Month in review, June 2007
[Previous months in review available here: May 07, Apr 07, Mar 07, Feb 07, Jan 07;]
“No more AHI blog posts to read and understand!”
In June, AHI graduated to a new Web site look — like it? — and a handy new shorter URL: http://dasblog.org. Try it now and you’ll come right back here!
On the Internet, nobody knows you’re a blog
With subprime woes dominating the news, I sought to shine a little light on means, motive, and opportunity, starting with Mortgage brokers: the honorable mercenary? and Mortgage brokers: the honorable mercenary? Part 2:
As Bob Hagerty of the Wall Street Journal provocatively asks:
The political debate over how to deal with a surge in defaults on home loans is raising a question that consumers ought to consider: Is my mortgage broker really working for me?
To which the answer is, “Of course not.”
“He’s not?!?”
“Why would you think so?”
Borrowers often see mortgage brokers as their allies, searching far and wide for just the right home loan at an attractively low price. But many brokers are making it clear they don’t see things that way. They are fighting efforts by federal and state politicians to impose a fiduciary duty on them to put their customers’ interests first, as lawyers, real-estate agents and financial planners generally are required to do with their clients.
“The mortgage broker does not represent the borrower,” says Chris Holbert, president of the Colorado Mortgage Lenders Association. “We sell access to money.”
“Selling access”? Spoken like an independent actor!
“Don’t look at me, I just sell access to money.”
Such a view is seemingly at odds with the CMLA’s noble statement of “Who We Are“:
Behavior of those honorable mercenaries partly explains how we gave rise to mysterious new financial creatures, as I explored in Risk Moonshine: Credit Derivatives, Part 1, Part 2, and Part 3:
Like risk, liquor appears intrinsic to the human condition. There’s a plausible theory that we owe our civilization to beer, because to cultivate the barley for fermentation meant settling down to an agrarian lifestyle, in a spontaneous community on the
Raise a frosty to civilization!
Just as a cool one at day’s end may just have been the stimulus that civilized man, so too maybe the management of risk is what lowers loan rates and increases homeownership.
In vino veritas might be translated, in the financial markets, in risko veritas.
Keep smiling
In terms of the potential unwinding of these positions, to what end nobody knows, I spent a lot of time talking about risk, with a primer post on The risk curve:
The origin — the theoretically risk-less investment — is sovereign debt. (It’s not really risk-less, but every other financial instrument is denominated in the currency, and if the currency collapses, everybody else does too.) In the
We can even populate this a bit. If we believe that the rating agencies know what they are doing, then the distinctions among ratings ought to lie neatly along the risk curve line, with all AAA-rated instruments of similar maturity clustering tightly around a particular spread. In reality, spreads do cluster, but this may be reverse-engineering — spreads concentrate toward ratings, rather than ratings to spreads.
I used the resulting conceptual risk curve to illustrate a point about the GSEs:
Which raises the question — where do we put the GSEs, Fannie Mae and Freddie Mac, on this chart?
If they were evaluated purely as private companies, their spreads ought to be in the AAA range. (Some would argue they should have their securities downgraded because the GSEs maintain very low capital ratios, but let’s give them AAA.) Yet in reality, GSE spreads are barely above Treasuries. They are, in other words, under the risk curve … except for the widespread perception that they are, in fact, safer than a AAA, because Uncle Sugar will bail them out.
Sheltering under the risk curve is why the GSEs make money, and in particular why they are so eager to expand their lending into as many arenas as possible. Lever that spread advantage over more and more dollars, and your profits go ever higher.
The GSEs’ risk profile figured prominently in a two-topic discussion of a high-fiber high-protein talk given by St. Louis Federal Reserve Bank President Bill Poole that I reviewed in GSEs: Still risky after all these years:
Any firm with such a privileged position will want to extend its scope of operations. Over the past 15 years, Fannie Mae and Freddie Mac have grown much more rapidly than has the stock of mortgages outstanding. Given the powerful incentive Fannie and Freddie have to grow, the systemic risk they pose to the economy will also grow.
If the capital markets were confident that the government would protect GSEs against risks, what would make them lose confidence in the stock price? Not accounting irregularities so much as the threat of capping GSE portfolio growth. In fact, that’s what happened:
That is why the promise of constraints on the portfolio growth at Fannie and Freddie had a significant effect on their stock prices.
In terms of market perception, this is a smoking gun.
What smoking gun? I don’t see any smoking gun
It’s as if the equity markets, realizing the GSEs’ earnings engines had been turbocharged, were entirely content that they do so as long as taxpayers stood behind them.
