September 29th, 2008

For want of a nail: around the world in the financial markets

I’ve been thinking lately of this old nursery rhyme, and its idea that there can be complex and far-reaching negative repercussions from lack of timely remedies that would really have been quite simple:

For want of a nail the shoe was lost.
For want of a shoe the horse was lost.
For want of a horse the rider was lost.
For want of a rider the battle was lost.
For want of a battle the kingdom was lost.
And all for the want of a horseshoe nail.

It’s seems axiomatic that lending money to lots of people who can’t repay, doing this on a huge scale, and spreading the risk around to every financial institution so that all are affected by the inevitable default, is a terrible idea. I’m no economics wiz, but even I can see that. The whole thing was predicated on the idea that housing would always rise. But had no one involved ever heard old adages such as “what goes up must come down?”

It’s puzzling. The explanation may be that in the short term everyone seemed to benefit. And now we all pay for that illusory free lunch.

When I say “all,” I’m speaking worldwide. We’ve been so focused on our own Congress and our own Presidential race that it’s easy to ignore the fact that this crisis is worldwide. And that’s not only because the entire world is affected by what happens here. It’s also because it’s also happening there, to a larger or smaller extent.

This article at Flopping Aces makes it clear that not only is Europe feeling the effects of our problems, but they experienced a similar cause. Here’s the money quote (B&B is a British mortgage lender that has failed):

But rivals are reluctant to take ownership of B&B’s book of 41 billion pounds of residential loans — representing 3.4 percent of British mortgages — as many of them are higher risk buy-to-let and self-certified loans and the British housing market is weakening, raising the prospect of rising bad debts.

Interesting, no? The piece goes on to say that although the UK did not have the legislative mandates to make the subprime loans that the US had, they were making a great many subprime loans anyway because they were riding the wave of increasing home ownership, both reacting to and therefore helping to fuel the housing bubble.


So what’s the lesson? (too late, perhaps…) Easy money = flood of buyers = unsustainable price hikes = economic spiral.

And it’s entirely possible that a “feel good” Congress started this world wide trend… all by themselves. Oh goodie.

So what’s the story? If the other nations were not under a US mandate to force subprime risky loans, why did the other nations follow suit?

Cash… it was a lucrative market. Private enterprise doesn’t need mandates to identify a money making proposition. And once the US identified that market by government mandates, and the other nations saw just how profitable it could be, is it any surprise that it’s a “monkey see, monkey do” scenario?

This gave me a bit of an “aha” moment. I’d been puzzled by the fact that bankers and lenders, once so careful with their money, had somehow become so loosey-goosey. Now I see it this way: the Congressional mandate that lending institutions make subprime loans to buyers who couldn’t afford them was the first nail that was lost, as it were. It took away the brakes on lenders, and made them see that, in the current rising housing market and with the current low interest rates, it might be profitable to expand risky loans to more and more buyers. Buyers, of course, were only too happy to oblige, the bubble was fed, there were more buyers needing help, and as the bubble grew they counted increasingly on continual growth of the bubble to meet their loan payments either through refinancing or through flipping. Once lenders around the world saw how things were going, they got on board too. And then there were the derivatives and….well, you know the rest.

And all for the want of a sane lending policy.

14 Responses to “For want of a nail: around the world in the financial markets”

  1. Lame-R Says:

    Absolutely spot on.

  2. Kat Says:

    It looks like Barney Frank, Maxine Waters, Gregory Meeks, Lacy Clay, Aurthur Davis, and Chris Dodd have made possible what the terrorists, who flew the planes into the World Trade Center could not do, and that is to bring down financial markets not just in America but world wide. God help us we got some real idiots running this country and it isn’t GW Bush.

  3. njcommuter Says:

    Reading posts over on Maxed-Out-Mama, I note two other things:

    First that when a less-liquid collateral-secured debt is bundled, sliced into tranches with different priorities in repayment, then rebundled and re-sliced several more times, insecurity ripples through the chain. Nobody can say accurately what their real exposure is, and the risk which must be reckoned in actually multiplies because a given mortgage payment failure can fall to one or another account depending on how big it is. So for stability this market needs either some sort of clearinghouse or someone not very deep in the chain who can effectively reconsolidate the debt.

