Roger Lowenstein on the Subprime Blowup
The End of Securitized Mortgage Lending

The Subprime Market and Derivatives Once Again...

A correspondent makes three points:

  • First, Moody's response to requests to rate highly complex structured mortgage derivatives should have been: "We don't have enough historical data on securities like this in a housing price environment where rent-versus-buy ratios are this low. We cannot rate them to our usual standards."
  • Second, if you are collecting a fee for rating things, and if your fee is based on your past reputation for providing good ratings based on long-term historical data, and if you use the same classification scheme to make ratings that are not based on sufficient historical data--then you do have a problem.
  • Third, the fact that there was an ABX index and thus an easy way for people to bet that the mortage-backed securities market would crash probably cut short the bubble--the true hedge funds were stabilizing speculators; the destabilizing speculators were (i) the funds that were long CDOs and (ii) the banks and other issuers who retained the CDOs because their portfolio managers believed their marketeers. A world without derivatives but with mortgage-backed securities would probably be a world in which we have a bigger problem than we have now.

This third point is very much Sandy Grossman's point about the 1987 crash: that the problem with "portfolio insurance" was that it was a trading strategy rather than a derivative security traded by a market, and so nobody knew how large the demand for it was, and so those planning to implement the trading strategy in a market downturn had no way of assessing how expensive implementing it was going to be. On Black Monday everybody found out.