

93% of 2006 AAA-rated subprime mortgage-backed securities now rated junk - mcantelon
http://www.nytimes.com/2010/04/26/opinion/26krugman.html

======
btilly
When people say they will act one way and have financial incentives to act
another, expect them to follow the financial incentives.

Appropriate regulation can help for a bit. But unfortunately the regulated
party has incentives to provide incentives (such as contributions to political
campaigns) to gain control of the regulations. This leads to regulatory
capture that then renders the regulations ineffective.

In a perfect world we'd be forcing the banks right now to write down
securities that took a hit, forcing them to declare losses, which would mean
that they wouldn't be paying out absurd bonuses. This would absorb the money
we gave them from the bailout. In a slightly less perfect world we'd be
enacting useful regulations that would avoid this problem returning for a few
decades (such as happened during the Great Depression).

In the real world we gave the banks a big bailout, have let them mark
securities to models of their choice, and they paid themselves big bonuses on
their "profits". Of course they are still sitting on lots of toxic securities
(like bad CMBS and the junk bonds issued by private equity) that they have not
marked down yet. When that blows up we have good odds that they'll ask for
another bailout. And the behavior of both parties says that the leadership
will try to get it for them. They nearly didn't manage to deliver it last
time, and given the public outrage since, they may not be able to deliver it
next time.

This could lead to interesting times. Interesting times.

~~~
gaius
_which would mean that they wouldn't be paying out absurd bonuses_

No it wouldn't. Investment banks are huge and diverse businesses. If you're an
FX trader, nothing whatsoever to do with mortgage-backed securities, and
you've done your job well this year and made excellent profits (which for the
bank as a whole offset their losses) then why _shouldn't_ you get a bonus as
usual?

Of course the loss-making traders shouldn't get bonuses (that is after all the
point of the bonus system) but lumping everyone in with them is both
inaccurate and counter-productive.

~~~
joe_bleau
I've wondered this too. As an employee of a small company, I _really_ wish I
could use the same argument (and trust me, I've tried). "Hey boss, I'm doing
the work of two people, at about a 40% discount to market rates for the
average embedded engineer. You don't seem to think I'm average, and there's no
question that you're more than happy with _my_ performance. I realize business
is off right now and sales suck, but why shouldn't I get a bonus/raise?"
"Cause we don't have any more money, and the government won't give us any."

I really like my job, but sometimes it's tough not to be jealous of the world
of big money and government.

I guess my answer to your question might be: "because Joe two floors down blew
up, and we wouldn't exist as a company anymore if not for the government
bailouts".

~~~
yummyfajitas
Try asking for the bonus Wall St style: "Hey boss, you know I am worth a lot.
Pay me more or I quit. "

Your boss may find the money, or your new job will pay more.

~~~
btilly
The better way to do this is to find the other job, get that offer, then go to
your current employer and say, "Another company is gave me an offer for more
salary elsewhere, but I don't want to go there for reasons X, Y and Z. However
(name financial reason - spouses are convenient) is pushing me to take the
money. Can you help me?"

The fact that you went to your employer first, and you made it clear that you
didn't want to leave, both go a long way to mitigate the possibility of bad
emotional reactions. (They don't eliminate it, but they mitigate it.) And they
put you in a position to renegotiate your salary. Furthermore if it doesn't
work, your fallback is a new job at higher pay.

Be warned, though, that this is a bullet you can only fire once. Having done
it, you've burned some social capital. If you keep going back to that well,
your employer is going to eventually cut you loose.

Also be warned that if you have actually accepted a job elsewhere, you should
_never_ accept a counter-offer. In that situation your employer will be
willing to offer a lot because they are desperate, but they know that it is
just a question of time until they lose unhappy people. So they will work to
replace you, and it is just a question of time until you are fired with no job
offer in hand.

That's why if you try this it is critically important to go to your employer
with the message that you want to stay, but (financial situation X) is a
problem for you. (It helps, a lot, if the financial situation is both real and
known to your employer.)

------
Alex3917
Headline is inaccurate, it's 93% of subprime-backed mortgage securities.

~~~
akronim
Exactly - the majority of AAA bonds would be US/Euro/Sterling government
bonds, which are still AAA rated.

