Lots of groups have been blamed for the recent financial crisis, including the Federal Reserve, banks, and Congress for deregulating financial institutions by repealing the Glass-Steagall Act (which separated banks that accepted deposits from investment banks). One that deserves scrutiny is the ratings agencies–Moody’s, Standard & Poors, and Fitch–that gave AAA ratings to bonds made up of subprime loans.
The ratings agencies definitely have a lot to answer for. Historically, only one in 10,000 AAA bonds defaults in an average year. So banks and other financial institutions confidently invested in AAA mortgage bonds only to see the value of those bonds fall dramatically.
Beginning around the 1980s, banks began packaging a thousand or so mortgages into one bond, known as an “asset-backed security,” and asked the ratings agencies to rate the bonds. The agencies assumed that a few mortgages would default (though no one tried to predict which ones), so the banks divided the bonds into subbonds called tranches. The lowest tranch would pay the highest interest rate, but it would evaporate if some of the mortgages (it didn’t matter which ones) defaulted. The agencies assumed no more than a certain percentage would ever default, so the highest tranch would get a triple-A rating but pay the lowest interest rate.
The first problem was that the banks learned to “game” the agencies by designing the bond to get the highest percentage of triple-A rated tranch. This was made easier because some of the ratings agencies, for transparency sake, published their risk models. For example, to maximize the size of the triple-A tranch, the average FICO score of borrowers had to be at least 615. Defaults were rare for people with FICO scores of 615 or more.
But people with FICO scores of 550 were much more likely to default. Yet a bond could get an average score of 615 if half the mortgages were 550 and the other half were 680. The result was the agencies would place 80 percent of a bond in the triple-A tranch even though half the mortgages were likely to default.
It gets worse. The banks found it easy to sell the triple-A tranches of the bonds, but not so easy to sell the tranches rated BBB or lower. So they collected those tranches into another bond, known as a collateralized debt obligation, and asked the agencies to rate that bond. Surprisingly, the agencies would give triple-A ratings to 75 percent of the bond–even in late 2006, when the housing bubble had already peaked and sales and prices were declining.
The ratings agencies made at least two fundamental mistakes. First, since the housing market had never dropped more than 5 percent in any year since the Great Depression, they assumed it never would drop. Second, and more particularly, they assumed that declines in home prices in, say, California would be offset by increases in prices somewhere else. So bonds made up of mortgages in California, Florida, Massachusetts, and Nevada were considered “diversified.” In other words, they assumed the correlation between mortgages was low; that is, just because one person defaults doesn’t mean another person will.
Treatment Tablets such as commander levitra visit this or Kamagra can be used treat erectile dysfunction, but if you are not supposed to use this medicine. Therefore, before using Kamagra, make sure to read the label on the back and take a look at past patterns to ascertain just about any aberrations or maybe irregularities. cute-n-tiny.com cheap generic viagra Yes, canadian pharmacy viagra 100mg online is said to be a dangerous and annoying disorder which is related to the erections of the man. Kamagra oral jelly is a fast acting formula that requires only few minutes and get plenty rigidness to the male organ which indicates for firm erection during coitus acts. levitra prescription A number of investors figured out there were serious weaknesses in the ratings agencies’ models. As Michael Lewis describes in The Big Short, they scrutinized the mortgages behind the bonds and found tranches that were practically guaranteed to fail. Then they bet against those tranches by purchasing credit default swaps, a form of insurance.
Curiously, before 2000 it was illegal to buy such a credit default swap unless you owned the bond itself, but the Commodities Futures Modernization Act of 2000 legalized gambling in securities that you didn’t actually have an investment in. This bit of deregulation arguably worsened the economic crisis because someone ended up having to pay off the people who were shorting the housing market, but in fact there were only a handful of such investors so it made little difference.
After the crash, the ratings agencies claimed that, in giving triple-A ratings to CDOs of triple-B or lower mortgage tranches, they weren’t promising that no more than 1 in 10,000 such bonds would fail in any given year. But at the time, it sure seemed like it to investors, who had good reason to be angry at the agencies.
Why did the ratings agencies get it so wrong? Stiglitz and others claim they had a conflict of interest: the banks were paying them to give positive reviews of the bonds, so they did so. This doesn’t seem likely, since the agencies didn’t hesitate to lower the ratings in 2007 when it became obvious that their previous ratings were too high.
In What Caused the Crisis, libertarian economist Jeffrey Friedman argues that the problem is an SEC ruling giving the three ratings agencies an oligopoly. The agencies knew the banks had nowhere else to go, so they made less effort to be reliable.
