Collateralized Debt Obligations

[koganbot]

"Repackaging dubious loans into collateralized debt obligations creates a lot of perfectly safe, AAA assets that will never go bad."

The sentence is from Paul Krugman's column in today's NY Times. He's using it as an example of sophistry (which his dictionary defines as "a deliberately invalid argument displaying ingenuity in reasoning in the hope of deceiving someone"), though I'd think that putting the word "dubious" into the sentence makes it not sophistic. (The first half of Krugman's sentence describes what investment funds actually did, not what they said they were doing, right? So no one ever actually made the argument. Or did someone?)

But anyway, if I understood that sentence I'd understand how we got into the current financial situation (recession believed to be looming, is possibly here already), but I don't know enough about either economics or Wall Street to understand that sentence.

I know what "collateral" means (a car, house, etc. that backs up a debt, so that if the debtor can't pay, the lender gets to take possession of the car, house, etc.). And I know that AAA means that the asset is rated highly (considered "reliable and stable" by a credit rating company such as Standard & Poor's). But I don't know how you get from "dubious loans" - i.e., mortgages at onerous terms given to unwary home buyers whom one could not reasonably assume would be able to pay off the mortgages or understand what they were getting into - to "collateralized debt obligations" and then to "AAA assets." Which is to say I don't know what happened, or what the assets were. I gather that the cautious responsible investors who purchased (?) the "AAA assets" were, in effect, investing in the risky subprime mortgages without being told that this was what they were investing in. (Is that right?) So it's not just the homeowners who took out the subprime mortgages who are struggling for cash and therefore not spending, but also a bunch of solid citizen investors, hence a lot of people and firms are scrapping for money rather than spending or investing it. (Right?) This tends to depress an economy.

So, anyway, what happened?

(By the way, Krugman's really good, even if he doesn't always have the space to explain everything. I read his blog whenever I get the chance.)

Comments

Re: BANKING AND BUBBLES IV

[dickmalone.livejournal.com]

But metals aren't intrinsicly worth anything either, are they? If people decide that they have no real need for gold then you couldn't use it to get useful material goods and the whole thing would collapse on that level too. The moment economics stopped being about bartering cows for grain, we reached a level of fundamental abstraction, right? The idea behind metals seems to be that we all agree that they're worth something, and that's the point we've gotten to with paper money too--there's a limited supply of it, people will give you food in exchange for it, and it seems "precious." The system hasn't really collapsed-collapsed at any point in the Western countries (there are depressions, yes, but people don't suddenly stop valuing paper money as a whole--of course this has happened in third-world countries but that seems outside of our current discussion).

So while I think it's interesting to think about the value of non-sober banking, I don't know if speaking of all banking as bubble is necessarily helpful. When people were warning of a housing bubble before the current crisis, they weren't arguing that eventually those houses would not be exchangable for gold, they were arguing that people were being enticed by artifically (i.e., non-transparently) created short-term gain to engage in an activity that would result in a net loss, plus all the concomitant social problems that would entail (i.e. since it would look like a good investment people's retirement funds would be tied up in it, that new home buyers would be forced to get these risky mortgages because the price of new homes had risen so high, etc.). Bubbles aren't a site of unreal value--you're right in saying that almost everything is a site of unreal value given our current setup--but are things that pop. The reason we can't be sure a bubble was a bubble is that bubbles have to pop. If housing prices just slowed down in their growth a bit everything would've been fine (-ish), but the predatory lending practices and shady investment strategies caused people to suddenly think they had no idea how much these things were worth.

I do think that things are much more stable now than they ever have been--certainly bad things still happen, but there a ton more controls in place and the current crisis isn't the result of some fundamental flaw in the system but retarded supply-siders not listening to legitimate calls for regulation. That said, one of the reasons I am somewhat gloomy about the likely prospect of a Democrat for president is that there are three giant messes they will have to clean up. Not just Iraq, but two huge problems the administration has been totally ignoring: the environment (where they're being outpaced by the states, who have now gone so far as to take the federal government to court over its refusal to enforce environmental regulations) and the defecit. A lot of the (perceived) weakness of the US economy comes from the weakness of the dollar, and (as I understand it) the weakness of the dollar stems in large part from our ginormous national debt. Foreign investors look at our debt, doubt our fiscal stability, and value the dollar down. So the next president is going to have to do something the GOP hasn't been willing to do since it got into power, ironically: cut spending. They're also going to have to eliminate tax cuts and, probably, raise social security taxes, none of which is going to be popular but all of which is absolutely necessary for the continued health of the US economy and the value of the dollar. (This is one of the reasons I'm so big on Obama--dude can make shit sound like Shinola, whereas Hillary makes you suspect that maybe cake is not so delicious after all. But she's still gonna win. Sigh.)

no future no future no future for we

[dubdobdee.livejournal.com]

"But metals aren't intrinsicly worth anything either, are they?" er no -- i didn't mean to suggest goldbugs are right; stable monetised value has always been a product of a (sustained) collective act of imagination

"I do think that things are much more stable now than they ever have been" -- but ARE they? ok, so the old-skool sober official defn of a bubble just revealed itself (tho not yet its scale) by bursting (it's ALREADY a pretty big deal, with a lot more to surface)

but much bigger (value) bubbles also sometimes burst: WW1, for example -- total collapse of european stability and order, unthinkable after the longest period of stable peace since euro-records began; there and unstoppable not quite overnight, but VERY quickly -- ie months rather than years... the gruelling assumption, thorugh the next quarter century, was that the old guard (the 19th century euro-empires that remained standing) could right themselves, rebuild shattered confidences in themselves (their own and the world's) and set something workable up again... this is totally not what happened