Lauren Wilhelm
November 8, 2013
GVPT 200
Prof Shirk
Risky Business:
Manipulation of CDOs and the Housing Market Crash
In
his book The Signal and the Noise, Nate Silver looks into and analyzes the
contributing factors for the housing market crash which led to the U.S.’s most
recent recession. In studying the inner workings of banks, loan sharks, debt
raters, NRSROs and so on, it can be discovered that their greed for money and
overall ignorance led to them overlooking many warning signs on the housing crash,
contributing to the crash in the housing market and recession. The corporate
workers in these industries wanted so badly for the system to work because of
the revenue it would bring in that they used confirmation bias, and built their
statistical data and proof around their ideas so it would support them. This
system of buying and selling debt may have seemed like a profit maximizing one
in the beginning, but eventually the false premise it was built on was bound to
catch up with it and take it all tumbling down.
The selling of
default rates and securities is wrong for more reasons than the simple fact
that the system failed. It was made more wrong by the fact that it was
essentially gambling. Gambling with debts and the possibility of risk may seem
exciting to those who can afford to lose money and take that risk, but when it
affects the livelihoods of others who need these loans and depend on them, it
is not okay. The system involved rating agencies predicting the probability
that someone would default on a loan and they predicted the nations 5-year rate
at .12%. This rate was considerably low so they saw only small risk and with
that sold and allowed for the trade of debt backed securities and CDOs as if
they were stocks. They tried to create a market for them because they saw the
possibility to bring more investors in on something they didn’t think existed
to sell in the first place. This prospect was propelled by greed and the hopes
of Wall Street’s new and young associates. The only problem with gambling is it
is almost always taken too far because no one knows when to quit, and
eventually, you lose it all.
The statistical
model these ratings were based on ended up being faulty in the end, and causing
the whole idea to fail because it was based on assumptions and not historical
data. In fact it caused the prediction rate to be wrong by more than 200%.
Those in charge were unapologetic and did not take responsibility for their
actions. Instead they claimed they were just unlucky and never could have foreseen
the housing bubble. They continued to blame external forces never truly taking
accountability for what they had caused. In essence they just passed the debt
around and spread it out more so that they could continue to reap the benefits
of being a big corporate laborer. They made assumptions using faulty world
models and instead blamed the fallout on a faulty world.
This goes to show
that Wall Street workers may not necessarily commit what is defined as
white-collar crime, but they do take actions that have larger repercussions on
the public and so they must be held accountable. There will always be greed in
the world just like there will always be those who believe business should be
left to itself and unregulated. However, something needs to change or else the
rich will continue to get richer by manipulating the system by creating these
entities that don’t really exist, and in the long run have huge fallout.
I agree with you and Silver that the financial crisis was largely caused by a failure to predict the possible repercussions of the growing housing bubble. Ratings agencies should have better taken into account the warning signs as many economists attempted to draw attention to.
ReplyDeleteExactly and they also should have done more research and obtained other opinions from outside economists and such before diving into this new idea.
DeleteI also agree with your argument that the rating agencies and corporate workers (like brokers) are the main reason for the recession. But, I think that they overall must have had some idea of the bubble they were creating. However, their morals were over-driven by their greed of more profit. I agree with Shiran's point that the economist's point should have been paid attention, in order to prevent the housing crash and economic recession that followed.
ReplyDeleteYasemin, I agree with your idea that the agencies had an idea of what was happening. As we learned through the video we watched in class, JP Morgan actually saw the monster that their synthetic CDO idea had become, and maybe this just makes things worse. If they knew and did not inform the government of the impending damage, or try to make reparations to a system which clearly wasn't working, maybe they could have alleviated the blow to the US economy in 2008.
DeleteEven though the rating agencies and corporate workers may have known that they were creating a bubble I believe they thought that their newly created system was one that was going to keep the boom going. This was obviously not the situation because whenever the housing market goes up it must come down which was devastating to the US economy in 2008.
DeleteYour point that gambling is always taken too far because people don't know when to quit really captures the actions of the bankers. They obviously knew that what they were doing was fraud but because it was making profit at the time, the risk did not matter. You have to wonder how these banks did not think that the system was going to fail when it was based on a fraud system.
ReplyDeleteI completely agree with you that the people in the system wanted nothing but money and they did not stop until they got what they wanted which also happened to lead to a huge collapse of our economic system. As Amanda said your gambling analogy fits perfectly into the situation because that is what they did and they all knew that at some point they were bound to roll snake eyes but they did it anyway.
ReplyDelete