Bigtime. Summers is a key proponent of the financial practices that led to the 2007 financial crisis.
>Summers oversaw passage of the Gramm-Leach-Bliley Act, which repealed Glass-Steagall ... He then oversaw passage of the Commodity Futures Modernization Act, which banned all regulation of derivatives
The vast majority of OTC derivatives was far less disruptive to the banking sector than your average vanilla home mortgage loan during the crisis.
An overwhelming majority of all the banks that failed during the crisis had zero OTC derivatives on their books, but plenty of average vanilla home mortgage loans.
Internal documents from the banks that did deal in more sophisticated financial products show that they had a good understanding of how these products exposed them to risks in the home mortgage market, they just didn't think that housing prices would fall that much.
Despite all this, people like to blame OTC derivatives for the crisis rather than overconfidence in the housing market.
>I'd be interested in some supporting documentation for your claim.
No offense, but it starts with having an understanding of what a derivative is and how they are used. There is nothing sinister about them in any fashion, nor were they the "cause" of anything. The mainstream, as usual, has it wrong.
At the base level, excessive risk was the problem, and because derivatives employ leverage, that risk is amplified.
I'm going to have to categorize that as being non-responsive.
Let's assume I know what a derivative is. We can go from there. The specific accusation made in the mainstream press was that by the time the instruments were sliced and diced a dozen times, risk was not made clearly visible to derivative purchasers, and that the buying and selling of derivatives got way ahead of the banks' ability to track the risk inside of them. At high leverages, it became such that being wrong by just a few percentage points could mean financial disaster. The guarantee that Freddie and Fannie made contributed to a general feeling that the market was mostly protected from huge systemic risks, when that wasn't the case at all.
Consider a plain vanilla housing package. Payoff = homeowner_payments.sum().
Now consider the least risky tranch of a CDO. Payoff = min(homeowner_payments.sum(), 0.7 x MAX_HOMEOWNER_PAYMENT).
Is it unclear that if homeowner_payments.sum() goes way down, you lose money? Of course not. For every derivative on the market, computing your gains/losses given a specific scenario is straightforward.
The only difficulty is computing the probability of each scenario, but derivatives don't change that calculation at all.
It's 180 degrees against the mainstream narrative because it is a ridiculous oversimplification of the crises and misleading in its claims about OTC derivatives. For a serious look into the complex causes of the crisis, I recommend Econned by Yves Smith [1].
My (weak) take on the crisis TL;DR:
Prolonged, low interest rates set by the Fed in the aftermath of the dotcom bubble led to investors looking for better returns outside of AAA bonds. With the introduction of CDOs, investors were given the option of purchasing AAA rated tranches that paid better rates than bonds. The interest in CDOs exploded, leading to weakening of lending standards allowing the housing boom to really take off. From there it gets much more complex, but ultimately the maths on CDOs didn't work out and everything came crashing down.
Why was there so much pressure to write absurd loans? Because the derivatives market was so lucrative. It's all connected. The housing bubble wouldn't have been what it was without all the extra money made available by people buying and repackaging mortgages.
Not really. OTC derivatives greatly contributed to what happened because it obscured who your counterparty was in a transaction. This is really important because as the world falls apart around you, you don't know if your OTC derivatives happen to be based indirectly and at least in part on some other failing financial institution. Multiply this by everyone you do business with and you have a complete dissolution of trust and ability to properly assess risk. Those institutions that failed and only had vanilla home mortgage loans failed because they themselves were the ones responsible for the irresponsible lending or because they got caught up by it at the end of the unraveling that destroyed enormous amounts of value.
There is no way that the markets would have fallen that far and that fast if most participants, and the rating agencies, had the capacity to accurately and directly determine how much risk they and their counterparties had.
I imagine that the complicitness of the rating agencies in the whole thing never would have even gotten so egregious if most institutions had vanilla instruments on their books that were straight forward to value. OTC derivatives made it very easy to hide finagling and create an environment where rating agencies feel comfortable playing the tit-for-tat game with banks because they thought no one would notice ethical transgressions among all the indirection of derivatives.
This is really important because as the world falls apart around you, you don't know if your OTC derivatives happen to be based indirectly and at least in part on some other failing financial institution.
This is simply incorrect. The cash flows involved in an OTC derivative are explicitly stated in the contract itself.