    Second that the security rating agencies have failed badly in their jobs. They should have been the ones sounding the alarms on the mortages, on AIG, on everything. Instead, they waited until everyone saw the structure tottering and then changed their ratings, helping it all to come down.

  4. njcommuter Says:

    Oh, a third item: the Mark-to-Market rules as they exist are just wrong for securities based on illiquid collateral. A mortgage that is being paid may still be a good asset even if the collateral is temporarily short of value. Look for, and hope for, and scream for, new rules on this subject.

  5. gcotharn Says:

    You’re onto it. When banks all around are cashing in, bank money managers have tremendous incentive to advocate for profit. Advocating for caution leads to losing one’s job and being dumped on the street. Any bank money managers who advocated caution are now justified, yet they have also long been terminated from their former places of employment.

  6. Ozyripus Says:

    With respect to subprime mortgages and the Democrat-mandated “equal opportunity” lending, there’s yet another pig metaphor that should have been remembered years ago:

    “You can’t make a silk purse out of a sow’s ear!”

  7. Artfldgr Says:

    The whole thing was predicated on the idea that housing would always rise. But had no one involved ever heard old adages such as “what goes up must come down?”

    no.. thats not it…

    it was all predicated that people werent stupid enough to loan money to bad risks that couldnt pay them back!!!

    the real problem is out confidence… since prior to this event, everyone thought that a banker was free to act in their own interest, and so not loan lots of money to people that couldnt pay and keep low fractional reserves covering them (clinton changed that rate to 2.5 percent down from 10)

    so now, everyone is in panic mode for different reasons. the left is panicking since they think that its the right that failed…the right, which knows more about the actual details instead of the empty concept of run away capitalism, is worried about all the other laws that might still be sitting there making bankers act in ways that bankers shouldnt act

    the law was no different thatn chavez demanding that store owners sell products below profitability.

    except that the banks are the underdog, and the polity is so stupd that they will not defend the people that hold their money!

    left in the cold to fend for themselves they treated these orders like a large tax. but once clinton lowered the rules, they were stuck… they couldnt use the good loans to pay the bad ones, since the bad ones were at a different backing rate…

    normal loans were 10 per 100, but these were 40 per 100, and were not as good!!!!!

    think about that… that the dems said lets lower the backing for bad loans so that 40 loans go out per one unit amount, rather than 10 loans.

    for every unit amount, they could handle 40 loans..

    the point is that the guys in the industry could do absolutely nothing to stop this. if they fought against it, everyone would say waaaa bad bankers too bad… (which is why the law passed and changes passed – we have no sympathy for money, even our own).

    the best they could do is keep shoveling the crap till it blew up, and if they were lucky they would have moved to anotehr area or job by then.

    its a version of bnakers hot potatoe.

    the killer of the whole thing was after all this was spread around, the unreal terms for fannie and freddie caused a funnnel effect, as the water of loans flowed downward to the state monopolies.

    but it took a change to security law to cause them to be bundled and let back out into the market looking like something different than they were.

  8. Artfldgr Says:

    that’s not only because the entire world is affected by what happens here. It’s also because it’s also happening there, to a larger or smaller extent.

    thats because the globalists are aligning the laws, and if the laws are bad, then we copy each others bad laws, not the good ones.

    bet you didnt knwo taht we agreed to get our laws in line with a majority of socialist countries, and so was tricked into becoming like them rather than they became like us.

    we all became sick, rather than the well joining together.

    so when you see a law in another state, be afraid, since they started using foreign precidence in US legal rulings now…

    welcome to the game… its deeper than you ever realized, and thats what this situtaion brings out.

  9. vanderleun Says:

    Another useful horse quote would be:

    Slave, I have set my life upon a cast,
    And I will stand the hazard of the die:
    I think there be six Richmonds in the field:
    Five have I slain to-day instead of him.–
    A horse! a horse! my kingdom for a horse!