~~~
goatforce5
Greek bonds aren't doing so hot right now:

"The ratings agency, Standard & Poor’s, downgraded Greece’s long-term and
short-term debt to noninvestment-grade status and cautioned that investors who
bought Greek bonds faced dwindling chances of getting their money back if
Greece defaulted or went through a debt restructuring. Earlier, S.& P. reduced
Portugal’s credit rating and warned that more downgrades were possible."

[http://www.nytimes.com/2010/04/28/business/28markets.html?sr...](http://www.nytimes.com/2010/04/28/business/28markets.html?src=mv)

There was an NPR Planet Money podcast recently that said if Greece failed,
others were likely to follow:

<http://en.wikipedia.org/wiki/PIIGS>

[http://www.npr.org/blogs/money/2010/02/podcast_yes_greece_co...](http://www.npr.org/blogs/money/2010/02/podcast_yes_greece_could_defau.html)

------
matasar
It seems to me that rating agencies should be paid by the institutional
investors that buy the bonds, not the banks trying to sell them. That might
help the incentives line up better.

Am I crazy? Nobody suggests this, and I think I'm missing something crucial
here.

~~~
jey
Rating agencies seem like an absurd idea altogether. Have they never heard of
the perils of having a single point of failure? Much less a single point of
failure that's a government-created oligopoly? Yikes.

It seems that businesses are just running on an outdated model developed when
information sharing was a lot harder, so only condensed forms like quarterly
reports and press releases were feasible. But now that information sharing is
a lot easier, shareholders should be demanding more openness from businesses
-- yes, today a lot of that information is considered to be a trade secret,
but at the same time shareholders need to stop allowing businesses to get away
with what's equivalent to deceit through "creative" accounting (e.g.
apportioning profits/debts amongst subsidiaries). That's just a textbook
example of exploiting information asymmetry. Shareholders should expect more
information about the business' books and transactions. There must be some
natural equilibrium between being open about transactions and protecting
strategic advantages, but right now we have the functional equivalent to price
fixing, er, information fixing -- companies don't release relevant information
because "no other company does" and shareholders don't expect real operating
information either because that's not part of the status quo.

Wouldn't an investment bank that was so confident in the principles behind its
analysis that it was willing to list all its transactions in a continuously-
updated XML file, despite the risk of copy-cats, seem like a pretty damn good
investment? They wouldn't have to divulge their proprietary methods of
analysis, just make their holdings public. This would greatly improve the
efficiency of markets as investors could use their own proprietary methods to
estimate the risk of an entity's portfolio management strategy when deciding
whether to invest in it.

And there's definitely historical precedent for this -- the fabled value
investor Benjamin Graham didn't go to great lengths to hide his trades,
instead he'd use them as examples in his classes, and yeah, people copied him.
And he _still_ made boatloads of money.

~~~
gaius
Well, it's more subtle than that. The big ratings agencies are Fitch, S&P and
Moody's. They are competitors for the business of issuers. So each one is
incentivized to rate higher than the others, without blatantly being seen to
take the piss.

The problem with complete openness is that it encourages short-termism. You
see this even with quarterly results, companies that have recently gone public
(and thus have minimal reputation) manage from quarter to quarter to quarter
and are hugely volatile. Imagine working for a manager who only cares about
the share price _tomorrow_.

The risk of your XML file is not copycats, it's front-running.

~~~
jey
The short-term price motivation is a great point. I'll think about that some
more.

But how does this scheme encourage front-running?

------
eavc
If anyone is interested in a very clear example of the story behind the stat,
I highly recommend this podcast/radio episode:
[http://www.thisamericanlife.org/radio-
archives/episode/405/i...](http://www.thisamericanlife.org/radio-
archives/episode/405/inside-job)

------
aac74
Krugman fails to mention that this is the corrupt fallout from his
cheerleading in 2002 for low interest rates in order to create a housing
bubble to fill the void of the .com bubble !

"Alan Greenspan needs to create a housing bubble to replace the Nasdaq
bubble." - Krugman 2002

[http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-
dip...](http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip.html)

~~~
DuncanIdaho
Now I don't understand what your motive is - but your quote is taken waaay out
of context...

