Email a copy of 'Insane Levels of Leverage by the TBTF Banks Caused the Financial Crisis' to a friend
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This is a step in the right direction that covers some of the key points, but I think it needs to be made more explicit.
The financial crisis was caused by a run on the shadow banking system.
The shadow banking system is essentially the nexus of 1) Repo 2) Commercial Paper and 3) Money Market Mutual Funds.
The way it worked (a vast oversimplification though) is that the big banks used a combination of Repo and CP to fund their asset holdings. They were enormously leveraged in so doing, and also exposed to an enormous maturity mismatch, with most Repo being overnight and most CP being one to three months (whereas the assets in question had effective maturities of many years). The counterparty on the other side of the Repo and CP was often a Money Market Mutual Fund, which in turn obtained its funding from retail and institutional depositors who, in an earlier era, would have placed those deposits with a traditional banks. That’s it in a nutshell.
Where does that leave us? On one level, the shadow banking system, on which the economy had become dependent on for financing, is till broken, hence the anemic recovery. On another level, there has been no real financial reform applied to this system, so if it does recover at some point, we’ll still be just as vulnerable to another crisis down the road.
“TBTF Banks on LSD indeed; massive amounts of Leverage, Swaps and Derivatives.” c2011
LOL – oh thats good – I copyright it for you (whoever is WashBlog – BR?)
Just a quick math lesson: 0 multiplied by 100 is 0. You’re gonna need another way to define a zero down mortgage if you’re gonna use phrases like, “by the same calculation”.
Why just one view or the other. Sure Wall Street was more leveraged, and the big institutions interconnected in a way home owners could not be, but at the then end of the day, you had an awful lot of home owners in homes with exploding mortgages that required refinancing and home prices going up(something that was not sustainable). And way too many homes were bought for no other reason than reselling a few years down the road.
The banks were over-leveraged, they lent and invested in too heavily with 100-1 leverage the same dodgy loans they helped create.
This left vs right argument feels as if it’s not so much about truth, but control for their vision of the future. Where is Al Smith?
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BR: Understanding causation is a significant part of policy analysis. Its not left vs right, its what actually occurred — what was unusual, different, significant — versus some silly but reassuring narrative.
Sorry james.cappuccio but I might have to correct the teacher in the ‘quick math lesson’…
The deposit is a proportion of the total, so the ‘number of times’ levered is given by the total borrowed divided by the diposit.
So in the first $500,000 example: 500000/100000 = 5 (a leverage of 5 to 1)
in the zero deposit example: 500000/0 = infinity (an infinite amount of leverage – not that infinity makes much sense that often in any maths)
Not sure if I am right but it seems to make more sense that way to me.
In Washington’s defense they did say ‘suffice it to say, 100 times leverage, it’s actually more but that’s a discussion for later’
But taking that point – I dont think a ratio of 100:1 is analogous to a ratio of infinity:1 – not by a long long long way.
oops… scrub ‘borrowed’ in the second line of my last post – damn I am getting to be a pedant in my old age.
One extra point, while the article does a great job, home owner leverage and bank leverage are quite different. Bank leverage is about margin calls and regulatory capital. For the home owner it’s not about the asset but how leveraged your fixed to variable expenses are(e.g. mortgage equal to 25% vs 70% of take home pay..), and given that reality home owners can’t lever up in quite the same way.
To me it is all about capital flows. I guess, I have a different view of it. The huge leverage is because of the flows from the post-information boom bust.
Similiar to the US in the post-WWI timeframe, we had a ton of capital available to muster and we blew it into freaking RE products wasting a generation of capital. Lets face, that is the truth. So the whole “left/right” paradym gets into its personally biased fantasies that don’t add up. For the left is was lack of regulatory oversight and the right it was a pursumed government intervention. As they say, move the hell on. Neither is really right. It goes deeper than that. It goes into how capital moves and flows. The decisions made to allow offshoring, taking more potential avenues for capital. The decision of the Bush administration to force through tax cuts on capital gains and dividends(which Buffet blames for the crisis’s heights as before those cuts, the bubble wasn’t monsterous yet). The lack of oversight in Wall Street and F/F’s relation to the secondary markets were both visably seen. F/F was following the “free market” as much as anything relation to its decision makers. Just like MERS would have started other places if F/F didn’t exist. See Ireland. Even if we banned no doc loans, does anybody really think, in the face of all that capital, that would have stopped lenders? Really?
So the “right/left’ is still stuck in the same problems and they need to move on. Just come to grips that the capital was wasted and we failed. The free market failed, the government failed and we as country failed. But no, we will live in our fantasies and must rebuild the boom that is unbuildable. The only choices is muddle or depression. The former may be fine to some(Ben Bernanke) while the latter fine to others(Ron Paul), but both have real risks, risks that will rock the political world and reinvent “right and left”.
The truth is out there for everyone to see!
Nothing will ever be done about this.
Talk is cheap!