OldManOnFire

I was trying to come up with a positive response to this...but I can't.

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Did you know both our problems and the solutions can be found simply by looking in our mirrors...and...Never confuse the extraordinary stuff I think and write with that of a well-balanced person...

infoseek

A good opinion from the looks of short and long term rates.

Prime cause of sub-prime crisis

G. RAMACHANDRAN

The comprehensive responsibility for the sub-prime crisis belongs to the White House and the US Congress. But the blame has been wrongly assigned to Wall Street and to Mr Alan Greenspan, says G. RAMACHANDRAN.

Washington’s political establishment is the prime cause of America’s sub-prime crisis. The comprehensive responsibility for this colossal crisis belongs to the White House and US Congress. But the blame has been wrongly assigned to Wall Street and to Mr Alan Greenspan, the former chairman of the United States Federal Reserve Board.

Washington started the war in Iraq in 2003. It then chose the wrong method of funding. It has channelled over $500 billion of short-term borrowings into the war since 2003. This is more than eight times the $60 billion estimated prior to the start of the war. Washington was optimistic that the war would be very short and very cheap. It has been neither.

Washington’s misjudgement has inflicted enormous costs. It first tripped the economy. It then ripped the mortgage industry. But America’s commercial banks are liquid and solvent. There are no Northern Rocks. Northern Rock is a British mortgage bank that was devastated by mortgage defaults; it was nationalised in February 2008.

America’s commercial banks are safe because Wall Street securitised the mortgages, especially the sub-prime mortgages, and invested in them. No one is thanking Wall Street for this protective role. But the calls for rigorous regulation and intrusive policing of Wall Street have grown louder. These have deflected public attention away from Washington’s egregious misadventure.
Complementary competencies

Critics of Wall Street do not understand why investment banks are mired in the sub-prime crisis. Surely, investment banks do not lend to buyers of homes. Commercial banks do nearly all the lending to home buyers. Investment banks securitise these loans. Lending and securitising are complementary competencies.

If a commercial bank had $1,000 of deposits and then gave this $1,000 away as ten $100 loans to ten borrowers, it faces the risk that some borrowers may default. If some borrowers defaulted, the commercial bank and its depositors would be in trouble.

So, the commercial bank sells the ten loans as an unsorted bunch to an investment bank at, say, $1,020. The investment bank’s core competence lies in selling the loans as ten securities, say, at $105 per security. The interest and principal (the periodic mortgage obligation) paid by the ten borrowers will then be paid to the holders of the ten securities. Securitisation restores liquidity to the commercial bank. Moreover, the commercial bank and its depositors are not exposed to the risk of default by borrowers.
Sub-prime’s attractions

America’s consumer credit markets have shifted dramatically since the early 1980s. They have moved away from credit rationing towards risk-based pricing. No applicant is denied credit. Risky applicants are offered credit at higher prices intended to reflect the greater risk posed by these loans.

Suppose the commercial bank knows that five of its ten borrowers are very unlikely to default. It applies risk-based pricing using a benchmark, say, the three-month US Treasury Bill (T-bill) rate. The bank lends to these ‘prime’ borrowers at 4 per cent over the annualised T-bill rate. The five loans to the prime borrowers are sold to the investment bank at, say, $540. The investment bank then creates five securities from the prime bunch and sells each at, say, $110.

The commercial bank applies risk-based pricing to the other five borrowers that are more likely to default. They are perhaps more vulnerable to economic downturns. So, it lends to these ‘sub-prime’ borrowers at T-bill rate plus 8 per cent. The five loans to the sub-prime borrowers are sold to the investment bank at, say, $480. The investment bank then creates five securities from the sub-prime bunch and sells each at, say, $100. The lower price reflects the higher risk.

Sub-prime securities are cheap at $100 apiece. And, sub-prime securities receive mortgage payments calculated with an annual interest of the T-bill rate plus 8 per cent. By contrast, prime securities are expensive at $110 apiece. Moreover, they receive mortgage payments calculated with an annual interest of merely the T-bill rate plus 4 per cent. Therefore, the return on prime securities is considerably lower than that on sub-prime securities. But prime securities are less risky. Investors with a poor appetite for risk choose prime securities.

By contrast, the return on sub-prime securities is considerably higher than that on prime securities. The adventurous with an appetite for high risk and higher returns choose sub-prime securities. So, sub-prime securities backed by loans to risky borrowers in the US found a huge market first in the US and then in Europe and Asia. This market included some investment banks.
Iraq blows America’s fuse

The war in Iraq has been funded primarily by borrowings. Generous tax cuts since 2000 had made borrowing unavoidable. But Washington had no realistic timetable for the war. So, the US Treasury chose to issue short-term T-Bills that mature, say, every quarter. It may have borrowed long term by issuing, say, 10-year notes and 30-year bonds if there had been a realistic timetable.

The dependence on short-term borrowings affected short-term interest rates. The average three-month T-Bill rate in 2003 was 1.04 per cent. It rose to 1.41 per cent in 2004 and then more than doubled to 3.22 per cent in 2005. It rose further to 4.85 per cent in 2006 and stayed there until September 2007.
In defence of Greenspan

The US Federal Reserve under the leadership of Mr Greenspan till January 2006 responded correctly and swiftly to the inappropriate method of funding the war. It periodically raised the federal funds rate, the rate at which banks manage short-term liquidity. When the war began in March 2003, this rate was 1.25 per cent. It was a whopping 4.5 per cent when Mr Greenspan handed over charge in 2006 to Mr Ben Bernanke, his successor.

