Securitization's Role in the Financial Crisis: Part 1

Editor's note: Parts 2 and 3 will be published this Saturday and Sunday.

I think we need to understand how this market evolved over the years -- because if we don't understand how we got here, we will run the risk of jumping to conclusions based on faulty assumptions. In a way, a market based on assumptions that proved to be vastly incorrect eerily foreshadows the dangers of our policy response. I will warn up front, that while I will try to simplify, this may be a little dense. This is not something that can be easily encapsulated into a sound bite or "Tweet," but only through understanding can we properly evaluate the situation. You will not need a PhD in Calculus to get through this; simple multiplication is fine, but I will make a few options market allusions. Part of the reason, I think, people have trouble explaining the root of the financial crisis is that this took the last couple of decades to develop. We kept building on what we took for Gospel. And as I mentioned in one of my previous articles which encompassed the Hayek quote, sometimes we need to look at the very bedrock of our assumptions--those views which we took for granted, that couldn't possibly be wrong. When you are in the weeds, often you forget to look at how you got there. So sometimes it is difficult for a market-maker to describe their role because they are on the battlefield. This is why I think some of the traders at the Senate hearing couldn't say, "No my role isn't as fiduciary, I serve my clients by making markets for my clients so that they can best execute THEIR role as fiduciary." The last systemic financial crisis we had was with the S&Ls in the late 80's. Of course this is subject to debate, because we have had the peso crisis, the Asian flu, the Russia crisis, the tech bubble, etc., since then, but the S&L crisis was the last real systemic crisis we had. If you think about the parallels, they seem like a replay: lax regulatory oversight led to excessive risk taking, we had real estate slumps both residential and commercial, certain key industries were in secular decline (then it was defense, now it is real estate tangential), large U.S. financial institutions failed and the financial plumbing underwent restructure. Of course there are some differences (rapidity of response, interest rates, global coordination), but I am sticking to the similarities because they are so striking.   Loading Comments...   1 2 3 4 5 6 Last » Next ›

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