Define and explain credit default swaps.
M.T.: So how are you feeling about McCain’s chances today?
B.Y.: I’ve just finished an article for National Review — the actual magazine — about the headwinds McCain faces. I was going to look at three, and then I started to list them. I stopped at ten. New Gallup numbers out today show that George W. Bush’s job approval rating remains at 25 percent, while his disapproval rating has ticked up to 71 percent. How hard is it to succeed a two-term president of your own party who is at 25-71? We don’t know because it’s never been done.
M.T.: Yeah, that’s a damned shame, too. I feel really badly for the guy. I suppose you think the media coverage is also a headwind?
B.Y.: Actually, I did not list media coverage among the headwinds. I listed the succeed-a-two-term-president problem, the right-track/wrong-track problem, the Republican-Democrat-enthusiasm gap problem, the Republican-Democrat-I.D.-gap problem, the financial meltdown, Iraq, Republican gloom on Capitol Hill, Obama’s fund-raising advantage, and McCain’s historical problems with the GOP base.
M.T.: But all of those “headwinds,” or almost all of them, are the direct result of McCain having supported policies that are now unpopular. There is absolute justice in his facing a “headwind” from the financial meltdown, from the unpopularity of the Iraq war, and so on. How is that a “headwind”? That’s just self-created unpopularity.
I mean, his onetime campaign co-chair and top economic adviser, Phil Gramm, basically created the credit-default-swap market back in 2000. Why shouldn’t he get hammered on the financial crisis?
B.Y.: Did I suggest that headwinds are unfair? But on the financial meltdown in particular, if you’re suggesting that that is a Republican creation, or even more specifically a McCain creation, I think you’re on pretty shaky ground.
M.T.: You don’t think the unregulated CDS market was a major factor in the current crisis? Were you watching when AIG almost went under? Were you watching the Lehman collapse?
B.Y.: I think that Fannie Mae and Freddie Mac were also major factors. And I believe that many of the problems in the mortgage area can be attributed to the confluence of Democratic and Republican priorities: the Democrats’ desire to give mortgages to people, particularly minorities, who could not afford them, and the Republicans’ desire to achieve an “ownership society,” in part by giving mortgages to people who could not afford them. Again, I believe that if you are suggesting that the financial crisis is a Republican creation, or even more specifically a McCain creation, I think you’re on pretty shaky ground.
M.T.: Oh, come on. Tell me you’re not ashamed to put this gigantic international financial Krakatoa at the feet of a bunch of poor black people who missed their mortgage payments. The CDS market, this market for credit default swaps that was created in 2000 by Phil Gramm’s Commodities Future Modernization Act, this is now a $62 trillion market, up from $900 billion in 2000. That’s like five times the size of the holdings in the NYSE. And it’s all speculation by Wall Street traders. It’s a classic bubble/Ponzi scheme. The effort of people like you to pin this whole thing on minorities, when in fact this whole thing has been caused by greedy traders dealing in unregulated markets, is despicable.
B.Y.: I was struck by the recent Senate testimony of James Lockhart, who is head of the Federal Housing Finance Agency, about the sheer recklessness of Fannie in recent years. Despite “repeated warnings about credit risk,” Lockhart testified, Fannie became more reckless in 2006 and 2007 than they had been in the scandal-ridden tenure of Franklin Raines (who departed in 2004). In 2005, Lockhart said, 14 percent of Fannie’s new business was in risky loans. In the first half of 2007, it was 33 percent. So something terribly wrong was going on there, and it became a significant part of the present problem.
M.T.: What a surprise that you mention Franklin Raines. Do you even know how a CDS works? Can you explain your conception of how these derivatives work? Because I get the feeling you don’t understand. Or do you actually think that it was a few tiny homeowner defaults that sank gigantic companies like AIG and Lehman and Bear Stearns? Explain to me how these default swaps work, I’m interested to hear.
Because what we’re talking about here is the difference between one homeowner defaulting and forty, four hundred, four thousand traders betting back and forth on the viability of his loan. Which do you think has a bigger effect on the economy?
B.Y.: Are you suggesting that critics of Fannie and Freddie are talking about the default of a single homeowner?
M.T.: No. That is what you call a figure of speech. I’m saying that you’re talking about individual homeowners defaulting. But these massive companies aren’t going under because of individual homeowner defaults. They’re going under because of the myriad derivatives trades that go on in connection with each piece of debt, whether it be a homeowner loan or a corporate bond. I’m still waiting to hear what your idea is of how these trades work. I’m guessing you’ve never even heard of them.
I mean really. You honestly think a company like AIG tanks because a bunch of minorities couldn’t pay off their mortgages?