  10. vanderleun Says:

    Or to put it in an even cheerier context:

    Slave, I have set my life upon a cast,
    And I will stand the hazard of the die:
    I think there be six Richmonds in the field:
    Five have I slain to-day instead of him.
    – A horse! a horse! my kingdom for a horse!
    -Richard III – Act V, Scene 4

    Joshua: Shall we play a game?
    David Lightman: Love to. How about Global Thermonuclear War?
    Joshua: Wouldn’t you prefer a nice game of chess?
    David Lightman: Later. Right now lets play Global Thermonuclear War.
    Joshua: Fine.
    - WarGames (1983) – Memorable quotes

  11. Jimmy J. Says:

    njcommuter said, “Oh, a third item: the Mark-to-Market rules as they exist are just wrong for securities based on illiquid collateral. A mortgage that is being paid may still be a good asset even if the collateral is temporarily short of value. Look for, and hope for, and scream for, new rules on this subject.”

    Spot on, njc. I asked M. O. Momma why this rule couldn’t be suspended and the MBSs assigned some conservative value while the companies worked through the individual mortgages to discover their true values. That step would have reliquified a lot of these teetering companies with the stroke of a pen. MOM replied that the game has gone on too long for that. No one would trust the assigned values so confidence would not be restored.

    The only thing left is to buy them and establish a floor under them, which the government can do because they are wqriting the rules.

    I estimate that about 5% of the roughly 90 million mortgages are in default at this time. Even if another 5% default that still means most of the MBSs are worth at least 90% of their original value. And, if they can recover some of their money when the foreclosed properties are resold, that reduces their losses even further. Right now they are being carried on the books at 20 cents on the dollar. 80% failure of all the mortgages? I don’t think so. That’s why this is more about confidence and fear than anything else.

  12. sergey Says:

    This potential domino effect, always possible on financial market (it occures every time when banking system collapses) makes neccessary strict regulation, audit and expert supervision of the main players.

  13. Beverly Says:

    Mark Impomeni posted the following on what the Dems REALLY did during those negotiations:

    >>Media reports are emerging from sources inside the White House meeting between the Administration and Congressional leaders of both parties. Contrary to the narrative Democrats are pushing, that Sen. John McCain’s presence at the negotiations slowed the process down, reports are that it was Sen. Barack Obama and the Democratic leadership that interjected partisan politics into the negotiations over a financial bailout of Wall Street.

    Obama, Senate Majority Leader Harry Reid (D-NV), and House Speaker Nancy Pelosi (D-CA) conspired with allies inside the Treasury Department to ambush minority Republicans at the meeting, causing the talks to devolve into a partisan shouting match.

    According to a source in the Obama campaign, Sen. Obama was provided with advance notice of an alternative financial rescue package being crafted by House Republicans through a campaign fundraiser and current employee of Goldman Sachs, Treasure Secretary Hank Paulson’s former employer. Obama was also made privy to Secretary Paulson’s concerns about the Republican plan. Republicans no doubt intended to present the plan at the White House meeting, which was billed as a negotiation.

    But Democrats opened their presentation by turning the floor over to Sen. Obama, who proceeded to attack the Republicans at the table using Paulson’s notes on the Republican plan, foreclosing on any possibility of constructive negotiations being conducted.

    Sen. McCain, on the other hand, did not take a high profile role at the White House meeting. He did not take a position on either the Administration’s proposal, or the House Republicans’ alternative. Rather, he listened to all sides, and spent the remainder of the evening in shuttle diplomacy between House and Senate Republicans, searching for a way to find common ground in their positions.

    Democrats have been busy criticizing Sen. McCain’s role in the negotiations today, with Sen. Harry Reid saying that there was an agreement, “until you know who came to town.” But that statement is patently false. There was no agreement yesterday that included House Republicans, as the Obama campaign and Sen. Reid claim. The Republican present at the meetings prior to Sen. McCain’s arrival, Rep. Spencer Bachus (R-AL) said at the time that he was not authorized to agree to anything on behalf of the House GOP. And since Speaker Pelosi has stated that she will not bring a bailout bill to the floor without protecting her flank with Republican support, no deal was possible.

    Democrats and the Obama campaign are trying to pin the failure to reach an agreement last night on Sen. McCain, and at the same time trying to accuse McCain of bringing presidential politics to the negotiating table. But that spin does not match the reality of what happened in the White House Cabinet Room last night.

    There is no more nakedly political act than taking action to cause a breakdown of negotiations, as Sen. Obama did in concert with Democratic leaders and Secretary Paulson, and then blaming the other side for the consequences.

  14. Beverly Says:

    Here’s the link for that Impomeni piece:

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