Ready for a Credit Crunchy 2008?
January 7th, 2008I just came back from vacation yesterday. I had a wonderful time with my family in San Diego and Los Angeles. I consider myself very lucky to have been able to go on the trip. Although I spent far too much time (and money) in theme parks, I did have a tremendous amount of fun with my wife and children, and even got some quality time in with close family and friends. What more could I ask for? I’m now refreshed, and ready for 2008.
Anticipating the months ahead, perhaps Credit Crunchy©™ (changed from copyright to trademark upon the advice of my lawyer) will be this year’s theme. That’s why it’s in the title. Your guess is as good as mine. We shall see how this blog thing evolves…
You also might be wondering why I told you about my vacation. After all, this is supposed to be a blog about strategy. Well, the vacation provides a nice segue into today’s topic.
When I go on vacation, I try to make a habit of reading an interesting book – be it fiction or non-fiction. I try to take a break from the academic articles that I read on a regular basis. And I try to take a break from writing. I find that this helps me recharge the batteries and clear my mind. Well, this vacation, I went back to a book I hadn’t thought about in many years. I decided to pick it up again because I remembered that it was about trading, I remembered that it had some interesting snippets about bond versus equity trading, and I remembered that it told the story of the heyday of Salomon Brothers (of which I’m not one – ok, technically I am, but not of those “Brothers”). I also remembered that it had something vaguely to do with mortgage-backed securities, which are at the center of today’s credit crunch. The book I’m talking about is Liar’s Poker, by Michael Lewis.
I’m assuming that most of you (especially those interested in trading) have read the book at some point. It’s a really detailed, poignant, and accurate account of life as a trader. Frankly, it’s a classic (my commissions are payable in Yen, Pounds, or Euros Mr. Lewis)!
In reading the book, the part that struck me about the whole mortgage-backed securities business is that it almost never was!
According to Michael Lewis’ account, Salomon had the only real, fully-staffed mortgage-backed securities desk when they exploded, giving them a virtual monopoly on the business from 1981-1984. Prior to that, there was extreme skepticism on Wall Street as to whether mortgage-backed securities made any sense at all. Many bankers saw no potential buyers for the assets, and couldn’t understand why anyone would want to own them. In fact, most of Salomon’s competitors (the usual suspects on Wall Street) had given up on mortgage-backed securities and had closed their shops prior to 1980. Salomon’s was the only one left standing. And it too was on the brink. According to Lewis’ account, it was probably only several months away from being shuttered.
And then came the Savings and Loan Tax Relief Act (I can’t remember the exact name) of 1981 1979 (or the exact year). In any event, according to Lewis’ account, this one act almost immediately created both sellers and buyers for mortgages, as S&L’s looked to get troubled loans off their books, and buy back the loans of other troubled S&L’s in order to book losses and earn tax credits.
In light of the current credit crunch, all this made me wonder: Would we be where we are today had another few months passed and had Salomon actually closed it’s shop, or had Congress never passed that ill-fated act? If so, there might not have been any market for mortgage products. Maybe the investment world would have decided that mortgages do not make for very good securitized, traded assets. As a result, perhaps the financial disintermediation in mortgage markets never would have occurred, and mortgages might still be held the old-fashioned way – by the banks that originated them, …potentially reducing future moral hazard in the lending/securitizing business.
That’s one view of the world.
The alternative is that it might have happened anyway. In the end, somebody somewhere in the market would have eventually realized the value in securitizing and trading these things, freeing up the capital of the banks to lend again thereby increasing the multiplier and opening the possibilities of homeownership to many, many more people who might otherwise be shut-out of homeownership.
I’m not sure where I stand yet, but it’s probably somewhere in the middle (such a political answer, I know). I do believe that there is a place for mortgage-backed securities in today’s market. However, better oversight of the entire process (from lending to securitizing to trading to insuring) might have helped it function better, perhaps averting today’s excesses.
