interview question

arbitraily in a finance interview, they asked you… so how do you think the US economy got into this mess… be comprehensive as possible… how would you guys answer?

liar loans, LEVERAGE, lack of accountability, lack of regulation, securitization, a fractured model for the BBs…(borrowing short), highly illiquid market for CMOs, CDOs, etc etc. Pick a few and run with it…

Root cause of this problem - Rating Agencies. You can blame everyone in this mess, but let us get the facts straight. This problem would not be that severe, if these asset backed securities were rated properly. People would have demanded appropriate risk premiums. Things are different when a paper is rated AAA and then we say - Well it is not as safe we thought it would be ! Rating agencies need to provide an explanation to the public. And problem is that they seem to be getting away with this. Though I saw CNBC raise this issue with S & P last week. And doesn’t surprise me all CNBC got was vague answers from them. Vague - Well they better use this tactic ,else how would you justify a downward rating revision by 3 notches on one day without any material changes to the structure of the company.

The problem with that explanation is that it’s hard to believe that a giant economic problem could be caused by something as simple as rating agencies that nobody gave that much credibility to anyway. I don’t like rating agencies much, but in their defense, they rated things with disclosed methodologies that were bogus. It just wasn’t clear what the right methodology was. The appropriate thing would have been for the rating agencies to say something like “It’s not appropriate to group tranched correlated default risk into ratings categories used for traditional default risk” and then come up with new measures. They messed up and I am all for public disclosure and accountability but a system so fragile that we relied on simplistic rating methodologies from unsophisticated rating agencies is a problem.

People thought that they could create an economy out of selling each other more and more expensive houses. Banks, Pension fund consultants, bond fund managers, rating agencies, bond insurers and politicians did everything possible to help them test this hypothesis. The hypothesis was false. Everything after that is describing what happens after the wings fall of the aircraft.

chrismaths Wrote: ------------------------------------------------------- > People thought that they could create an economy > out of selling each other more and more expensive > houses. I remember a NYTimes columnist raising this exact same issue(people getting richer by selling each other houses). He(I think it was Paul Krugman) wrote about this in a column, during the election year hooplah in 2004. Of course, his voice got drowned in the “the economy is doing great” and pro-war(oops… pro-troops) cries from the Republicans.

I vaguely remember that article, and yes, it was Paul Krugman. He was commenting on the fact that the US doesn’t appear to produce much added value in the world economy, and yet our home prices keep rising. So while the government was busy saying that the US economy was strong, all we seemed to be doing to generate income is sell each other our houses.

GREED! home owners, real estate speculators, mortgage brokers, rating agencies, politicians, fed reserve, invest bank mortgage securitization desks, investors (hedge funds, insurance co, pension funds). Granted irresponsible mortgage brokers, ratings agencies and wall street banks definitely had a major hand in this but i am really getting tired of hearing about the poor guy who has to foreclose on his house because he can’t pay his his mortgage payments. Nobody put a gun to his head to take out the loan. Nobody forced him to refinance 3-4 times and take money out of his house. Nobody forced him to spec the real estate market and take down 5 homes to flip at a profit. If you are going to sign your life away at a mortgage closing it is your responsibility to know what you are signing and what your future payments will be. Everyone kept high fiving each other as real estate $$$ were rising but as we saw with other bubbles such as tech stocks-nothing can continue to rise without a correction if the fundementals aren’t there. Unfortunately once this mess is all cleaned up and forgotten there will be another asset bubble, a newer better financial product, and plenty more greed to go around!

my 2c: Greenspan! Real short term rates were NEGATIVE in 2004 in the run up to the election while old georgie was bragging that homeownership rate was at its highest in U.S. history. Money was ridiculously cheap and it needed a place to be invested – real estate was a better alternative to a gunshy equity market. This is when the bubble really started to heat up. Why in a time of stable economic growth would real short term rates be held negative? Hmmmm. We may not have completely avoided this meltdown, but it would have been less painful. Of course the Democrats share the blame for making Fannie and Freddie buy exotic mortgages, beginning in the mid-90s, on homes whose owners had no business buying. I cringe to write this but Bill Clinton recently made a good point (which is related to the point made by the NY Times columnist): Had the U.S. pursued a comprehensive energy policy over the last decade, there would have been many more opportunities to invest in the real economy and capital may not have been stuffed so much into the housing market through ever-increasingly complex (and suspect) investment vehicles. But, with money so cheap, the energy economy probably would have seen its own bubble. To me it all comes back to cheap money.

Greenspan kept shoving “deflation” down our throats as he’s keeping rates low. Looks like Bernanke is going to do the same. I forgot to add Fannie/Freddie in my list. Their accounting problems in 2003-2004 were followed by their regulator/congress putting limits on the amount of mortgages they could buy. This in turn gave banks/wall street the bright idea that they could do it better (ie. subprimes, alt A)

The problem was that the people underwriting the loans weren’t holding the risk associated with those loans. The loans, residuals, b-pieces, et. al. were structured and/or sold off. This led to deteriorating underwriting standards as IB’s and banks originated as many loans as possible to generate fee income from origination and structuring/syndication. They didn’t have enough skin in the game.

Root causes are Greenspan (how dare I say this) and rating agencies

I agree with the theory of cheap money as leveraging is the real cause of the current debacle.If you can run a ponzi scheme successfully for long it becomes a structured vehicle. The IB guys and all the great brains if can play on borrowed money why will they not? The global liquidity glut helped the perpetual american consumer to borrow even more and consume. Till the cost of money remained cheap it was fine but lo one day the guys lending say we want back our money and majority say the same then what you get is the CREDIT CRISIS. HAPPY DOWNSIZING HAPPY RECESSION I AM GETTING A JOB AS US PRESIDENT - PLAY POKER WITH TAXPAYERS MONEY

Loans to people who couldn’t afford to pay them - high fees up front with no consequences for mortgage brokers and originators, who have no capital so just go under if someone comes back at them, refusal of Congress to rein in Fannie and Freddie who greased everyone in DC with cash and fake “we’re just helping the little guy and discriminated groups get $500K houses” populist BS, and the smart guys who couldn’t resist grabbing a piece of that while it lasted and hanging around a crap market too long. And now swing to opposite side of paranoia and not believing any asset, even good ones, will hold value. And those good assets being dumped because have to meet margin calls, bond covenants, or capital levels and selling the crap won’t get you there. And hedge fund folks making money off that panic are NOT the issue - they ain’t big enough to cause the problem; just taking advantage of the panic. And if they didn’t, wouldn’t make a damn bit of difference. Barney and the other Dems REFUSED to put real limits on fannie and freddie and their leverage game which only worked because guaranteed by the government. So I’m about tired of hearing that regulation was the issue. Everyone in Congress and exec branch knew damn well what was happening, and the few people who tried to stop it were told they were party poopers who hated a boom (repubs) or were just against minorities owning homes (dems), both of which are silly beyond belief. Keep waiting for some grownups to show up in the midst of this clown show that is the TARP and still waiting … and the AAA tranches are still paying, by the way - so while rating agencies blew some calls, it is mostly the lower rated tranches that the banks got stuck with at the end of the bubble and therefore had to keep on their books that are not getting paid - which is exactly the risk of buying those chunks. Anyone with cash that can wait a few years can make a crapload of money right now by doing good due dil and buying the good stuff that’s being lumped in with the crud …

^good post.