Fed Creates $1 Trillion 'Out of Thin Air"

[Piggy]

So once again, insurance causes an overall increase in risk-taking: it allows people to engage in risky behavior that they would avoid if they had no insurance. Which is not usually a bad thing. Risk leads to innovation and advancement.

Well put!

 

[mhaze]

Well put!

Now let the Gov. rush in and "back guarantee" this worthless junk and we just got manuevered into the bullfight of "moral hazard", led by bought off politicians with eyes wide shut.

 

[Thunder]

Don't we also "create money out of thin air" by simply selling bonds??

The Chinese buy our bonds...we get money.

 

[Piggy]

Now let the Gov. rush in and "back guarantee" this worthless junk and we just got manuevered into the bullfight of "moral hazard", led by bought off politicians with eyes wide shut.

Oh, really?

Show me the money.

 

[Piggy]

Now let the Gov. rush in and "back guarantee" this worthless junk and we just got manuevered into the bullfight of "moral hazard", led by bought off politicians with eyes wide shut.

And btw, this junk isn't as worthless as you think it is.

Prices are now getting into the zone where it makes sense for investors to start picking it up again.

 

[TraneWreck]

Actually risk is lowered by the removal of insurance. What insurance does is disseminate the risk, not reduce it. People will undertake risky projects if they can be insured because the risk of failure to them is lessened.

Thus the problem with mortgage backed securities and credit default swaps. People kept doing risky things because (1) they were highly profitable and (2) they could transfer much of the risk to other people and still make a nice profit.

Mortgage originators would not have made loans to people with no money down and no income check if they were depending on those people to pay them back. But they knew they could sell the mortgage as soon as it closed and collect their origination fee. Now it's someone else's problem. The person who bought the mortgage to securitize wouldn't have done so if they couldn't sell the security. And the hedge funds and banks that bought the security wouldn't have done so if the security didn't have a AAA rating. And the security wouldn't have had a AAA rating if they hadn't been insured by the world's largest insurance company, AIG. Thus the whole risky chain would have not been possible without AIG's insurance: essentially, mortgage lenders would have been forced to lend money only to people who they thought would be able to pay them back.

So once again, insurance causes an overall increase in risk-taking: it allows people to engage in risky behavior that they would avoid if they had no insurance. Which is not usually a bad thing. Risk leads to innovation and advancement.

There's something like an equivocation with the word "risk" going on here. You have to be clear about who bears what responsibility. From the perspective of someone engaging in a transaction, paying for insurance limits your potential losses, or risk. But insurance can also lead you to take more chances, or risk.

Those are two separate concepts. Here you're discussing the idea of taking chances beyond what is reasonable. I was discussing the idea of limiting losses. Ideally (or practically for the most part) no insurer would underwrite extraordinary chance. But as we know, the financial industry engaged in wide-spread fraud.

One interesting thing they would do is package a risky mortgage with other financial instruments like car loans or credit card debt. You pool it all together and the odds that some of it will be payed back is fairly high. This is how they finagled those AAA ratings. Then it's relatively easy to get insurance when you have a AAA rating, then the leveraging...etc.

And the basis for handing out those sub-prime mortgages was that housing prices would raise infinitely. Thus, even if a client couldn't keep up with payments, you could always refinance. This was a silly gamble that had little to do with the concept of insurance. If it were simply the case that they gave houses to people who couldn't pay (another canard as the leading cause of foreclosure is health care costs--meaning many of the people could initially pay, but something intervened), then no one would have allowed them to leverage against the initial mortgage. There was a bizarre adherence to the idea of infinite refinancing.

But the presence of insurance itself shouldn't cause imprudent behavior because those underwriters wouldn't offer coverage for something so uncertain. There are plenty of things that are too risky to be insured, and the weird financial schemes should have been among them. But all of that fraud allowed the insurers and risk takers to essentially be complicit in a plot to create money.

 

[mhaze]

And btw, this junk isn't as worthless as you think it is.

Prices are now getting into the zone where it makes sense for investors to start picking it up again.

Sorry for being unclear, stock market cannot be worthless junk except perhaps for zombie companies.

"Worthless Junk" is CD swap style junk issued by AIG and subsequently paid off by the taxpayers thru the US Gov's beneficence...

....One interesting thing they would do is package a risky mortgage with other financial instruments like car loans or credit card debt. You pool it all together and the odds that some of it will be payed back is fairly high. This is how they finagled those AAA ratings. Then it's relatively easy to get insurance when you have a AAA rating, then the leveraging...etc.

And the basis for handing out those sub-prime mortgages was that housing prices would raise infinitely.....

However (IIRC) the $324B bill signed by Bush 7-2-2008 fully brought all subprime into a gov-insured loan quality level. Thus those derivative instruments which were not fraudulent from then forward should have been quality instruments.

Now go figure.

 

[Piggy]

But the presence of insurance itself shouldn't cause imprudent behavior because those underwriters wouldn't offer coverage for something so uncertain.

I think you and gdnp are on the same page here.

Note that he doesn't equate risky with imprudent.

