We Will, We Will Wonk You!
Bank Lawyer’s Blog:
In today’s edition (tomorrow’s edition, if you haven’t crossed the International Date Line) of the Asia Times Online, consultant George Pugh has a rather “wonky” article on Collateralized Debt Obligations backed by subprime mortgages, how fraud by originators of those loans caused the bubble that has now burst, and how rating agencies may have dropped the ball by not properly accounting for fraud in their models. He asserts that the creators of CDOs, on the other hand, reacted properly to the prospect of fraud once they comprehended the breadth of the problem, even building their own processes to by-pass the rating agencies’ flawed processes.
The authors of Bank Lawyer’s Blog are not wonks. Rather, our day usually consists of sitting on a cabin porch in the backwoods of the Ozarks, picking out “Foggy Mountain Breakdown” on the banjo. When we
begin reading an article that contains a technical analysis of CDOs, we’re overcome with the irresistible urge to grab a .22 and go a-huntin’ for varmints. However, there may be mortgage-backed wonks out there who will enjoy that aspect of the article.
Our interest was in Mr. Pugh’s conclusions.
[I]t is clear that the frauds started with
the people making fraudulent mortgage applications which were not caught by the
people issuing the mortgages. The second conclusion is that the firms were only
later involved and did not try to hide the problems in a meaningful way; though
there may have been instances in some firms, it was by no means generalized.
[...]
Fraud distorts market signals for demand and more importantly growth in demand and price. In this instance, increased mortgage financing bid up existing stock and created a multiplier effect among existing home owners, who sought to reinvest their gains in larger properties. These price increases encouraged builders to build…