B.Y.: When you refer to “Phil Gramm’s Commodities Future Modernization Act,” are you referring to S.3283, co-sponsored by Gramm, along with Senators Tom Harkin and Tim Johnson?
M.T.: In point of fact I’m talking about the 262-page amendment Gramm tacked on to that bill that deregulated the trade of credit default swaps.
Tick tick tick. Hilarious sitting here while you frantically search the Internet to learn about the cause of the financial crisis — in the middle of a live chat interview.
B.Y.: Look, you can keep trying to make this a specifically partisan and specifically Gramm-McCain thing, but it simply isn’t. We’ve gone on for fifteen minutes longer than scheduled, and that’s enough. Thanks.
M.T.: Thanks. Note, folks, that the esteemed representative of the New Republic has no idea what the hell a credit default swap is. But he sure knows what a minority homeowner looks like.
B.Y.: It’s National Review.
Taibbi is hysterical here, but there is no recognition from those who are trying to blame the entire problem on Freddie, Fannie and the CRA that the complete lack of regulation created by Gramm led to an unregulated market in derivatives that few people understood and no one checked to see if there were adequate reserves to back up these instruments.
Obviously, there were not. But to point out for the umpteenth time, Fannie and Freddie had little exposure directly to the subprime mortgage market. Their exposure came from buying mortgage backed securities to boost their profits. The problem with Freddie and Fannie then was not their lending practices, but their investment practices. Same problem we see with the investment banks and others who bought up the securities without any real idea of what the securities were really worth.
The situation was only made worse with insurance companies like AIG backing the credit default swaps without any regard to reserves or real risk and with no one to even regulate the reserves for the risks they took. And AIG’s problems aren’t done yet–they still have a ton of obligations for the Lehman collapse where they provided insurance for many of their products. Oops!
As I’ve pointed out previously though, Fannie and Freddie products weren’t the problem. Fannie and Freddie’s problem were products they bought from other issuers. Here, there is certainly room to criticize HUD and a lack of regulation for Fannie and Freddie, but not in the way that most conservatives are doing it. They are trying to connect CRA, Fannie and Freddie, and subprime lending as all one phenomenon. That’s not the case at all as Fannie and Freddie products originated as such are seldom subprime. CRA loans are also usually not subprime. CRA has nothing to do with the current problems.
Where Fannie and Freddie intersected on the subprime market was in buying subprime MBSs from others and then HUD gave them affordable housing credits for buying up those MBSs which is both unethical in promoting crappy lenders who exploited those who were poor and had bad credit and incredibly stupid in exposing Fannie and Freddie to risk that would not normally exist for them. And it broadened the market for such instruments leading to a far greater incidence of predatory lending.
Where it gets really odd is in trying to blame ACORN housing for the crisis. ACORN housing does a lot of affordable housing work focusing on middle and lower income families. Much of that includes putting people together with lenders who are stable and offer reasonable products instead of putting people into ARMs and other gimmicks. It also often includes credit counseling which decreases the risk of default by half.
But most of all, ACORN has been blowing the whistle on predatory lending for years such as in this report from 2001. In addition, ACORN provides free counseling to individuals and the tools to avoid bad loans in addition to insisting people get their credit and budget into order. Some loans are then subprime, some are not, but they are all made with reasonable income and debt to income ratios.
They also fought predatory lenders like Ameriquest
In a $360 million commitment for consumer safeguards against predatory lending Ameriquest Mortgage Co. has agreed to standards it says could define the ethics in home mortgage lending.
Under the three-year pilot program, Ameriquest will make subprime mortgage financing available to residents in up to 10 low and moderate-income urban neighborhoods while ACORN (Association of Community Organizations for Reform Now) and its affiliate ACORN Housing Corporation will provide consumer information, financial education and loan counseling services to community residents.
ACORN, the nation’s largest low and moderate-income membership organization, has been waging an in-your-face war against predatory mortgage lending and since last fall staged a steady stream of local protests against Ameriquest Mortgage Company.
In March more than 400 ACORN members from around the country stormed the Washington, DC office of Salomon Smith Barney, which purchases loans from Ameriquest. Later that same day, the 400 ACORN members took over an Ameriquest office and occupied it for over an hour until Ameriquest’s president called from California and agreed to meet and negotiate about how Ameriquest should improve their practices.
Look at the 2005 listing for the biggest Subprime lenders:
Most are indpendent mortgage companies. Big surprise as they were the least regulated and not subject to the CRA. Of course, when ACORN works with lenders they tend to work with banks like Bank of America and Citimortgage, both of whom are relatively healthy.
So how is it that ACORN caused the problem?
ArchPundit
