So the Fed is proposing new rules to prevent another meltdown, but here's the thing...

I've only once heard anyone give a real cogent explanation of what happened and how to fix it. It was former Labor(?) Secretary Robert Reisch(sp?) on NPR.

Let's review the situation and I think you will see what I mean...

Time was when you wanted to buy a house you would apply for a mortgage at your local bank or S&L. Now since they were looking at a long-term relationship -- potentially as long as 30 years -- with a lot of money on the table they would carefully look at both the property and the credit-worthiness of the borrower.

Then somebody got the bright idea of selling a bunch of mortgages off as an investment instrument -- a bond. That way they could get their capital back in play very quickly and make more loans. The payoff was that they could collect fees, points, and/or commissions on the loan origination. They transformed themselves from lenders into brokers.

Now there's nothing wrong with that in principle. It's really just the same thing we all do in a modern economy, specialization. The main difficulty is that the loan originator was no longer looking at a long-term relationship. Once the mortgage was sold off, they were out of the picture. If the borrower defaulted, they didn't care because they already had their money. Furthermore, they could invent "new and improved" kinds of loans like "interest-only" and "teaser-rate" products to increase the customer base.

Now we all know what happened, but the thing here is that according to Free Market Theology all the bad stuff still shouldn't have happened. Why? Because in between the originator and the investor buying the bond is something called a rating agency, like AM Best. They should have looked at these bonds, shook their little pointy heads, and slapped a junk rating on them. They didn't. Why not? After all, their entire business is based on reputation and trust. When they attach a AA or AAA rating to a product that's supposed to mean something.

Here's where it gets interesting. It turns out that the way the rating agencies were getting paid was by the seller of the bond and only if and when the bond was sold. Uh-oh. Isn't it Ron's contention that "Incentives Matter"? These guys literally sold their company's soul for a few bucks.

The fix should be obvious. We don't need a bunch of new rules about what kind of loans are permissible or consumer disclosure requirements or any of that. All we need is a rule, one simple rule, that states that bond raters must NOT be paid by the seller. Instead they should be paid by the bond investors as a subscription service.

This would incentivise the raters to do their jobs properly. And if the raters are doing their jobs right then the loan originators won't have any incentive to write shaky loans because then they won't be able to sell them. Instead they would be forced to service them themselves and incur any losses from them. All the loosey-goosey, wheely-dealy crap goes away because they simply can't afford to do business that way. By necessity they have to start acting like boring old banks again.

This a British comedy skit that explains the subprime problem.

I apologize in advance if the 'black man' reference is offensive to anyone, but the Brits just aren't as PC with their language as we Americans.
Having said that in day to day life they are much more accepting and much less segregated than in the US.

Food and Drug, Aircontrollers, National Parks Administration, minerals, forests, cities, (New Orleans, for example), and a sinkhole of a war.
This list is not exhaustive, the number of areas in which the citizen has no protection or control seems to have taken a great leap forward since the golden reign of St. Ronnie.
Inspectors? We don' need no stinking inspectors!

"The Dollar and US Hegemoney" by Ingo Schmidt and "Alternative Economics: Removing the Log from Our Economy" by Marc Batko are available at
http://portland.indymedia.org/en/2007/12/370115.shtml

The dollar devaluation since 2001 is a necessary adjustment for the twin US deficits, the national budget deficit and the foreign trade deficit. US imports are double US exports. The dollar devaluation should have led to higher import prices. A drastic change of lifestyles is imperative where modesty and simplicity are encouraged, limits are recognized and the future is protected.

"May we abandon the path of least resistance (market radicalism) and support one another in alternative economic thinking, truth-telling and story-telling where the future is open, welcoming, supportive and creative."
"A drastic change of lifestyles is imperative where modesty and simplicity are encouraged, limits are recognized and the future is protected."
The elites are quite willing to see a reduction in the life styles of everyone in the world, as to a rational economics, well, I wouldn't hold my breath.

quote:

The dollar devaluation should have led to higher import prices.

Demandside, it didn't in 85-87 as far as remember. Then it was a 40% drop on a trade weighted basis in two years.

quote:

Here's where it gets interesting. It turns out that the way the rating agencies were getting paid was by the seller of the bond and only if and when the bond was sold. Uh-oh. Isn't it Ron's contention that "Incentives Matter"? These guys literally sold their company's soul for a few bucks.

Rt, I am glad that at least one person was paying attention (assuming the "Ron" statement was to indicate myself. Yes, any buyer or seller should look at the motivations of the various actors in the transactions. If you have a real estate agent representing both sides of a transaction then he would prefer higher closing prices overall. This is the same reason that when buying a house the buyer should have his own inspector examine the house. Sure take the sellers information as much as you can but still put more faith in your inspector.

Yes, Ron, I was referring to you. I'm glad you agree with me, but here's what I don't get...

I understand this principle. You understand this principle. It's not anything earth-shatteringly profound. In fact I would say it belongs in the "Duh" bucket.

Yet apparently these financial super-geniuses playing with tens of billions of dollars didn't understand it. WTF??!! Could I be excused for believing that maybe some of them are a tad over-rated and over-paid? (Maybe they went to Conservative Christian schools and aren't so hot at math.)

What does this say about Free Market Theology with supposedly rational players acting according to their own best interests? Isn't that supposed to ensure the best results? I mean anyone can be wrong and investments can always go south, but this was just stupid.

Finally, given the behavior of the "professionals" in this affair, how can anyone seriously point fingers at the homebuyers, who after all, aren't making any claim to financial genius? While all the parties were motivated by greed to varying extents, the homebuyers were merely ignorant. The lenders, raters, and investors are all professionals. Ignorance is not an acceptable excuse for them.