The Antiplanner doesn’t buy this explanation either. In The Big Short, Lewis relates that some mortgage bears met with ratings specialists from Fitch, the smallest of the three agencies, and suggested, “If you want to make a statement–and get people to notice you–why don’t you go your own way and be the honest one?” Fitch’s people didn’t act embarrassed that they were giving good ratings to bad bonds; they acted surprised that anyone thought there was a problem with the bonds.
In other words, everyone except a few bears thought the bonds were sound. Since the banks selling the bonds were the ones paying for the ratings, if one agency consistently downgraded a particular type of bond because the agency could see a bubble and potential crash, the banks would simply give their business to other agencies.
If there is a flaw in the system, perhaps it is that the ratings agencies were paid by the sellers of the bonds, not the buyers. Since the buyers are the ones who risk losing money if the bonds fail, they would have an incentive to find a ratings agency that was more likely to be accurate.
But I am not sure that even that would have saved the day in this case. Remember that almost everybody who was anybody, from Greenspan and Bernanke on down, claimed there was no housing bubble. The reason why they were all wrong was that none of them realized that urban planners had changed housing markets by creating artificial shortages in cities housing as much as 45 percent of the nation’s families. But that’s a story for a future post.
The reason why they were all wrong was that none of them realized that urban planners had changed housing markets by creating artificial shortages in cities housing as much as 45 percent of the nation’s families
Amen. But planners will refuse to accept even a single bit of the blame for the actions. As evidenced by Dan’s imminent post about “hand-flapping”, “sock-puppets”, “making up sh-t”, and so forth. The planners’ failure to accept responsibility, and stop their actions that helped cause this, combined with the current smart growth lunacy, will cause the next bust to be simply catastrophic.
Yup, that’s another one. The ratings agencies.
DS
If there is one possible positive that might come from this event, it is the opportunity for learning on the part of all the players involved. Not just from the post-hoc narratives that are written by people like Lewis and Stiglitz, but more importantly from the institutional participants who bought and sold (and rated) the products that went bad.
Owners of these assets have much more incentive to avoid risky bets, and to do more in-depth analysis when they are buying something they don’t entirely understand. Ratings agencies will have to do the same to restore their reputation and the belief among their clients that they are a trustworthy source of information. And hopefully, all involved will learn not to operate on the assumption that housing prices can continue to indefinitely rise at rates much faster than incomes or general price levels.
Fortunately, some lessons may also be learned about public policy. I heard that the president of the Minneapolis Federal Reserve recently made some remarks at a housing forum encouraging the federal government to reduce its role in taking on mortgage credit risk, and to redirect policies aimed at homeownership toward encouraging savings and equity accumulation, rather than large-scale borrowing and easy credit.
I heard that the president of the Minneapolis Federal Reserve recently made some remarks at a housing forum encouraging the federal government to reduce its role in taking on mortgage credit risk, and to redirect policies aimed at homeownership toward encouraging savings and equity accumulation, rather than large-scale borrowing and easy credit.
Yes, exactly. Translated: stop the HMID and cease subsidizing SFD. Surely this gives the ADC much angst and ennui. The public increasingly prefers SG-type areas, but continues to want SFD so who knows how ceasing to subsidize housing will play out. Especially in our new economy.
DS
Mr. O’Toole,
As with all of your recent book reports, your analysis is sound until the last sentence. While I am a planner who believes that growth management can increase property values, I don’t understand how you can study the roles of these various actors and how they played a part in this crisis but still come to the conclusion that its all the planners fault.
Your analysis on these boos has been truly insightful for me (sans the blame it all on planners part)and I look forward to reading more.
-B
Bennett,
The last sentence is, “But that’s a story for a future post.” So when I get around to that future post, I look forward to your review.
I also don’t buy that the crisis is the fault of planners (except the central economic planners @ the Fed and in DC). Don’t think the case that planners created artificial shortages in cities has been well made.
Where was the artificial planner induced shortage of housing in Las Vegas, the Inland Empire, Phoenix, Tuscon, Orlando, Tampa, or Miami? There are vast amounts of undeveloped land or simply vacant developed houses/condos/apartments there.
Aren’t those places Ground Zero of the Housing Apocalypse?
I fail to see the connection at all.
The present recession is a classic sunland land development bubble going pop combined with the historic and long time coming bankruptcy of the Michigan-Ohio auto industry under its terminal collapse from union work rules, unimaginative vehicle design, and brain dead management.