Original quote: "The basic point is that the recession of 2001 wasn't a
typical postwar slump, brought on when an inflation-fighting Fed raises
interest rates and easily ended by a snapback in housing and consumer spending
when the Fed brings rates back down again. This was a prewar-style recession,
a morning after brought on by irrational exuberance. To fight this recession
the Fed needs more than a snapback; it needs soaring household spending to
offset moribund business investment. And to do that, as Paul McCulley of Pimco
put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq
bubble."

Here Krugman basically quotes another source. The way I interpret this quote
(and article) is not cheerleading for lower interest rates. The message to me
is that whole system is unsustainable and that only move that will be able to
perpetuate the lie is to replace one bubble with the next.

In this context Krugman's vision has proven prophetic.

The whole notion, nothing personal - I have noticed it more than once, that
Krugman somehow argued that replacing one bubble with another is good for
economy somehow is ridiculous.

~~~
yummyfajitas
The point of that editorial is that business investment won't end the
recession, so the only hope is housing.

"To fight this recession the Fed needs more than a snapback; it needs soaring
household spending to offset moribund business investment. "

Krugman is just repeating the same "insufficient demand" theory of recessions
that Keynesian economists are using today.

~~~
jbooth
And he was right. 7 years from 2001 to 2008 he was saying this and everyone
dismissed his concerns by calling him a partisan bush-hater. Maybe so, but he
was still right.

Keynesian economics brought us out of the great depression and the lack of
their application led to deflation and the lost decade for Japan.

Supply-side economics, on the other hand, have been tried twice in the last 30
years and both times they ended with massive government deficit and collapsed
asset bubbles.

Before casting aspersions on someone by virtue of their -isms, I'd check the
record of the -isms in question.

~~~
yummyfajitas
I didn't cast aspersions on anyone. I simply summarized Krugmans column: to
increase consumer demand, the fed should create a housing bubble, but even
that is unlikely to work.

~~~
jbooth
I don't think that's what he was intending to say. I remember a whole bunch of
cautionary columns of his from that time period, some of which were very
partisan and accused Greenspan of keeping interest rates low for political
reasons.

------
david927
93% isn't bad luck. 93% is fraud.

~~~
_delirium
Not that I think everything was above-board, but to be fair, these are hugely
correlated instruments: it's not reporting 93% of all AAA debt tanked, but 93%
of all AAA-rated derivatives of subprime mortgages. Given the subprime-
mortgage crash, it's not surprising that everything tied to subprime mortgages
uniformly tanked too.

The way an AAA-rated derivative of a subprime mortgage could exist to begin
with was via "tranching", where debt was sliced up into different buckets of
repayment priority, which heightened the correlation. In a minor crash, the
AAA securities would do okay, because they'd get the payments from the non-
defaulting loans, and the lower-rated tranches would take the losses. But once
you go over the threshhold where there isn't enough money to even repay the
top tranches, then everything tanks all together. So really, near-0% and
near-100% default rates were the likely outcomes.

~~~
WorkerBee
_but to be fair, these are hugely correlated instruments_

That makes them more risky, not so? How did they get the AAA rating then?

~~~
gvb
By recursion.

The initial iteration is that they pool a bunch of loans together to aggregate
the risk. They know from history (short term history - a vulnerability that
turned into a failure mode) that mortgage defaults are quite unlikely to
happen in the first, say 5, years, so they can sell paper that matures in 5
years and be confident that it has a low failure rate from the (flawed)
historical perspective. The longer term paper on the loans will historically
have a higher probability of failure, so the longer term paper has lower
ratings.

Then the recursion occurs.

1) Homeowners kept refinancing their houses (encouraged by the insatiable
appetite for new mortgages to slice and dice into AAA-rated paper), so their
loans never aged, they just kept getting reset.

2) The bankers took the remaining less-than-AAA-rated aggregated debt and used
to create a _new_ debt vehicle and then claimed _all over again_ that the
"new" debt (which was really old debt reheated) could be re-sliced into AAA-
rated debt plus residual lower rated debt.

This quickly turns into a house of cards which inevitably failed when short
term history (low failure rates based on long held mortgages and "perpetually"
increasing house values) failed to model reality.

