The New York Times has a story on “Paralysis in the Debt Markets” which says, basically, that credit has dried up because of lack of demand for asset-backed securities. In English, that means that since no one wants to invest in securities that are made out of home mortgages, the people who originate mortgages have no place to sell the mortgages to, so they don’t have any money to lend. And this is also true of commercial real estate, student loans, and so on. For example, “A once-thriving private market in securities backed by home mortgages has collapsed, from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year.”
The response of the Fed has been to prop up the securitization market by buying the stuff itself when no one else will buy it. But that program is reaching its provisional limit — according to the times, the Fed has bought $905 billion out of a budget $1.25 trillion in securities — and with the Fed hawks on the warpath, it is likely to be pulled before the private market recovers.
I wasn’t planning to write about this weekend’s New York Times article about the securitization of life settlements after reading Felix Salmon’s post saying there was no new news there. But I was thinking about it some more and thought it was an interesting concept, whether or not it gets off the ground.
Life settlements already exist. The idea is that someone has a whole life insurance policy with a death benefit of, say, $1 million. The insured bought it when he was 35 and had two kids; now he’s 70, the kids are working on Wall Street and don’t need the death benefit, but they’ve cut him off and he needs some cash to fill the prescription drug donut hole and pay his Medicare co-pays. The insurance company will give him a cash settlement value of, say, $100,000. I don’t know what this actual number is, but the key point is that it is less than $1 million at the insured’s expected date of death, discounted back to the present (let’s call that the current actuarial value of the policy). In a life settlement, an investor pays the insured a lump sum that is greater than $100,000 – say, $200,000 – and makes the premium payments (if any are left to be made) on his behalf; in return, the investor becomes the beneficiary on the policy. Again, this already happens, although there are concerns about churning, misrepresentation, the whole deal.
JPMorgan Chase has a “community support” page entitled “The Way Forward.” It features a report by JPMorgan executive Michael Cembalest on the credit crisis called “The Big Dig,” which tries to argue that bank lending has actually increased during the credit crisis. Many more accomplished people than I have debunked this myth in the past, but I couldn’t let this pass.
Here’s the main claim: “Changes in credit are often thought to have been wrought by banks. But a simple exercise in forensics reveals that not to be the case: the rise and fall of securitized loan markets have a much larger impact. Bank lending has remained stable throughout, while securitized markets collapsed.”
in credit are often thought to have been
wrought by banks. But a simple exercise in
forensics reveals that not to be the case: the rise
and fall of securitized loan markets have a much
larger impact. Bank lending has remained stable
throughout, while securitized markets collapsed.
And here’s the evidence:
For a complete list of Beginners posts, see Financial Crisis for Beginners.
This is more of an advanced beginners topic – I already covered CDOs (collateralized debt obligations) in my first Beginners article – but I imagine that most of our readers are already familiar with structured products. At least, many people know that first a bunch of securities are pooled together, and then they are “sliced and diced,” in the common media parlance I find incredibly annoying. But Joshua Coval, Jakub Jurek, and Erik Stafford have a new paper, “The Economics of Structured Finance,” which does a brilliantly clear job of describing what these securities are and why they were so widely misunderstood, with the results we all know.
The paper is 27 pages long, not counting references, tables, and figures, and if you are comfortable with probabilities and follow it carefully you can understand everything in it. I will provide a summary to whet your appetite. I am not going to use numerical examples because the examples they use throughout their paper are so good.