I imagine that the complicitness of the rating agencies in the whole thing never would have even gotten so egregious if most institutions had vanilla instruments on their books that were straight forward to value. OTC derivatives made it very easy to hide finagling...
You imagine incorrectly. Pricing most of these contracts is 8'th grade math given a specific scenario - fancy math comes into play only in estimating the probabilities of each scenario. In principle, the pricing formula is this:
price = P(housing goes down) x BIG LOSS + P(housing goes up) x MODERATE GAIN
That's the price, regardless of whether it's a straightforward vanilla mortgage or a fancy synthetic CDO.
The ratings agencies, banks and government all assigned a very low value to P(housing goes down). Using vanilla instruments doesn't change this basic calculation.
In OTC trading by definition you know who your counter party is since you called them on the phone or they called you. What you are really trying to say is that you had no idea whether they had an off setting contract or if they were taking the other side of your position directly. I am not sure the exchange system we have for derivatives now has made things any better.
I take issue with the connotation as you describe derivatives; they hide and obscure. They are a tool, nothing more.
Other than that, I agree. It was the lack of a central clearing house for the derivatives -which would have allowed issuers to determine counter party risks and price it properly -that was the failing. But that's a human error. There's no need whatsoever to blame the securities themselves.
The campaigning for federal reserve chairman has been unprecedented. President Obama I am sure promised Summers the position for some of the water he and Christina Romer carried; however, since President Obama signaled Bernanke's position will not be renewed, the sharks started to circle and we have the current situation.
I think opposition started with Scott Sumner in July. http://www.themoneyillusion.com/?p=22379
Very good news.
I expect to see the markets react tomorrow, ala balmer on a much greater scale.
Scott Sumner (http://www.themoneyillusion.com) and Nick Rowe (http://worthwhile.typepad.com/) have done an incredible job at helping me understand money and its role in the economy even though I have no training in economics. It's worth going back and reading their archives.
Janet Yellen might as well the the first woman Fed chairman. We have first-woman for pretty much everything else already, so this will be good. Next up, Hilary for President ;)
Both his apparent tolerance of corrupt self-dealing and his reckless investment philosophy should have disqualified Summers from ever holding any top governmental financial office, but I guess we should count ourselves fortunate that his intemperate sexist commentary, or something anyway, has disqualified him from holding any more top offices.
This was a political decision. Larry Summers is one of the sharpest and most productive economists around and would have been as qualified as any Fed Chairmen in history. However he has tended to speak his mind too freely for a job requiring the approval of our timid politicians. I'm sure they will find someone almost as good to fill the spot and he will be fine making millions on Wall St rather than helping formulate our monetary policy.
> However he has tended to speak his mind too freely for a job requiring the approval of our timid politicians.
Krugman thinks the problem with Summers would have been too much timidity: "Summers, on the other hand, while he often expresses unconventional views when not in office, has a strong tendency to revert to conventionality when in office." ... "So the apparent decision to appoint Summers is a strong anti-regime-shift signal on Obama’s part." (http://krugman.blogs.nytimes.com/2013/09/03/summers-the-shif...)
It's a political decision, but sometimes this is how the political process works best. For better or worse our political process pushes towards extreme edges during the primaries as candidates have to play to the base. Getting appointed officials through congressional approval forces the people actually doing the work to be closer to the center of the country's political thought.
34 comments
[ 2.4 ms ] story [ 21.3 ms ] thread>Summers oversaw passage of the Gramm-Leach-Bliley Act, which repealed Glass-Steagall ... He then oversaw passage of the Commodity Futures Modernization Act, which banned all regulation of derivatives
http://chronicle.com/article/Larry-Summersthe/124790/
An overwhelming majority of all the banks that failed during the crisis had zero OTC derivatives on their books, but plenty of average vanilla home mortgage loans.
Internal documents from the banks that did deal in more sophisticated financial products show that they had a good understanding of how these products exposed them to risks in the home mortgage market, they just didn't think that housing prices would fall that much.
Despite all this, people like to blame OTC derivatives for the crisis rather than overconfidence in the housing market.
Why is this?
I'm not trying to bait you or argue, but do you have any links? I'd be interested in some supporting documentation for your claim.
No offense, but it starts with having an understanding of what a derivative is and how they are used. There is nothing sinister about them in any fashion, nor were they the "cause" of anything. The mainstream, as usual, has it wrong.
