April 01, 2016

When securitization wedded the capital requirements for banks, the subprime mortgages' inferno overheated.

Sir, I refer to Gillian Tett’s “Unorthodox answers to the inflation enigma” April 1.

Ms Tett writes: “If the Fed, or any central bank, wants an illustration of why ethnographic research matters, they need only look at the last credit bubble, when most economists missed the subprime mortgage boom because they shunned on-the-ground research. Fed officials need to get into consumers’ lives. Or else hire a few anthropologists to work with those office-bound, and baffled, economists.”

Unfortunately central bankers have yet to understand the missed subprime mortgage boom, and so has anthropologists like Gillian Tett.

Anyone who has read Kirsten Grind’s spectacular tale of the Washington Mutual failure “The Lost Bank” 2012, Gillian Tett has praised it, should have been intrigued by a question the book poses but that remains unanswered. Why was there especially such huge demand for basically the lousiest mortgages?

An objective researcher would then have found that combining the dark secret of securitization, with the importance given to the credit rating agencies for determining the capital requirements for banks, created a temptation impossible for any ordinary humans to resist.

What “dark secret of securitization”? That the worse the assets to be securitized are, the more can those involved in the securitization process profit. Selling of a $300.000, 30 years, 11 percent mortgage, packaged in a security for which an investor thought that 6 percent was a great return, would immediately yield $210.000 in profits.

And on credit ratings, if a security got an AAA to AA rating, then the banks, according to Basel II, needed only to hold 1.6 percent in capital against it, and were therefore allowed to leverage a mind-blowing 62.5 times to 1.

The problem with any central bank research though, is that it would lay much blame on all central bankers involved with bank regulations… and, among colleagues, we can’t have that, can we?

Oh how I wish Kirsten Grind would go back to the subprime inferno and research the causes for why it overheated.

@PerKurowski ©