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Please note, I’m really enjoying this discussion with you, you are making me think.

I worked on Wall Street for 10 years, during the mid 1990’s to mid 2000’s. Wall Street marches instep. If they didn’t we wouldn’t have had this crisis. We wouldn’t have had the tech bubble either. There’s an old saying “The Market can remain irrational longer than you can remain solvent.”

In Wall Street, first comes the innovators, next comes the imitators, finally the idiots.

Ok, I need to help you clear up some terms. When we are talking about securitization, we are talking about packaging debt together and selling off the repayments. So for example when you bought your house, the bank didn’t keep your loan on the books, and wait until you repaid them, that would kill their business practice. If you put 20% down, then they probably sold your loan with a bunch of other people to Fannie or Freddie. Fannie then sold off investors in chunks. It wasn’t an exciting business, the investors didn’t make much money, but there was low risk. And this worked quite well for over 70 years. Securitization made it possible for affordable mortgages.

Now some investors might want a bit more profit, and a bit more risk. That’s the subprime lenders, Unregulated Mortgage brokers would target people with bad credit, low down payments, spotty neighborhoods. They would charge a higher interest rate, and higher fees to justify the risk. A traditional Fannie/Freddie security might pay 3%, a sub-prime might pay 10%. Greater risk, greater reward. People knew what they were getting into, Moody’s & S&P would give the sub-prime mortgages lousy ratings and low-risk investors would stay away from them.

Things went to hell when Wall Street decided to get creative and fraudulent at the same time. First they got creative, they figured they could divide up the sub-prime securities with three tiers, low risk, medium risk and high risk. When they talk about the CDO people usually mean this. And all that really meant was low risk people would get paid first at the lowest interest rate, medium risk would get paid next, and the high risk would get paid last but at the highest rate. Once again, that was pretty clever, risk=reward.

Then the fraud started. The Securitizers started hiring employees from the ratings agencies to package the mortgages to get AAA ratings. They were gaming the system. Moody’s & S&P knew this but didn’t say anything because they were making a ton of money. With the AAA ratings suddenly you were able to get High Reward with LOW Risk. The Holy Grail of finance. Pensions, Mutual Funds, Government treasuries, municipalities all flooded the market. With cash.

But there weren’t enough buyers for the the high risk portion of the CDO’s. Until somebody realized they could buy insurance (Credit Default Swap) on the entire CDO. Suddenly, if you had a lot of money, you could go to the investment bank, tell them you would buy the worst part of a CDO if they make it your way. So think about it, there a CDO worth 250 million, you buy the worst part of it for 50 million, your insurance premiums is 40 million. When it goes belly up you are paid 250 million. You know it’s going to fail. I repeat you know it’s going to fail. You will profit 160 million. You used your own capital, you bought 20% of your own security, that’s a pretty hefty %. Double it to fifty %, nobody on wall street is going to sneeze at a 85 million payday.

So Nicole’s first point really doesn’t work at reducing fraud.

And the same issue happens with her second point. It works if and only if AIG knows what they are doing. 10 Billion might be the right amount to have on hand if you are predicting a 10% failure rate on a 100 Billion of obligations. But if you are wrong, we are back where we started from.

In other articles she is advocating the regulation of all Financial institutions, an increase in capital requirements, the banning of all propriety trading and making many current financial tools illegal. This is a Radical departure from the last 40 years of Modern Conservatism.

A couple of points to add is that the “insurance” aspect of the swaps was imaginary. The underwriters weren’t held to insurance backing standards — BECAUSE IT WASN’T REAL INSURANCE, it was just touted like it was. So the CDS were being used as a collaterization or to balance against loans with the supposed reinforcement that it was backed by “insurance” but the “insurance” was bogus.

Additionally as the 90s brought us the “mark-to-market” accounting (partly due to the tax-man’s lust) the holders of all these various derivatives and lumped investments failed to accurately start marking down their valuse and massive distrust insued. The distrust fueled the short sellers and sharks, like the hedge funds — shorting rulls had be scraped in the 90s so it was a feeding frenzy as they beat down those not being deadly honest.

Much of the push to avoid honesty was that (as you pointed out to begin with) they were almost all public traded firms with quarterly reports and stock prices making up major compensation. Additionally, as they lost value in these investments on their books, now being marked to current market value, those that were finacially regulated firms had insuffient reserves so they went hunting for big cash influxes and those were limited by falling stock worth.

Tulips. I tell you it was just like Holland and the Tulip bubble.

Since government planned outcomes and planned economies were the cause, they are obviously not the solution. Regulation was not the cause however and neither was law. The too sudden change to regulation was contributory but the government planning of outcomes (hat-tip to Road to Surfdom) was the true cause and must not be used as the solution.

“In other articles she is advocating the regulation of all Financial institutions, an increase in capital requirements, the banning of all propriety trading and making many current financial tools illegal. This is a Radical departure from the last 40 years of Modern Conservatism.”

I would not consider the last 40 years a ‘conservative’ market. Not sure what you mean by ‘modern conservatism’. I don’t look at the market as conservative or liberal. The policies that help or hinder it could be considered such at times(like the CRA). ‘Free markets’ didn’t use to be solely a ‘conservative’ term until the progressives came along wanting to take people’s property and spread the wealth. After that outrage began, it was the natural thing for conservatives to gravitate towards defending their property from government theft. Free markets..true free markets worked. They kept our economy humming and competitive. This all fell apart, not with a free market,but big government manipulations imho.Can you really blame WS for trying to get ‘creative’ when they were forced to loan money to millions of people that they knew were bad bets on housing and credit cards? I am not excusing them mind you for putting our entire system at risk and now running to the taxpayer to bail them out...but the root of the problem lies with Congress..not the markets imho.

I get tired of the liberals throwing around the term ‘greed’ all the time too. It’s not ‘greedy’ to want to earn the most money you can in life..it’s the responsible thing to do imho. What true greed IS lurking around in the human soul cannot ever be ‘regulated’ out of existence anyway. It’s not a fixed pie. If you didn’t get your ‘share’..go make another pie...lol.

Your clarification on the term ‘securitization’ is appreciated. That has happened to all of my mortgages over the years with each home we bought, but I never knew the term..lol. I just knew they were selling my mortgage to another lender. To a casual observer, ‘securitization’ should mean a way to ‘secure’ your asset or debt with your collateral.I should have googled it before talking about it..lol.