But I'm actually very curious, and I'm not really sure where to look up the answer. This is a very specialized, very random question to ask...but I just want to take a shot:
Does anyone know why the ratings agencies like Moody's and S&P gave subprime mortgage bonds such bulletproof ratings? It seems like the crux of this whole massive meltdown is the fact that investment banks, hedge funds, and whoever else believed that the subprime mortgage bonds were high-yield with low-risk. In other words, easy money. So let me rephrase the question in two parts:
1) What made sophisticated financial investors believe that a free lunch was even possible with high-yield mortgage bonds? What was the reasoning that ran through their heads?
2) Why did the rating agencies believe that? What was the logic?
I guess it's the same question...but from my remedial understanding of the problem, I simply don't get it. Does it have to do with the strength of the housing market? Have mortgage loans historically been very safe, and thus had very low rates of default? Were they not aware that the banks were giving subprime mortgages without proper risk assessments, and assuming that the mortgages were approximately equivalent to the mortgages of the past?
I honestly think that this topic is intensely fascinating and I'm utterly thrilled that I happen to have finally understood these issues just as our markets are melting down into goo. (except for the fact that my first job will be taking place in a pool of market goo...i guess...)
Seriously though, it's random, but does anyone know?
6 comments:
From Gregg Easterbrook's Column:
According to last week's Wall Street Journal, Harvard's endowment is up to $34.9 billion and Yale's has risen to $22.5 billion. To put those numbers into perspective, the Harvard endowment now exceeds the gross domestic product of Sri Lanka or Kenya and the Yale endowment exceeds the GDP of Costa Rica or Iceland.
Based on its endowment, Harvard will soon demand a seat on the United Nations Security Council.
It's wonderful that such great institutions of higher learning are funded so well, with assets that seem to assure their continued existence for centuries. But as Tuesday Morning Quarterback asked last year when Harvard's endowment hit a mere $29 billion, why does anyone pay anything at all to attend this school?
Conservatively managed investments using low-risk strategies yield 5 to 7 percent per year; federal law requires many types of philanthropies to disburse a minimum of 5 percent per year or lose their tax-exempt status. At 5 percent, the Harvard endowment would throw off $1.7 billion annually. That's $104,000 for each of the 16,715 undergrads and graduate students currently attending the university. Yet according to College Board figures, the average undergrad who lives on campus at Harvard this year will pay $37,900, that being the official price minus average financial aid award. Can Harvard seriously expect us to believe it is spending $144,000 per year per undergraduate? (That's the actual payments from students plus 5 percent of the endowment.) Shifting Harvard's endowment spending from empire-building to reducing tuition -- either lower prices for everyone, or, say, eliminating all costs for students from families that make $200,000 or less -- would be a tremendous progressive step without jeopardizing Harvard's legitimate desire to hold a rich endowment into the indefinite future.
Instead, Harvard just keeps charging an arm and a leg and the endowment keeps empire-building. One result of the extremely high cost of private colleges is that many graduates feel they must go into high-paying professions to justify what was just spent. If Harvard were free for students whose families aren't rich, or cost much less for all students, perhaps graduates would be more likely to become public-school teachers or Peace Corps volunteers or work for the U.S. Public Health Service or in legal-aid settings. Rather than use its colossal financial assets to educate a generation of smart people willing to serve society in thanks for a great education at little cost, Harvard continues to soak parents, teach money obsession and set an example of hoarding.
RS
Interesting. But Random. Now go copy and paste the answer to my question.
I think it was a combination of historically high R/E price increases and historically low mortgage interest rates. Banks felt confident in lending to those w/ dubious credit b/c they figured that the R/E value increases would more than offset their risk. In other words, if the buyer defaults in a high growth market, the bank simply re-takes the property, resells it, and actually makes a profit. But the banks were smart enough to realize that this would not continue forever. Thus, they started to re-package most of these loans into various types of financial products and re-sold them (at a discount) to the hedge funds and other secondary financial markets. And actually, banks have been doing this for years to lessen their risk.
This of course does not entirely answer your question, which is why the hedge funds and rating agencies of these types of debt products were rated as secure investments, other than I would guess greed. Similar to the 2000 market correction, good times can go on for a while, but at a certain point there is a correction and someone is left holding the bag. In this case, the hedge funds, or more accuarately, the investors in them and the similar mortgage-backed financial products.
DA
P.S. Thanks for coming to STL this weekend!
I think you're exactly right, and your discussion leads directly to the same question I had...which is in the face of such a market where risk assessment by the lending banks goes RIGHT out the window because they no longer "hold the bag"...what made these ratings agencies not aware of these problems? Was there some sort of conflict and collusion with the investors and the ratings agencies? Is that what you mean by greed?
And of course! I had a great weekend, through and through. (You're old.)
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