 

[Piggy]

Sorry for being unclear, stock market cannot be worthless junk except perhaps for zombie companies.

"Worthless Junk" is CD swap style junk issued by AIG and subsequently paid off by the taxpayers thru the US Gov's beneficence...

No, I know what you're saying.

Or thought I did... I believe you're referring to CDOs not CDSs.

But yeah, I meant what I said. The so-called "toxic assets" are not nearly so toxic anymore, now that the valuations have deflated.

The swap mess is a whole nother can of worms.

 

[TraneWreck]

I think you and gdnp are on the same page here.

Note that he doesn't equate risky with imprudent.

Well there are a number of questions on the table. AIG's behavior with respect to the credit default swaps was imprudent and possibly legally fraudulent.

There's supposed to be a relationship between the degree of risk taken and the amount you pay for insurance. I can't think of an example (maybe you guys can) where someone has a simple project, but once they receive insurance they go ape-****.

In fact, if you are taking unecessary or wild risks, the insurance companies will point this out and refuse to pay. So I'm not exactly sure how insurance itself will lead to riskier behavior.

 

[Piggy]

Well there are a number of questions on the table. AIG's behavior with respect to the credit default swaps was imprudent and possibly legally fraudulent.

There's supposed to be a relationship between the degree of risk taken and the amount you pay for insurance. I can't think of an example (maybe you guys can) where someone has a simple project, but once they receive insurance they go ape-****.

In fact, if you are taking unecessary or wild risks, the insurance companies will point this out and refuse to pay. So I'm not exactly sure how insurance itself will lead to riskier behavior.

I'll leave it to gdnp to hash this out w/ you, but I still think y'all are using slightly different language to come around to basically the same point.

Cheers.

 

[gdnp]

There's something like an equivocation with the word "risk" going on here. You have to be clear about who bears what responsibility. From the perspective of someone engaging in a transaction, paying for insurance limits your potential losses, or risk. But insurance can also lead you to take more chances, or risk.

Those are two separate concepts. Here you're discussing the idea of taking chances beyond what is reasonable. I was discussing the idea of limiting losses. Ideally (or practically for the most part) no insurer would underwrite extraordinary chance. But as we know, the financial industry engaged in wide-spread fraud.

Do we know this? Who, so far, has been charged, tried, and convicted of this fraud?

And the basis for handing out those sub-prime mortgages was that housing prices would raise infinitely. Thus, even if a client couldn't keep up with payments, you could always refinance. This was a silly gamble that had little to do with the concept of insurance. If it were simply the case that they gave houses to people who couldn't pay (another canard as the leading cause of foreclosure is health care costs--meaning many of the people could initially pay, but something intervened), then no one would have allowed them to leverage against the initial mortgage. There was a bizarre adherence to the idea of infinite refinancing.

I put the major blame with the actuaries and the bond rating agencies that did not correctly assess the risk. They gave AAA ratings to things that depended on the continuation of an unprecedented run of housing price increases? I would have thought that the question "what will happen to the value of this bond if housing prices drop?" would have been pretty basic.

But the presence of insurance itself shouldn't cause imprudent behavior because those underwriters wouldn't offer coverage for something so uncertain.

But this is exactly what they did. If they had only insured reasonable bets, they wouldn't have lost $65 billion last quarter, would they? Which raises two possibilities. Either they miscalculated the risk, or they knew the risk and chose to ignore it because their own personal benefit through pay and bonuses was paramount, not the long term health of the company.

There are plenty of things that are too risky to be insured, and the weird financial schemes should have been among them. But all of that fraud allowed the insurers and risk takers to essentially be complicit in a plot to create money.

I'm still not convinced that this was outright fraud, or if it was who was guilty. The mortgage originators? The companies that hired them? The investment banks? The bond ratings agencies? AIG? Was it the worker bees or at the highest levels?

 

[TraneWreck]

Do we know this? Who, so far, has been charged, tried, and convicted of this fraud?

As we've seen so often in these last 8 years, criminal fraud will be hard to prove because the actors can always plead incompetence. And for a number of their shady acts they got the ok of the fed (the go ahead to create credit default swaps with out cash on hand, for example).

Hopefully some of the major players will go down, but I'm not holding my breath.

I put the major blame with the actuaries and the bond rating agencies that did not correctly assess the risk. They gave AAA ratings to things that depended on the continuation of an unprecedented run of housing price increases? I would have thought that the question "what will happen to the value of this bond if housing prices drop?" would have been pretty basic.

No kidding, that's one of the all-time stupid moves. It seems that those actuaries were working in concert with the lenders and leveragers. It was like one gigantic blood orgy.

But this is exactly what they did. If they had only insured reasonable bets, they wouldn't have lost $65 billion last quarter, would they? Which raises two possibilities. Either they miscalculated the risk, or they knew the risk and chose to ignore it because their own personal benefit through pay and bonuses was paramount, not the long term health of the company.

I'm agreeing with you there. That was the source of the problem: the way we assumed things were supposed to work was subverted years ago. And with the complete elimination of oversight, no one was around to say, "hey, stop that."

