Bubble? Iraq might become a major player in that, with all the old Saddam-era Russian tanks and clapped out US armored Hummers.
Maybe the Seawall Bubble, as we fight rising sea levels.
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This is why life insurance companies.....
...Well that and the fact that insurance companies essentially keep two sets of books on the business. One for insurance operations and one for investment operations. The key is to show zero or less than zero gains on the insurance side of the business where the bulk of the taxes and regulation is, and to make most of the earnings off the investment side of the business concurrently which has a better regulatory and tax position.
Of course on the M+M book for life, DI and similar products, yes you're right, the experience rated policies are very well understood across selected populations.
But the wider issue is, you can't really have it both ways. You can't build a wall around all the financial institutions you choose to dislike today and arrange something so that you're not harmed by their failures while at the same time, your pension fund, IRA, personal equity and such are locked up in 'other' firms you choose to participate in. What for example should you do if TIAA-CREF chose to invest poorly and wiped out 50% of the worth of 10 million teachers' pension funds?
If we remember Enron, one thing that was crystal clear was that many of the people who lost their shirts did the ONE thing all financial professionals tell you NOT to do - invest all or most of your money in YOUR OWN company. That's ALWAYS a dumb thing to do. Now is Enron guilty? Yes, but people got chopped in the neck BECAUSE they did what any sane person told them not to do. If they had taken that advice they would have lost their jobs but not all their money.