Tied to that assessment of continuing GSE riskiness was Mr. Poole’s review of their affordability performance, covered in Evidence of absence: Part 1, GSE affordability performance and Part 2, GSE capital-markets behavior:
Absence of evidence, one learns in law school, is not by itself evidence of absence. But Mr. Poole cites numerous bits of evidence of absence:
Mortgage spreads — the most direct measure of GSE affordability benefit — remained utterly unaffected:
· When Freddie Mac admitted major accounting mistakes causing earnings to go up.
· When Fannie Mae admitted major accounting mistakes causing earnings to go down.
· When OFHEO announced hard caps on the GSEs’ ability to grow their portfolios.
· When the GSEs’ share of the mortgage market dropped by a full third, from 22% to 14%.
During those years the GSEs were hit with exogenous shocks up, down, and sideways. What did those whacks do to stock prices?
“Is something wrong with your stock price, sir?”
In our quest to digitize capital, we often overlook that which does not readily render itself into numerical form, yet these ‘invisible’ flows predate structured capital and are more powerful, as shown in Capital’s underground river: Mexican remittances and The Bank of Family: Part 1 and The Bank of Family: Part 2:
Capital, my favorite businessman Auric Goldfinger explained to James Bond, is a catalyst:
“My treasure of gold is like a compost heap. I move it here and there over the face of the earth and, wherever I choose to spread it, that corner blossoms and blooms. I reap the harvest and move on.”
Goldfinger, page 135
“That’s the second lesson: when the odds aren’t right, make them right.”
Where does the capital from Mexicans’ labor go? Back into
The World Bank reports that remittance flows are developing countries’ second largest source of external funding, after foreign direct investment.
This is really important. We make much of wealthy-nation governments’ foreign aid efforts, and yet right behind them is the grass-roots foreign-aid source: millions of expatriate workers sending their money home to their families.
Further, remittances are more stable than private capital flows, which often move with business cycles, raising incomes during booms and depressing them during downturns.
Any economic-development strategy for
Similar economic motivations animate the City of
“Gentlemen, you can’t fight about housing policy here, this is the war room!“
We shone lights on programmatic corners dank and obscure in The El Dorado of permanent sustainable affordability and revealed secrets unknown to mortal men in Bureaucracy: the secret imperatives:
“Our bureaucratic culture can expel the most energetic reformer.” Over more than two decades of watching bureaucracies at work, I have many times seen the phenomenon I think of as the parachuting reformer. A new administration takes over, and appoints an energetic, smart, capable and committed outsider as the agency’s head. The new person, fully charged up and committed to the cause, arrives in the building ready not only to make change but also to show the organization how it’s done.
Look, we were just trying out some new procedures!
Often the incoming head manifests an unconscious — or worse, even conscious — disdain for the people who have long labored inside the cubicle maze. Perhaps he or she expects to carry all by the force of intellect, or the power of job title. Possibly thinking himself or herself invulnerable, he or she fails to cultivate allies, fails to persuade, fails even to notice the organizational resistance — or, if noticing it, puts down that resistance to only ignoble motives.
But, as the Chinese learned two millennia ago, emperors come, emperors go, and the mandarins go on over. Potent indeed is the emperor who can defeat the internal opposition.
Useful principle for program participants: see Summers, Larry; or Wolfowitz, Paul.
In larger trends, one bad, one neutral, we explored The coast-ification of America and what that means for housing demand and house prices, and the consequences of public housing’s being systemically if negligently starved in: Selling the family silver:
The housing authorities are in a terrible bind. I’ve previously documented public housing’s continuing troubles, which are no longer ‘relatively under control‘, particularly in two NAHRO Journal of Housing and Community Development articles, The Ghost of Christmas Yet To Come and Public housing’s Gordian Knot. The problem is that many housing authorities still engage in things hard to defend, and some are spectacularly dysfunctional (such as San Francisco, what’s wrong with this picture?).
What’s wrong with this picture? Look carefully. Take your time.
I ended the month on the same themes I began, the relationship of capital and housing, working through the Economist’s excellent multi-part story in Capital markets: flashes of insight, Part 1 and Part 2:
In mathematical terms, risk is volatility of return. In normal human terms, it’s uncertainty about the future. About the only thing certain about the long run, as Maynard Keynes famously observed, is that we are all dead. In the meantime, risk is what motivates human achievement, so like other intoxicants, a little is good for you … but not too much. As the Economist’s piece, Eggheads and long tails, puts it, the question is not how you take zero risk, but which risks you choose to take:
In a report last year Moody’s looked at Goldman Sachs, the most profitable investment bank and, in many respects, the envy of its peers. Describing its risk philosophy, Moody’s said Goldman saw risk not only as the counterpart to revenues or profit, but as “the source of profit”.
You sure there’s profit at the end?