In that context, the question, we ought to ask ourselves is this: Why did the banks lose a lot more money in the current mortgage debacle than they did in the equity bubble, where the losses were higher.

The answer can be very revealing: It was because the leverage providers — margins lenders — didn’t provide term leverage. It was on variable terms. If the collateral was good, leverage would eb available. If it wasn’t it wouldn’t be. That pushed the onus on to the equity holder. In the current debacle, because of the termed out leverage and availability of this on a gargantuan scale, when the cycle was turning, the equity tranche holders stake was so little that they were being paid off of the underwriting fee. In other words, they had no effective equity and term leverage to boot. So a solution that focuses on retention of the equity will only work if the size of the equity tranche is large AND if the leverage provided by the senior tranches is either revocable or not fully termed out. Otherwise it just wouldnt work.

The “money multiplier” based on liquidity reserves hasn’t been operationally relevant in the US banking system (and others) for several decades.

What name would you give to such an arrangement?
Well, every person who owned a home would be both a home-owner (which we are endlessly told
is a good thing) and an owner of a wealth creating
asset being paid off over time (which at least is not a bad thing) At the same time, everyone would also
be a tenant. Some, just as today, would be only tenants, but not owners.
The question arises: What would the price of these houses be? Certainly a multiple of market rent to be imputed by the prevailing interest rate,
discounted by the other costs of ownership.
What would be the underpinning of the mortgages
on such houses? Not the income of the owner, but that of the tenant. What would be the propensity to
oversupply? Something close to zero.
How would the prices of these houses compare with
present prices? They would certainly be much lower, for the principal reason that the bulk of their
value would represent their ability to generate an
income stream over time, as opposed to the
“entertainment value” and speculative value which is today such a significant portion of house values.
Such a system, which I am not proposing, would not be immune to losses. When a 1 company town shuts down, the owners still lose. But they lose less, because prices have much lower speculative and entertainment components built in.

The free market ideologues have to get it through their thick skulls that there is no fundamental right to expose others to risk. We do not allow people to build nuclear reactors in their backyards without any sort of regulation so that they can sell power back to the grid, even though in theory it might result in more plentiful and lower priced electricity. The reason we do not do this is because of the _RISK_ of a release of deadly radiation or of a meltdown, even though it’s not absolutely certain that such an event will occur. One can draw a similar parallel to drunk driving laws. The die hard libertarian will claim that one should be allowed to drive drunk, so long as one does not actually crash into another vehicle. This completely misses the point, and assumes that one has the unlimited right to expose others to risk provided that the negative event never comes to fruition. Yet, for some reason, this is precisely what we are doing with our financial markets.

The financial markets, because of the very nature of the payments system, serve as a link between almost all players in the economy. As a result, actions taken by one participant (e.g., highly leveraged speculation) expose the entire economy to risk. So let’s stop apologizing for simply suggesting that such actions be regulated, ok?

I thought sponsors made their “estimates” based on historical loss experience (maybe historical losses of $0), despite the fact that losses looking low due to things like the sponsors previously taking back distressed assets from the conduit, or perhaps not having operated in a long-term credit crisis.

The SEC and FASB have gotten some complaints about allowing this. Senator Jack Reed send a letter to FASB and IASB complaining about various rules, including FIN 46, as allowing banks to hide liabilities/losses.

It is impressive how effective the banks are at lobbying for friendly legislation, accounting rules, regulations, and such.

Where be thy broad, deep and liquid mortgage markets TODAY, Alan?

Yves’ experience of mingling with the true believers at the Milken Conference, is available to all of us every day. We just need to read Alan Blinder and any one else who utters nonsensical comments that carry within them characterizations of time frames that no loner exist.

“This seemingly convoluted model gave Holland — indeed, the known world — the broadest, deepest, most liquid tulip markets.”

“This seemingly convoluted model has given the United States the broadest, deepest and most liquid ‘dot.com, hits-based’ new economy and equity markets”

“This seemingly convoluted reasoning has given the US and the World the broadest, deepest and wisest financial and economic commentary and, thereby, opinion markets”.

Here is a shortlist of how securitization might be saved. Not, to be clear, that I would recognize a CDO prospectus if I was lighting a Franklin stove with it. Nor am I, personally, even sure that securitization should be saved, but a functioning financial economy has some larger value for society. 1) The concept of tranches—dedicated payment streams _without_ actual ownership of the underlying assests as I understand them—is inherently ripe for abuse, and distorts the sense of what is being bought. It would be better if these were largely eliminated so that a CDO buyer was holding the intsturments, the risks and the profits outright; y’know, like _BONDS_, friends. NOT like derivatives. 2)Such fairly unitary insturments would better be _smaller_ per security, so that investors take bite size chunks of asset classes, and make a risk assessment of their own with each purchase. If someone wants $3B in T-bills, they buy them in blocks not en bloc. Oh, by the way they can _sell_ them in blocks or individually, too. Smaller chunks would also allow investors to diversify the asset class and region themselves. Yes, it’s more work for the investor but look where they got themselves to speeding down Easy Street. 3) These instruments need to have real cash bundled into them as a form of ‘first loss recovery’ overcollateralization. Say, one has a certain value of T-bills, just for the argument, of similar term tied into the instrument; this is part of the profit that the investors ‘buy’ in buying the security and holding it to term if none of it is sold to offset losses depending upon the design of the instrument. There could be many variations on this, but the constant is that there needs to be _real_ reserves locked into the securities themselves so that their face values don’t plunge catastrophically in the event of internal losses.

Oh, and the inability to do mods on the underlying debt notes in the CDOs wasn’t a bug but a feature as far as the dealers and the wheelers in these things were concerned. If you can’t do mods you don’t _have_ to do mods: the suckers with the debt just have to pay up. Surprise, surprise: they can’t. So 4) clear, legally enforceable provisions _with consumer protections_ need to be written into the collateralization covenants. This will take an Act of Congress most likely, but will make the securities more functional in actual practice, and so, y’know, ’save the investors from [their greedhead] selves.’

“I gasped out loud when I heard that the list had been expanded to include securitized credit card and car loans.” I did myself; this is so beyond absurd—at face value. Those _car loan_ securities are guaranteed to take massive losses in an economic downturn, they’re the worst definition of ‘collateral.’ “Here, collaterallize yourself with this No. 4 best bar anchor while you try to swim to the rescue ship.” The point is, to me, that the whole ‘collateral’ requirement is just a fig leaf. The Fed will hold this stuff until the banks recover and buy it back, is the idea. So it’s the equivalent of someone’s personal IOU, there is never any intention to cash out the stuff. (Famous last words.) The Fed would hardly be less exposed simply giving T-bills in billion dollar blocks to banks on a simple promise to repay. And I fully expect we will reach that point of nonsense in the determination of the Fed + Treasury to keep asset prices from falling. They are prepared to go to ANY LENGTH INCLUDING GIVING MONEY AWAY FOR A SONG to prevent a real correction of asset prices. . . . Won’t work. There is such a thing as gravity, and running as fast as you can doesn’t get your appendages going up to helicopter speed so one simply burns calories on the way to the canyon floor below. Sez I.