

Wall Street exports boomed with 'fools' born to buy debt   - bootload
http://www.bloomberg.com/apps/news?pid=20601109&sid=a0jln3.CSS6c&refer=home

======
pg
This is fascinating. It helps explain why the savings rate in the US has gone
down so much since the 1980s. People didn't suddenly become financially
irresponsible. There was _demand_ for debt, because it was the raw material
debt-backed securities were made of. So companies were working much harder to
convince consumers to get into it.

Incidentally, though no doubt debt-backed securities will be demonized for a
while, I suspect they're useful with proper regulation. Market crashes often
turn out to be due to the appearance of some new economic phenomenon that
people get over-excited about initially, causing a boom-bust wave, but which
in the long term turns out to be good.

~~~
bokonist
There's nothing inherently wrong with debt-backed securities. They can be a
very healthy part of an economy. Variations of debt backed securities have
been around for centuries.

The real problem is the maturity mismatching, which in this case was
fraudulent.

Here's how it works:

I put cash in a money market fund. The fund promises me that it only invests
my money in very safe short term debt, It promises I can get my money back at
any time, on demand. The Sentinel money market fund - to pick a random example
- promised that 50% of its investments were overnight loans.

The trouble is that Sentinel lied. It turned out that 80% of their holdings
were in long term bonds, and only 8% were in overnight loans. The average
maturity date of their holdings was an astounding _32 years_. Other money
market funds had their money invested in securitized student loans, mortgages,
corporate bonds etc.

When you mismatch maturities like this, it becomes a license to print money.
The fund accepts my investment. It then loans my dollar out to someone who
wants a mortgage. That person pays the builders of the home, who then deposit
the money back in the money market fund. The money market fund then loans the
money back out again. The cycle keeps repeating, like a great big money
printing machine.

This manufacturing of money is what caused gold prices, oil prices, stock
prices, and real estate prices to take off over the past five years. More
dollars floating around chasing the same quantity of assets causes prices to
rise. It also explains the rise in consumer debt. With high inflation and low
interest rates, borrowing lots of money is rational. This also explains why
the financial industry was responsible for 50% of all American corporate
profits in 2006.

At some point, some event causes depositors in the money market fund to get
spooked. Perhaps information comes out that a money market fund has too many
defaulting loans. The CFO of a VC backed startup is counting on that money to
meet payroll in the next few months. He can't afford to accept any risk, nor
any delays in redemption. So he decides to withdraw from the fund immediately.
Except the CFO of many other companies have the same idea. The money market
fund does not actually have the money to pay them. All the fund has is a bunch
of IOU's saying, "we will pay you back with interest in 30 years." But the
CFO's need the money now, not 30 years. The money market fund is forced to
liquidate the IOU's for pennies on the dollars. Everyone loses their shirt.
Worse, many businesses were counting on the low interest rates created by
maturity mismatching. As people withdraw from money funds, the loan market
dries up, and debt financed businesses start to go bankrupt.

This hardly is some "new economic phenomenon". Maturity mismatching has been
at the heart of every single systematic financial crisis in the history of the
Anglo-American financial system. The most notorious case was the Great
Depression.

In the current crisis, the last step - the liquidation of the money market
funds - has not happened. That's because Ben Bernanke is a student of the
great depression, and recognized what was happening. When the bank run on the
money markets began a few months ago, he decided to guarantee all the money
market funds with full faith and credit of the government. He was basically
saying, "We know that financial industry has been counterfeiting for decades.
Unfortunately, now everyone is holding these counterfeit notes, including
good, solid businesses. So instead of considering these bills counterfeit and
allowing to a financial apocalypse, we're just going to consider these notes
legitimate legal tender."

~~~
mynameishere
Vanguard sends me a report containing all the securities involved in my money
market funds (which, by the way, have prevented me from losing anything in the
late stock crash). Are you saying that these reports (or reports like it) are
commonly fraudulent?

~~~
bokonist
In the case of Sentinel, it was in their investment objects and allowed
investments ( see this article for more info -
[http://seekingalpha.com/article/44695-duration-mismatch-
at-s...](http://seekingalpha.com/article/44695-duration-mismatch-at-sentinel)
). If you paid close attention to what they were actually investing in, you
might have seen that the prospectus wasn't telling the right story.

In all honesty though, I don't think people would have invested that much
differently had they known. People are so used to FDIC insured bank accounts,
they don't realize that maturity mismatching in an uninsured account will
always lead to bank run. Of course, because of the perception that the
government was going to insure the accounts, the government actually did have
to insure the accounts. So no one has actually lost money in the money market
funds. It was all paid for by the inflation tax.

------
bootload
_"... Securitization was based on the premise that a fool was born every
minute, Joseph Stiglitz ... told a congressional committee on Oct. 21.
Globalization meant that there was a global landscape on which they could
search for those fools -- and they found them everywhere ..."_

What he left out was the bit where _"I know more than you do"_ \- instead of
the essential financial transparency of banks, finance is supplied by non-
regulated sources. Where the risk history of where the finance was coming from
is removed. To end consumers, all this meant was cheaper finance. It doesn't
mean _"fools"_ could be found everywhere. It means the real risk was
externalised. You can read the results here ("Mortgage Meltdown", ABC,
4Corners, 2007 ~ <http://www.abc.net.au/4corners/content/2008/s2389716.htm> )

The Structured Finance industry today is what the Junk bond market was the '80
~
[http://en.wikipedia.org/wiki/Junk_bonds#Debt_repackaging_and...](http://en.wikipedia.org/wiki/Junk_bonds#Debt_repackaging_and_subprime_crisis)

------
gills
The problems did not arise from demand for debt, rather the dealers' reaction
to demand for higher yields on debt. The instruments which have been
problematic were specifically designed to provide a higher yield with the
_appearance_ of risk commensurate with lower-yield instruments. These were
backed by credit that was pimped out to people who could never possibly pay it
back and then obfuscated in a package that the buyer was very unlikely to
critically examine.

You are right, debt-backed securities have a future; but fraudulent securities
do not. This is not a new economic phenomenon -- lies and fraud are as old as
mankind.

