I'm not sure how you can possibly characterize the housing bubble as occurring in the "unregulated edges" of markets.
Banks purchased AAA rated MBS because they were legally obligated to own AAA securities (by Basel I and II) [1]. The securities underlying an MBS are heavily subsidized and regulated by the government, and several major players in the market were backed by the government [2].
Derivatives are a sideshow. The speculative bubble was created by banks and real estate speculators ("homeowners", as politicians call them, even though most of them only own highly leveraged call options on a house), with the strong encouragement of the government.
[1] You can satisfy capitalization requirements by purchasing AAA bonds from another party.
[2] In spite of assorted claims that they had nothing to do with the crisis, the GSEs seem to require the biggest bailouts.
The ratings were obviously unregulated. The oversight committees that received reports that agencies were slapping AAA on garbage outright ignored those complaints.
The unregulated derivatives were a necessary instrument to obscure the risk of the underlying assets. I don't know how you could imagine institutional investors being conned into thinking trash tranches of subprime mortgages were safe investments without derivatives obscuring their contents and ratings agencies blessing garbage as AAA.
If the bubble only wiped out speculators, it would have been the sideshow. The money that chases high risk is a rounding error compared to the money that can only chase 'safe' investments.
Without derivatives and fraudulent ratings the bubble couldn't have ensnared nearly as much money, the banks couldn't have become so precariously leveraged and the system itself wouldn't have been on the brink.
Let me get this straight. The government requires banks and other financial institutions to purchase securities rated AAA by one of five ratings agencies. As of 2006, the ratings agencies could even be subject to some penalties if they screw up the ratings in certain ways. The ratings agencies are all selected by the SEC. The downside risk is bounded below by the implicit guarantee of a government bailout, and again the biggest players in the market are government sponsored entities.
I think we have a very different definition of "unregulated".
Also, I don't know where you get the idea that the crash of the housing bubble was somehow based on people being conned into buying securities that were too complex to understand. An MBS is a fairly simple security, and so far MBS's have done exactly what they are supposed to do: allow you to take exposure to a long position on housing.
> "I think we have a very different definition of "unregulated"."
Yes. I recognize unenforced regulation as not being regulation.
Also, the implicit guarantee of a bailout wasn't a known or accepted feature of our financial system prior to TARP.
> "I don't know where you get the idea that the crash of the housing bubble was somehow based on people being conned into buying securities that were too complex to understand"
The crash wasn't. But the feature of the situation that put our entire financial system on the brink were the securities.
Again: if high-risk crap wasn't rated AAA and being sold to institutional investors, then much less of it would exist, exposing the banks to much less risk. More of what they could sell would be properly rated, meaning there would be enough reserves and insurance to cover the expected losses. There still would have been a bubble and crash, but it would have been more on the order of the Dot Com cycle, than what we just experienced.
When dot coms bottomed, investors were wiped out, but the banks themselves were fine. When the properties behind the securities bottomed, the banks were obligated to continue making payments. Payments they couldn't possibly make, because they didn't have enough reserves or insurance to cover the spread between the risk they _said_ they had and the risk they were actually exposed to.
Yes. I recognize unenforced regulation as not being regulation.
If regulations were unenforced, why were banks bothering to meet capitalization requirements at all? Why invest in MBS at all rather than something with higher returns? And if capitalization regulations were unenforced, why bother selling your own loans and purchasing an MBS of loans from some other bank (paying a chunk to loan packagers in the process)? And why bother buying wasting money getting a AAA rating from the government specified ratings agency?
What regulation do you believe was not enforced?
Also, the implicit guarantee of a bailout wasn't a known or accepted feature of our financial system prior to TARP.
Again: if high-risk crap wasn't rated AAA and being sold to institutional investors, then much less of it would exist, exposing the banks to much less risk.
This is not in dispute. Also not in dispute: if regulations didn't demand that banks own lots of AAA rated securities, they wouldn't have bought as much.
You may be able to, with the benefit of hindsight, pinpoint some specific regulation that might have prevented the bubble. But lack of that particular regulation is not the same thing as an unregulated market.
Interesting that you waste so much "productive time" that you claim you value so much arguing about those things on HN. It's not like HN exactly attracts the crowd that will write next banking regulations, is it? Then what's the point of having these arguments here? If it's about getting more karma, then it's obvious you'll get plenty from extremely libertarian tech crowd here, but it's not like your 12000 karma is convertible into real dollars?
Another observation is that many times you come in with an argument you seem to purposefully derail it into something that more suits you. The original argument was:
Similarly with nonexistent regulation of derivatives and the ratings thereof during the real-estate bubble.
instead of addressing those two issues you go into government involvement in housing market and Basel requirements. Those are important issues not unrelated to housing bubble, but that wasn't original point!
Of course housing market was heavily regulated and influenced by government. But market for housing securities wasn't! It is basic knowledge now that pretty much everyone could structure, rate, insure and sell pretty much anything to pretty much everyone. I don't understand how you could argue with that?
And finally, back to the topic, is it not indicative of something that SecondMarket is now the marketplace for both the toxic housing junk and hi-fly tech start-ups?
Well put. At some point, the market structure/complexities intended to provide a benefit, became too difficult to manage and too easy to exploit. It's a tough balancing act.
Was going to comment on your MBS statements, but this report has much better analysis:
BBB corporates vs. AAA RMBS seem to have similar credit spreads (07/2008).
Certain credit enhancements would make AAA RMBS/AAA corporates equal risk.
AAA corporates have a default rate of 5 out of 10,000 - 07/2008.
P.S. For the ggparent comment, here's a decent (from 2002) summary of pension fund investment restrictions by country:
Banks purchased AAA rated MBS because they were legally obligated to own AAA securities (by Basel I and II) [1]. The securities underlying an MBS are heavily subsidized and regulated by the government, and several major players in the market were backed by the government [2].
Derivatives are a sideshow. The speculative bubble was created by banks and real estate speculators ("homeowners", as politicians call them, even though most of them only own highly leveraged call options on a house), with the strong encouragement of the government.
[1] You can satisfy capitalization requirements by purchasing AAA bonds from another party.
[2] In spite of assorted claims that they had nothing to do with the crisis, the GSEs seem to require the biggest bailouts.