That is why almost all the recessionary pain is in the Southwest, Florida, Michigan, and Ohio.
In places like Orlando, Phoenix, and Las Vegas, the entire economy revolves around building houses and retail/commercial space (along with the concomittant financing/insuring of the development, and building roads to new developments), and tourism. When the building houses part collapses upon itself in a speculative blackhole of failed loans and vanishing jobs from the flurry of overbuilding and combines with a nationwide pullback in distance tourism in reaction to high gas prices consuming discretionary dollars, the result we see was pretty inevitable, and it is pretty unsurprising that much of the country is left relatively unharmed beyond the damage nationwide from the loss of buying power in those locales.
It’s been well-established here that the assertion a for plannurz-induced artificial shortage is an erroneous argument. It keeps coming back, like a stray kitten that you give milk to.
DS
Will someone please explain to me how we can have a price bubble in any commodity that can be easily produced in any quantity to meet any demand?
Planners in perfectly planned Portland would have you believe that housing prices rise here because of demand, completely ignoring the supply side of the equation. They appear to be too economically illiterate to realize that if supply were NOT restricted, by crackpot schemes such as urban growth boundaries, the supply would match demand with NO resultant price increase. AND no attraction to speculators because there would be NO upward spiral in prices.
Thanks
JK
“It’s been well-established here that the assertion a for plannurz-induced artificial shortage is an erroneous argument.” – dAN
“If you repeat a lie long enough, it becomes truth.” – Joseph Goebbels
Jim,
Planning increases property values because it creates a stable development process (zoning), implements rules at the request of neighborhoods (parking restrictions, noise ordinances etc.) and often results in capital improvements and the provision of amenities (parks, trails, sidewalks).
Many of the most expensive neighborhoods in America are not expensive because of an artificial lack of supply. They are expensive because they are nice and have lots of rules that keep them nice.
In theory growth management will restrict housing supply, but there is a large absence of evidence that shows the effects are substantive (it’s peanuts). Planning does drive up housing values, but not because it restricts supply.
“Planners in perfectly planned Portland would have you believe that housing prices rise here because of demand, completely ignoring the supply side of the equation. They appear to be too economically illiterate to realize that if supply were NOT restricted, by crackpot schemes such as urban growth boundaries, the supply would match demand with NO resultant price increase. AND no attraction to speculators because there would be NO upward spiral in prices.”
Let’s talk Portland. First, the demand to live in Portland is high. Full buses of bright-eyed hipsters/aspiring baristas arrive daily from far off locales like Minnesota. These new urbanites shun the suburbs for the glitzy city so they can walk to coffee shops or dive bars that serve PBR in a can for $1. (At a trendy restaurant called East Burn, I overheard some hipsters talking during Gay Pride about how all the homophobes were coming in from the suburbs and how they would NEVER live in the suburbs and would rather gouge out their eyes.)
There is a relatively fixed housing supply in the inner core. These trustafarians bid up rents. Just before the crash, I went to a rental open house in NE not too far from Lombard and MLK. There were at least 40 young urbanites waiting in line for a peak at a tiny, tiny house in an “up and coming” (read: ghetto) neighborhood. I ended up renting a house a few blocks away a couple of years later. It’s on a .17 acre lot and packed in by dozens of other houses, built in the 1920s. The house behind and across from mine was on a corner triple lot, on which two houses were later built.
So, my point is that I’ve see new housing springing up IN Portland to try to meet demand. Most close-in neighborhoods, where many prefer to live, have long been established and are either too pricey or have small lots with as many houses jammed in as possible. Where are these new houses going to go? How are planners limiting supply? It seems like the greatest limitation of housing supply in Portland is human geography and lack of space. Can’t just wave a magic wand and create more open space in Laurelhurst or Irvington or Hollywood; those areas are packed, already settled, and not available for new housing development (unless you want to build in Laurelhurst Park–damn planners, limiting growth!). Many people moving to Portland or who live in Portland do not want to live far from the center in some green belt development.
The idea that planners caused the housing bubble is ludicrous and ignores the facts on the ground.
Frank makes some great points.
What’s particularly galling about the type of suburb-hating urbanite he describes is that they are typically the same whiny ghouls who complain ad nauseum about Portland’s “overwhelming whiteness” and “lack of diversity.” Yet if you suggest they go live where the minorities are and where the diversity is (e.g. suburbs like Gresham, Beaverton, and Hillsboro), they will scoff and roll their eyes.
