Guest: Well, they just look at pieces of the data and the fact that the housing market collapsed is taken to be the cause; but the housing market could collapse for other reasons. People don't just decide that prices aren't high any more. They have to look at supply and demand somewhere in the background.
Russ: We did have people holding second and third homes who didn't have the income and capability of repaying the first one.
Guest: Sure. Standards were relaxed. But then you have to look on the supply side, the lending side. The people who were lending to these people had the information.
Russ: Yes, they knew it. I don't think that they were fooled. They were not overly optimistic about the value of those loans. They were willing to do that because they could sell them.
Guest: The puzzle is why they were able to sell them.
Russ: Correct. Now my claim is the people who bought them did it with largely borrowed money.
Guest: No, that's not true. These were bought by people all over the world.
Guest: No one borrowed money. Remember now: savings has to equal lending. For everyone that's short bonds, somebody is on the other side. The net amount of leverage in the world is always zero.
Russ: That's true.
Guest: So you can't tell a story based on leverage.
Russ: So what's your story? I have to think that through. It's undeniably true, and I'm not going to argue with that point. So, what's your explanation of why people bought these things?
Guest: Well, I have no explanation. Again, I'd say the market crashes because of the big recession. Even a minor depression if you like. Remember that all the people buying these subprime mortgages all over the world, they are the ones making the loans in the end, they were sophisticated investors. Institutions, big banks all over the world. They thought these things were appropriately priced. They might have been at that time, but they weren't ex post.
Friday, February 3, 2012
FLG found this interview with Eugene Fama very fascinating. He claims there wasn't a housing bubble, but rather the recession caused the housing price collapse. FLG feels Fama is wrong, but cannot figure out how he is. He's obviously right that net leverage always equals zero, but in our global markets that means worldwide net leverage is zero, not that leverage isn't a problem in particular markets or in particular institutions. But for that to be true there has to be some relaxation of market efficiency assumptions, for example, some sort of information asymmetry between American banks issuing mortgage-backed securities and the foreign banks and investors who were buying them.