Hopefully, someone will alert him to your buzz sawing of his article, and he’ll back off his more absurd claims. On the other hand, this bodes badly for a Democratic administration really coming to grips with regulating the financial industry – Shiller, I imagine, would be a powerful influence on either Clinton or Obama.

I have a suspicion, no more, that these defaults are a function of _speculative purchases_ by small scale operators. At the top of the boom, folks who had bought and flipped a house or two, made a bundle, and thought they knew what they were doing took on two or three at once, intending to float the extras for fat money before their total payments even began to bite let alone the ARMS reset; in ‘a few months’ was likely the idea. This isn’t fraud per se, just small time operators being stupid. Then the market locked up, their potential buyers couldn’t get a mortgage, the value of the properties plunged enough overnight to make refinancing impossible, and omigod, there they were . . . dead broke in the headlights. Of course they stopped paying on the total loss properties immediately; I mean, most folks like wouldn’t even have the dough to make multiple simultaneous mortgage payments for even six months.

The ‘quick washout’ is likely a function of small speculators nailed at the market top. As such, though, it may not be indicative of the actual weakness or strength of comparable mortgages overall. —But I’ve yet to see the issue sized up this way by those competent to read the tea leaves (which I am not).

Now, I think there may be a real case to be made that securitization of mortgage pools is a public good—if these securities are transparent, properly written, against soundly issue mortgages, with recourse for their unwinding if and as they go bad. I say that as no friend to the industries involved, nor do I deal in or even have a mortgage (I rent). But the ’solutions’ Shiller proposes to ‘lax issuing standards to “undesirable” borrowers’ [my paraphrase] are clearly designed to prevent recourse _against underwriters_ for badly performing securities and retain for them the ability to shave the system with any scheme they can think up to inflate their profits. *blecchh*

We should more nearly have a system for mortgage securities where the underwriters are libable for the first X% or losses in a pool, where they have to post collateral against that liability at the time of issue, and where X at the very least equals their total profit on the deal. This is the kind of requirement that _will_ get us better paper, and actually maintain liquity for the mortgage market. Forget about outside ratings: nothing clears the mind like liablity and escrow.

As for other issues in Shiller’s article, they do him more harm then good. His contention that derivatives exchanges ‘have improved the quality of information’ is totally risable: they have actively done the reverse. Due to their complexity, diffuse structure, size, and closely held inside information by issuers, these instruments are among the most confusing and opaque ever designed—deliberately. The industry doesn’t want you to see them making sausage, particularly since they are skimming out far more meat from skein than you or they would be comfortable for you to know. Shiller must know this, and he becomes Shill-er by touting the benefits and staying silent on the costs of these products.

If that wasn’t enough, his failure to acknowledge the complicty of the industry in creating and trading the ultra-speculative and unstable OTC derivative instruments in his call not to ‘over-regulate’ [the profits] of his buddies, the ‘heroic innovators’ [naked speculators more like] expends at the outset all the credibility he had and more.

There is a good point to be make in his article, but the way he tried to make it is underhanded and intellectually discreditable, and in my view speaks to his real goals, presumably to save his friends profits.

If anyone is to be filleted here, it should be Berry, not Ashcraft and Schuermann(aka. The Fed).

Berry is taking generous liberties using the single pool data presented in the Ashcraft/Schuermann paper as representative of the entire market.

The authors make it clear that the single pool data used is nothing more than an example used to facilitate the (little better than) cursory analysis of the securitization process.

Frankly, it appears that Berry cherry picked an example and leveraged the author(s) credibility to make an appeal to authority.

I find it rather remarkable that Fed economists who ought to know better based an entire paper on one pool of MBS issued by one issuer in one month when there are vastly more comprehensive data sources available.

The American CoreLogic databases as of March 2007 contained 38 million mortgages. Their extraordinarily detailed analysis of 8.4 million ARMS originated between 2004 and 2006 showed only 9.1 % with initial interest rates of 8.5% or higher (note that the paper claims an average of 8.64%)

There were more mortgages ate 2% and below (1,1 million) than above 8.5% (770 thousand). Without throwing in the intermediate levels, it’s obvious that the weighted average is well below 8.64%

So that paper was a garbage-in, garbage out exercise, and it appears designed to forestall criticism of the Fed.

I must also note that delinquencies on some pools are running at unheard-of rates before reset, as high as 3-4% per month.

http://faculty.fuqua.duke.edu/~charvey/Research/Working_Papers/W56_Does_financial_liberalization.pdf

Titled: Does financial liberalization spur growth

Not the volatility paper

Lower interest rates only postpone the problem–unless you think incomes are going to soar, or you think that home prices are going to zoom back up and allow for refinancing or sales at the level of the mortgage debt. When interest rates go up in a year, or two years, or whenever, these “homeowners” will have their rates reset higher, and they will default. We are thus hostage to this debt, because it requires that interest rates stay very low forever, or at least a long, long time.

“But now distrust of opaque structures, poor underwriting standards, and unreliable credit ratings is so high that it is naive to think that many investors will have appetite for complexity absent tougher regulation.”

Much of the financial press and commentary seems fixated on the impact of the blow-up of certain sectors (monolines, subprime etc) as if they (and their investor base) represent the whole of securitised / structured products, and I read this comment in the same light. For the record, there are many of us working in the industry who didn’t buy the subprime bullshit, and who still have confidence in our portfolio! In particular, the assertion that structures are opaque is simply not true – the problem is that people forgot about credit fundamentals when doing investment work, and are paying for that now. When a deal goes from first marketing to launch in 24-48 hours (as many US RMBS deals did), you have to ask yourself why. Was it well understood? Given some of the investors to come out of the woodwork, clearly not!

Does that mean that the rest of us (prudent) investors hate structured credit? Actually, no. Will we continue buying? Well, it certainly meets our spread targets(!), and now the idiots have left / are leaving the room, maybe we won’t have to worry so much about not getting paid enough for the risk.

I know most will disagree, but I’ve always thought he was a bit overrated; you didn’t need to blow him any kisses before pulling out the buzzsaw. When you’re wrong, you’re wrong – it doesn’t matter who you are.