Why, you ask?
Because the Mexicans and blacks who live in those suburbs don’t listen to Yo La Tango and don’t attend tweed bike rides downtown. In other words, Portland’s suburb-hating urbanites don’t want anything to do with diversity. Or perhaps they simply want diversity on their own privileged Caucasian terms — they’d totally welcome a hip black DJ from Paris named Dmitri, of course, or a snarky blogger from Australia, but they sure as hell wouldn’t be caught dead hanging out with the impoverished Mexicans, Vietnamese, Russians, Uzbeks, Georgians, Ukrainians and Somalis in East County.
It wouldn’t be hip enough.
Frank: So, my point is that I’ve see new housing springing up IN Portland to try to meet demand. Most close-in neighborhoods, where many prefer to live, have long been established and are either too pricey or have small lots with as many houses jammed in as possible. Where are these new houses going to go?
JK: Beyond the suburbs, but that is forbidden by the Metro wall (urban growth boundary to outsiders). That building would have allowed price sensitive people to move to outer locations, thus reliving pressure on prices closer in, but Metro forbids it just like East Germany forbad people moving out.
Frank: How are planners limiting supply? It seems like the greatest limitation of housing supply in Portland is human geography and lack of space.
JK: And Metro’s wall preventing people from moving further away from higher inner city prices (and crime & crappy schools & Sam’s corruption).
Frank: Can’t just wave a magic wand and create more open space in Laurelhurst or Irvington or Hollywood; those areas are packed, already settled, and not available for new housing development (unless you want to build in Laurelhurst Park–damn planners, limiting growth!).
JK: But you can allow development further out to relieve the pressure on close in prices. But Metro’s wall forbids that.
Frank: Many people moving to Portland or who live in Portland do not want to live far from the center in some green belt development.
JK: But others would move to the lower cost burbs if Metro’s wall didn’t make the burbs overpriced.
Frank: The idea that planners caused the housing bubble is ludicrous and ignores the facts on the ground
JK: And you are ignoring grade school economics. Metro’s wall restricts supply, so even a little demand drives up prices.
Can I assume you are employed in the planning cartel?
And you have no understanding of basic economics?
And you get your city planning information from the Sierra club, Metro & Trimet?
Thanks
JK
You can make those assumptions, but you look like an ass for so doing. Clearly, you haven’t been paying attention for the last two years. I feel really embarrassed for you.
Again, urban elites will not move to the suburbs. The people with whom I rubbed shoulders on Hawthorne, Belmont, and Alberta under no circumstances would move BEYOND the suburbs. Consider that apartment vacancy rates in Troutdale/Fairview/Wood Village/Gresham are twice those of inner SE Portland where all the cool cats live. If you look at the sticks, such as East Vancouver or Wilsonville, apartment vacancies are over three times inner SE. There’s a relative glut of apartment supply in many of Portland’s outer areas.
Suburban Portland housing prices have declined; packed Multnomah County was flat:
Housing inventory is higher for the metro area than for Portland and certainly for hip neighborhoods like SE. Additionally, average sell times are twice as high in Tigard, Tualatin, Sherwood, and Wilsonville than they are in SE PDX, further highlighting preferences and supply.
Metro isn’t “preventing” anyone from moving away from “inner city prices”. There is plenty of cheaper housing supply away from the center. What is keeping people from moving is their preference for living in specific neighborhoods. As far as crime, with the exception of Downtown, crime rates are similar in inner neighborhoods and in the suburbs.
Market conditions, social realities, and lack of empirical evidence refute the assertion that planners are primarily responsible for perceived higher housing costs in Portland.
SMART growth = Segregate Mexicans in Another Region’s Town
Here’s the extreme end of planning and “SG”:
The Inevitable Result of Central Planning: China’s Ghost Cities and Malls
Frank, how do you explain the fact that Portland has moved from being one of the most affordable housing markets in the US (before the Central Planning Committee aka Metro came to be) to being one of the least affordable housing markets?
“…Portland has moved from being one of the most affordable housing markets in the US …to being one of the least affordable housing markets”
Sources, please.
I mis-labelled that. I meant to say that Portland has experienced a high rate of decline in affordability as compared to other metro areas. Even Randall has talked about that:
http://www.ti.org/vaupdate52.html
It’s ridiculous to draw an artificial boundary around an area and not expect it to raise prices inside the boundary [insert bogus defenses of magical, holy UGB by Dan].