Where were the regulators on April 26, 2007?

I just read in the Washington Post that the CDO discussed in the suit against Goldman Sachs, ABACUS 2007-AC1, and in which investors lost more than $ 1 billion, was created on April 26, 2007

Just out of curiosity I went back to my blog TeawithFT and found the following letter:

On March 19, 2007: Let us pray the estimates are wrong

Sir, let us pray for that the estimate that 2.2m of American families could lose their homes and that John Gapper mentions in “The wrong way to lend to the poor” is totally wrong. If not, then let us prepare for the worst, as the political consequences of such fallout in the sub-prime mortgage market would by far surpass whatever all other thorny issues such as Iraq and the illegal immigration could all produce, together.

What I miss in this scarily good saddening and scaring article, is some words of how it came about that some 2.2m obviously individual shaky loans could have, when all was said and done, produced the sufficiently good ratings needed to attract so much money. The credit rating agencies sure must have some explaining to do, as has those Bank regulators responsible for giving the credit rating agencies so much power to begin with.

You can find it here http://bit.ly/9clEC9 ... but that’s not all friends;

On April 13 I responded to an article of Gillian Tett in FT titled “Subprime proposals could broaden litigation risk all around” http://bit.ly/d9I0rt

Also on April 13, 2007 I responded to an article in FT by Richard Beales titled “A whiff of double standards” http://bit.ly/d2vopp

And on April 18, 2007 I responded to a comment in FT by Desmond Lachman titled “Housing bubble burst into American elections” http://bit.ly/cxKT3P

And so there obviously has to be so much more to it? Where were the regulators on April 26, 2007?

Think tanks are also to be blamed for their lack of thinking

Sir Desmond Lachman from the American Enterprise Institute writes that “Greenspan will have to be called to account for regulatory failings and his interest rate policy” February 20. That might very well be so but others must also recognize their failings in the process. For instance not alerting to the abominable systemic risks that could be created by investing so much power over the financial markets into the hands of the credit rating agencies is more than proof that very little thinking occurred in the think tanks.

Now let us connect urgently the lessons learned with the what to do.

Sir, Desmond Lachman, in “America’s subprime blues have historical echoes” August 3, is absolutely right when he says “At the heart of today’s subprime crisis is the unfortunate interaction of financial innovation gone awry, inept market regulation [by which we might presume he also refers to inept regulators] and a failure of the rating agencies to exercise their fiduciary responsibility to protect the average investor.” By the way the credit rating agencies would probably argue that part about “fiduciary responsibility” since they way they describe it, they only give opinions in accordance with their freedom of expression rights.

Now what Desmond Lachman does not yet do, is to connect the lessons learned with the what to do. As I see it and following that old advice of when in a hole stop digging, the first thing we have to do is clearly to recall all the empowerment awarded to the financial fortune tellers, the credit rating agencies, to dictate so much about where the financial flows can or should not go. Let us pray that the current problems are just a minor tremor that serves us as a warning and that we still have time to runaway from construing a financial system on top of a systemic fault that if we do not amend will produce mind-boggling catastrophes.

PS. "minor tremor"? The 2008 Global financial crisis GFC

A rescue plan for the subprime mortgage blow-up

Sir, Desmond Lachman in “Housing bubble burst into American elections”, April 18, paints a very sombre picture that is just made much worse by the possibility that the first order of action, in this fire, will be to apportion the blame. We all must know that any plan that wants to have a chance to contain this disaster, needs to accept that its goals have just as much to do with improving borrowing, lending, packaging, rating, investing and regulating histories. No party is without blame.

1. If companies can have a Chapter 11 time-out, there should be no reason why the subprime mortgage sector should be forced to panic.

2. There is but one way to minimize the overall costs to borrowers, lenders, investors and society, which is to find the mechanisms to turn these uncollectible subprime loans into collectible prime loans and then have the costs of doing so shared by the parties, with a final settlement postponed in time, way down the road. For instance, if the borrower can only service a normal low fixed rate loan at a level equivalent to seventy cents per dollar on the actual dollar owed, then the loan has to be written write down to 70% plus a reasonable loss recovery clause applicable much later, when the real value of the houses support it.

3. In order to implement the program there will be a need for a fund that would repurchase mortgages through an auction system at the lowest cents per present value of dollar tended.

4. Those lenders, or packagers, or investors who would wish to implement a similar program on their own, or proceed directly with their foreclosures after the time-out, are free to do so, but need then to accept direct responsibility for any wrongful behaviour that could have been present during the original signing of the mortgages.

China does not take away anything in the World Bank from sub-Saharan Africa

Sir, Desmond Lachman, November 3, asks for the World Bank to withdraw from lending the majority of its resources to a handful of middle-income countries, e.g. China, instead than to the really poor, like those in sub-Saharan Africa. It all sounds very reasonable but perhaps he should ask himself whether his proposed change of strategy would result in more effective assistance to the very poor. Indeed, it could mean less. As is, China and Mexico and other middle income countries do not take away anything from the World Bank and on the contrary they provide the volume of operations that allows the bank to keep in place an impressive cadre of development professionals, able to generate that type of technical assistance capability that as he correctly implies should perhaps also benefit the victims of the Hurricane Katrina. Finally since in calling for his reforms Lachman argues that this would result in more “bang for its taxpayers’ buck”, it might be timely to remind him that in reality there is unfortunately an immense lack of taxpayers’ bucks going for development.

Desmond Lachman
Middle Income Countries
World Bank