~~~
roc
Trick is, the ratings agencies _knew_ 1 and 2 were happening; questions about
the practice were raised.

That no-one _did anything_ when questions were raised is what brings us back
to fraud. The ratings agencies were allowing a known-flawed system to apply
known-incorrect ratings because it served their own financial interests.

------
fname
If anyone listened to the hearings, they quoted a part from the book, "The Big
Short: Inside the Doomsday Machine" which discusses some of what the author
thinks were the inner workings. I've been reading through it now and cannot
recommend it enough.

[http://www.amazon.com/Big-Short-Inside-Doomsday-
Machine/dp/0...](http://www.amazon.com/Big-Short-Inside-Doomsday-
Machine/dp/0393072231)

------
ksraines
Let's not forget that Krugman was one of the chief advocates of the housing
bubble (before it popped) and that his "berating of the raters" should begin
with an apology.

[http://blog.mises.org/10153/krugman-did-cause-the-housing-
bu...](http://blog.mises.org/10153/krugman-did-cause-the-housing-bubble/)

~~~
anigbrowl
I'm not a big fan of Krugman, but let's also not forget that we were in a
recession at the time of those remarks; when Krugman was saying the Fed should
raise interest rates a few years later, and taht the US was addicted to
Chinese treasury purchases, libertarians scoffed and called him an alarmist.

This 2005 example of libertarian economic thought is particularly ironic,
arguing that measures of inflation like CPI give too much weight to housing
and car prices while an adjacent advert promotes a book explaining how the
crisis was caused by too much easy money:
<http://www.cato.org/pub_display.php?pub_id=3752>

Other sparkling jewels of economic wisdom include his prediction at the
beginning of 2008 that recession was a non-issue, or his comments from earlier
in the decade (when the Fed had raised rates a bit) that the nation would
achieve substantial long term benefits from the 'glorious housing boom'
created by previously low rates, which had allowed many refinancers to invest
and consume more.

Physician, heal thyself.

~~~
ksraines
Point taken. However, Krugman's comments were a little stronger than what you
suggest. He explicitly called for the creation of a housing bubble (see my
other response below).

Please don't take the link as a blanket endorsement of libertarianism; it was
just the first link that came up as a result of my google search. I remembered
reading up on Krugman's predictive failures many months ago ...

Krugman stopped being an economist a long time ago and is now a political hack
- regardless of whether or not he has a point in this particular instance. I
imagine that you didn't need Krugman to tell you that the raters were issuing
ridiculous ratings ...

~~~
anigbrowl
_political hack_

no disagreement there. It's just I think the same is true of some of his
loudest critics :)

~~~
ksraines
Nice.

------
bkmrkr
Your title is wrong and misleading

------
nickpinkston
Can someone actually find the source for this 93% figure? I haven't been able
to. I just keep seeing the link back to the NYT page. I'd be good to actually
see real numbers - not just Krugman's opinion.

------
kevin_morrill
Thank god that we have government regulated credit ranking agencies to protect
us from this mess and having to use our own judgment when investing. Oh
wait... hmmm...

------
c00p3r
This rating agencies are making their money the same way the big business
consultants does - by confirming client's illusions and narcissistic views.
This is called corruption.

------
asymmetric
what does this have to do with news.yc ? it's not even about startups!

~~~
JCThoughtscream
From the FAQ:

"On-Topic: Anything that good hackers would find interesting. That includes
more than hacking and startups. If you had to reduce it to a sentence, the
answer might be: anything that gratifies one's intellectual curiosity.

Off-Topic: Most stories about politics, or crime, or sports, unless they're
evidence of some interesting new phenomenon. Videos of pratfalls or disasters,
or cute animal pictures. If they'd cover it on TV news, it's probably off-
topic."

This one's a bit of a gray area, as it's heavily political in nature, but the
mechanics of loan securities is of both intellectual and personal interest to
what I'd imagine is a heck of a lot of HN readers.