At the base level, excessive risk was the problem, and because derivatives employ leverage, that risk is amplified.
Let's assume I know what a derivative is. We can go from there. The specific accusation made in the mainstream press was that by the time the instruments were sliced and diced a dozen times, risk was not made clearly visible to derivative purchasers, and that the buying and selling of derivatives got way ahead of the banks' ability to track the risk inside of them. At high leverages, it became such that being wrong by just a few percentage points could mean financial disaster. The guarantee that Freddie and Fannie made contributed to a general feeling that the market was mostly protected from huge systemic risks, when that wasn't the case at all.
Now consider the least risky tranch of a CDO. Payoff = min(homeowner_payments.sum(), 0.7 x MAX_HOMEOWNER_PAYMENT).
Is it unclear that if homeowner_payments.sum() goes way down, you lose money? Of course not. For every derivative on the market, computing your gains/losses given a specific scenario is straightforward.
The only difficulty is computing the probability of each scenario, but derivatives don't change that calculation at all.
My (weak) take on the crisis TL;DR:
Prolonged, low interest rates set by the Fed in the aftermath of the dotcom bubble led to investors looking for better returns outside of AAA bonds. With the introduction of CDOs, investors were given the option of purchasing AAA rated tranches that paid better rates than bonds. The interest in CDOs exploded, leading to weakening of lending standards allowing the housing boom to really take off. From there it gets much more complex, but ultimately the maths on CDOs didn't work out and everything came crashing down.
[1]http://www.amazon.com/gp/aw/d/0230114563
There is no way that the markets would have fallen that far and that fast if most participants, and the rating agencies, had the capacity to accurately and directly determine how much risk they and their counterparties had.
I imagine that the complicitness of the rating agencies in the whole thing never would have even gotten so egregious if most institutions had vanilla instruments on their books that were straight forward to value. OTC derivatives made it very easy to hide finagling and create an environment where rating agencies feel comfortable playing the tit-for-tat game with banks because they thought no one would notice ethical transgressions among all the indirection of derivatives.
This is simply incorrect. The cash flows involved in an OTC derivative are explicitly stated in the contract itself.
I imagine that the complicitness of the rating agencies in the whole thing never would have even gotten so egregious if most institutions had vanilla instruments on their books that were straight forward to value. OTC derivatives made it very easy to hide finagling...
You imagine incorrectly. Pricing most of these contracts is 8'th grade math given a specific scenario - fancy math comes into play only in estimating the probabilities of each scenario. In principle, the pricing formula is this:
That's the price, regardless of whether it's a straightforward vanilla mortgage or a fancy synthetic CDO. The ratings agencies, banks and government all assigned a very low value to P(housing goes down). Using vanilla instruments doesn't change this basic calculation.Other than that, I agree. It was the lack of a central clearing house for the derivatives -which would have allowed issuers to determine counter party risks and price it properly -that was the failing. But that's a human error. There's no need whatsoever to blame the securities themselves.
http://finviz.com/futures_charts.ashx?t=ES
http://www.businessinsider.com/el-erian-market-reaction-to-s...
http://www.slate.com/blogs/moneybox/2013/05/27/summers_for_f...
Ezra Klein's piece on gender that prompted the original "word" that Summers was going to be the nominee:
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/07/19/t...
Krugman pro-Yellen case before annoucement:
http://krugman.blogs.nytimes.com/2013/07/19/the-fed-successi...
Felix Salmon:
http://blogs.reuters.com/felix-salmon/2013/07/24/dont-send-s...
Wall Street:
http://www.huffingtonpost.com/2013/07/26/wall-street-yellen-...
Both his apparent tolerance of corrupt self-dealing and his reckless investment philosophy should have disqualified Summers from ever holding any top governmental financial office, but I guess we should count ourselves fortunate that his intemperate sexist commentary, or something anyway, has disqualified him from holding any more top offices.
Krugman thinks the problem with Summers would have been too much timidity: "Summers, on the other hand, while he often expresses unconventional views when not in office, has a strong tendency to revert to conventionality when in office." ... "So the apparent decision to appoint Summers is a strong anti-regime-shift signal on Obama’s part." (http://krugman.blogs.nytimes.com/2013/09/03/summers-the-shif...)