I'm still not convinced that this was outright fraud, or if it was who was guilty. The mortgage originators? The companies that hired them? The investment banks? The bond ratings agencies? AIG? Was it the worker bees or at the highest levels?

The difficulty with the fraud charge is proving the appropriate mental state of the actors. But as we've seen with Maddof and that Stanford dude who bought the cricket team, a great many of the players were baldly fraudulent. It will be interesting to see what was stupidity and what was criminal.

I think the only place we have any real disagreement lies in how to go forward in the short term. In the long run I think you're right about what needs to be reorganized, but I'm taking my lead from Krugman and other economists who recommend making sure we free up credit and easie the short term pain before we start cleaning house. But that's not the same as just writing blank checks to the idiots who never bothered to consider what would happen when housing prices fell.

 

[gdnp]

I think the only place we have any real disagreement lies in how to go forward in the short term. In the long run I think you're right about what needs to be reorganized, but I'm taking my lead from Krugman and other economists who recommend making sure we free up credit and easie the short term pain before we start cleaning house. But that's not the same as just writing blank checks to the idiots who never bothered to consider what would happen when housing prices fell.

I'm not even sure we have much disagreement there. I lean towards Rubini's opinion that the banks should be nationalized, cleaned up, and reprivatized. I suspect it may still come to that.

Hell, the price of Citigroup stock right now is about the same as the price of using one of their ATMs if you aren't a customer.

 

[mhaze]

Do we know this? Who, so far, has been charged, tried, and convicted of this fraud?
I put the major blame with the actuaries and the bond rating agencies that did not correctly assess the risk. They gave AAA ratings to things that depended on the continuation of an unprecedented run of housing price increases? I would have thought that the question "what will happen to the value of this bond if housing prices drop?" would have been pretty basic.

But this is exactly what they did. If they had only insured reasonable bets, they wouldn't have lost $65 billion last quarter, would they? Which raises two possibilities. Either they miscalculated the risk, or they knew the risk and chose to ignore it because their own personal benefit through pay and bonuses was paramount, not the long term health of the company.



I'm still not convinced that this was outright fraud, or if it was who was guilty. The mortgage originators? The companies that hired them? The investment banks? The bond ratings agencies? AIG? Was it the worker bees or at the highest levels?

As I understand it, (prepare to cringe) top tier offerings like from Lehman, AIG AUTOMATICALLY GOT STAMPED "AAA".

As for criminality, detailed examination of the company in receivership, Chapter 11, would have revealed what was there. They didn't want that, so what we are unsure about is of their choosing. Give it about 2 years to unravel in the normal legal process with interrogatories, stalls, supeanas.

Bankrupcy would have opened the entire rat's nest in December...

 

[gdnp]

As I understand it, (prepare to cringe) top tier offerings like from Lehman, AIG AUTOMATICALLY GOT STAMPED "AAA".

As for criminality, detailed examination of the company in receivership, Chapter 11, would have revealed what was there. They didn't want that, so what we are unsure about is of their choosing. Give it about 2 years to unravel in the normal legal process with interrogatories, stalls, supeanas.

Bankrupcy would have opened the entire rat's nest in December...

Lehman went bankrupt a year ago and is in the process of being liquidated. And so far we have found...

 

[mhaze]

Lehman went bankrupt a year ago and is in the process of being liquidated. And so far we have found...

I referred to my second paragraph "company in receivership" as AIG, if not clear.

But your analogy is worth pondering. Consider:

• It's okay for Lehman fall
• It's not okay for AIG to collapse

Where would Columbo look?

 

[drkitten]

And btw, this junk isn't as worthless as you think it is.

Prices are now getting into the zone where it makes sense for investors to start picking it up again.

Yeah, and I should take your unsupported word for this WHY?

Is there anyone else out there who believes that this junk isn't totally worthless? Aside from Warren Buffet, I mean? Since, after all, it's obvious that he knows less about the market than the Chicken Littles wandering around terrified of falling sky....

 

[TraneWreck]

I'm not even sure we have much disagreement there. I lean towards Rubini's opinion that the banks should be nationalized, cleaned up, and reprivatized. I suspect it may still come to that.

Hell, the price of Citigroup stock right now is about the same as the price of using one of their ATMs if you aren't a customer.

I can't tell you how happy it would make me to nationalize those failing institutions, fire all the goofballs that caused this mess, and put smart, ethical people in their positions for 1/100 of the salary.

Then we could all watch as the cleaned up institution worked fine without execs taking home $20 million salaries.

 

[drkitten]

I can't tell you how happy it would make me to nationalize those failing institutions, fire all the goofballs that caused this mess, and put smart, ethical people in their positions for 1/100 of the salary.

Then we could all watch as the cleaned up institution worked fine without execs taking home $20 million salaries.

That's the problem. I'm not sure how many "smart, ethical people" with the relevant experience would be willing to take the job at 1/100 the salary. Or to put it another way, I'm not sure I'd believe that anyone willing to take the job at that price was actually that smart or ethical.

Driving a bank isn't like driving a lawn mower; it's not the sort of thing any neighborhood fifteen year old can do. And the consequences of a mistake are a lot worse than simply a badly mown lawn.