Mr Greenspan raised the federal funds rate on 14 occasions after the war began. Therefore, it would be patently wrong to claim that Mr Greenspan triggered a housing bubble by keeping interest rates low. Mr Bernanke too kept pace with the war’s unfavourable consequences. The federal funds rate rose to 5.25 per cent after three more hikes in 2006.
Iraq flattens America

Short-term interest rates rose above the long-term interest rate in America. The average three-month T-bill rate was 1 per cent in 2003; the average 10-year T-bill rate was 4 percent. The average three-month T-bill rate rose to 4.85 per cent in 2006. But the average 10-year T-bill rate was merely 4.79 per cent in 2006.

Rising short-term rates and a long-term rate that was lower than the short-term rate meant that America could no longer fund long-term assets profitably. America was forced to defer long-term investments that usually create the steady, long-term jobs.

Who would pass up a short-term return of 4.85 per cent without any risk to fund a long-term asset that had a mere 4.79 per cent return but all the long-term risk? So, America’s recession is a result of the war in Iraq. The mortgage crisis came thereafter.
Iraq crushes Americans

The war in Iraq then began crushing American homeowners with mortgage payments indexed to either the T-bill rate or the federal funds rate. Almost all sub-prime borrowers had adjustable rate mortgages. Their mortgage obligations rose when short-term interest rates rose. They struggled to make their mortgage payments.

Home prices began to fall when the economy began to stall. Wages too began to fall. Many sub-prime borrowers began to lose jobs when America began to postpone long-term investments.

But mortgage obligations continued to rise. Many borrowers chose to default. Who would honour a mortgage obligation of $100,000 when a home’s resale value fell to, say, $50,000? Default is a rational choice in such circumstances.

However, America’s commercial banks have not had to face the adverse consequences. Wall Street has borne most of the massive losses because it had chosen to invest in the sub-prime securities. It is unjust that it should bear any guilt at all. The blame for Wall Street’s plight belongs to Washington.
(The author is a financial analyst. Feedback may be sent to indiagrow@gmail.com and pari@thehindu.co.in)

The Hindu Business Line : Prime cause of sub-prime crisis

cheapseats

I think the government should subsidize art at least through acquisitions. Art is valuable...that's why the Nazis ransacked everyone's.

The Smithsonian is a good thing, I think.

An impressive statue here and there never hurt anyone...with plaques bearing history...like we look at when we visit other countries. Sounds kinda dignified, if the art bore on American history and heroes. Particularly in state capitals. It's uplifting.

I can see arguing about the size of the budget, I can see arguing the composition of the expenses.

Far Left Fringe would argue that we must spend the same number of dollars on statuary in EVERY berg in America because EVERY human is entitled to the same opportunities to appreciate art and learn history.

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PursuitOfHappinessParty

True, but where do you draw the line and who decides? What's truly art and what's bathroom tiles glued to a pillar? Why can't those who are 'patrons' of the art take care of the finances. I believe the Smithsonian is patron funded as well as admit fees.

Why can't I have UHC while the city spends a million bucks on some gaudy metal thingamajig?

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It puts the lotion on its skin, or else it gets the hose again.

PursuitOfHappinessParty

Redesigning money because the increasingly idiotic Supreme Court says it discriminates against blind people?

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It puts the lotion on its skin, or else it gets the hose again.

DRS112

it does though....it sucks that it does...

PursuitOfHappinessParty

Not really. There's a little hand-held doodad that the blind can use that tells them what the money is.

Discriminates connotes intention, and the money and its designers didn't intend to do anything.

The blind are a vastly small number, especially for use as a cause for this kind of change.

It would've been cheaper to hire them someone to count their money for them individually. Seriously, it would've been cheaper to at least by them that identifyer machine.

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It puts the lotion on its skin, or else it gets the hose again.

DRS112

descriminate does not imply intention to do so...as in this case it just implies what is...and that's a currency that places a group of people at a disadvantage to others.

I don't think that blind people would like to be marginalized by their disadvantage by saying since there isn't a large enough number (tens of thousands) of them that they don't matter.

and here's the thing and why it matters....how do they know how much money they are getting( or spending)...even if you hired somebody?

and I'm not familiar with the "doodad" that counts it for them....

oh and it was an appeals court that ruled it...not the supreme court...right?

PursuitOfHappinessParty

Currency (the lack of) is descriminatory to those who don't have it, so let's give away money too? Fair and balanced would mean to keep the rest of us from running roughshod over any minority (in practice), yet doesn't necessarilly mean the minority gets to control the majority either. This is a sweeping solution to a not so sweeping problem.

Until recently, I worked as a volunteer with blind people reading newspapers over a sub-carrier of a radio station. They are much more capable than many believe as well as being quite independent.

I didn't marginalize their disadvantage, but I'm not going to quantify the changing of wallets, changers, money readers, and ATM not to mention the changing of the entire money printing practices that then impact the entire population for a comparatively small population when there are alternatives that put the onus onto them.

Back to the doodad


Went back to the paper, yes it was an appeals court.

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It puts the lotion on its skin, or else it gets the hose again.

DRS112

There are some that make that argument...that all should be equal...that's how communism/socialism came about...

but the whole point of anything anti-discriminatory is to give everybody the same chance....not to guarantee the same outcome...


Good....but I never said they were completely incapable....only that a product of our govt puts them at a disadvantage.

We change currency all of the time...big deal if the next change involves something like raised numbers.



So...what's up with the doodad?