John At The Center

On 130/30 Funds, there no real magic:

Essentially you are leveraging up your bet on a manager’s ability to add value though taking on only a bit more market risk than with a regular fund. The tricky part is that the manager has to be quite good at both longs and shorts to make it work. And from the looks of it, not many managers have been able to add value in this strategy this year. Of the 18 leveraged net long (our phrase that encompasses 130/30 and 120/20 funds) funds only three are ahead of their category benchmark for the year to date.

Having leverage and 100% net long exposure is a tough place to be in a bear market.

http://news.morningstar.com/articlenet/article.aspx?id=261584

Robert Shiller wants to step back and talk about long-run considerations for policy. He is one of the leaders in what is now a consensus among economists that we need to reject the theory of economic policy that I call “Greenspanism.” Greenspanism is the doctrine that the Federal Reserve must make sure that consumer-price inflation stays low and that expectations of future consumer-price inflation stay low, but that otherwise should let the macroeconomy govern itself and if exuberance leads to an episode in which the economy is saying laissez les bon temps roulez, then laissez les bon temps roulez.

Nowadays there are few Greenspanists. Indeed, Alan Greenspan is no longer a Greenspanist.

Link

Covered bonds do help to resolve some of the difficulties associated with the originate-to-distribute model.  The on-balance-sheet nature of covered bonds means that the issuing banks are exposed to the credit quality of the underlying assets, a feature that better aligns the incentives of investors and mortgage lenders than does the originate-to-distribute model of mortgage securitization.  The cover pool assets are typically actively managed–non-performing assets are replaced with similar, but performing assets–ensuring that high-quality assets are in the cover pool at all times and providing a mechanism for loan modifications and workouts.  The structure used for such bonds tends to be fairly simple and transparent.  These features, together with the demonstrated success of covered bonds in other countries, make this approach attractive.  That said, given longstanding features of the U.S. system such as the prominent role of the Federal Home Loan Banks, covered bonds may remain an unattractive option to U.S. banks.

From his speech.  He actually offers three alternatives– privatization, covered bonds, and an even more publicly regulated GSE.

On the Future of Mortgage Finance in the United States

Chairman Ben Bernanke
Federal Reserve Board of Governors (via satellite)
Christina Romer, UC Berkeley, Moderator

You can follow his speech here.

Link to invited papers.  Includes:

Why are the Cycles in Homes and Consumer Durables So Similar?– Edward Leamer, UCLA leamer-homes-and-consumer-durables

Policies to deal with the implosion in the mortgage market – Rober Shiller, Yale shillerberkeleyconferenceversion04

House prices, interest rates, and the mortgage meltdown - Mayer and Hubbard, NBER and Columbia University mayer-bep-10-2008-v7

Subprime mortgages, foreclosures, and urban neighborhoods – Gerardi of Fed Reserve Bank of Atlanta and Paul Willen of Fed Reserve Bank of Boston willen

Three mortgage innovations for enhancing the American mortgage market and promoting financial stability – Diana Hancock and Wayne Passmore, Federal Reserve Board of Governors mortgage-innovationshancockpassmorewithfigures

Regulating the investment banks and GSEs – Dwight Jaffee, UC Berkeley jaffeeregulationoct23

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Original zip file is here:www.urbanpolicy.berkeley.edu/mortgagemeltdown.zip

Martin Leibowitz, managing director of research at Morgan Stanley, examined the risk and return characteristics of a hypothetical endowment model portfolio with a 40 per cent allocation to alternatives between 2003 and 2007. Although the portfolio outperformed a traditional one with 60 per cent in stocks and 40 per cent in bonds, he discovered that it did not materially reduce volatility. In fact, the performance of US equities explained 94 per cent of the endowment portfolio’s overall return.

http://www.ft.com/cms/s/0/40c40a0c-a484-11dd-8104-000077b07658.html

It wasn’t that the story was untrue; it was old. Growing global demand probably was the reason for the gradual rise in oil prices from $20 a barrel to $40 earlier in the decade, and even to $60 by mid-2005.

It was the moon shot to $147 that took on a life, and a litany, of its own. Emerging nations didn’t start gobbling up crude, coal and copper all of a sudden in the middle of 2007.

http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_baum&sid=aZ_wEtBdohjM

“Computers are deciding when to buy and when to sell. When the herd mentality gets automated, the stampede [in and out of markets] gets turbocharged.”

Some analysts argue that while algos do not produce volatility, they can amplify existing volatility considerably.

Overall an fascinating article and worth a read

http://www.ft.com/cms/s/0/c9814b98-a5e7-11dd-9d26-000077b07658.html

Some analysts consider Goldman’s relatively high leverage — a measure of assets to shareholder equity — to be a major factor behind the huge profits it has churned out in recent years.

http://dealbook.blogs.nytimes.com/2008/10/30/goldman-sees-no-limits-on-leverage-analyst-says/

Anthony Downs, Brookings Institution, Moderator

Panelists:

Robert Van Order, University of Michigan

Points to two things that created all this– rise in housing prices and underwriting.  Believes a lot of the fault was in moral hazard, because variable like Fico score don’t explain alot of what happened.

Views the primary culprit as subprime securitization.  There was a big surge in this after 2003.  The subordinated pieces were put into CDOs and it got very complicated.  Problems arise when you need to figure out what is behind all these securities.

Overall, was very pessimistic about agencies’ ability to do anything about this problem.

Susan Woodward, Sand Hill Econometrics

Sees value in fixing Freddie and Fannie and privatizing them after they are fixed.  They are very effective in lowering mortgage interest rates and introducing liquidity into the MBS markets.

John Weicher, Hudson Institute

Spoke mostly about HUD and FHA.

Susan Wachter, University of Pennsylvania

Thinks this is mostly a US problem, that started around 2003 with the rise of aggressive, non-traditional mortgages.  This increased liquidity.  Lots of bad loans were made and bad loans are not apparent when house prices are rising.  In fact, bad loans directly increased house prices.

Wasn’t apparent to her why investors were buying these things until she realized that AIG was insuring these through CDS.

Fannie and Freddie largely avoided this risky space and were not growing with the overall industry until they decided later on lower lending standards and participate.

Most interesting Q&A item was on transparency.  Some were surprised that less transparency would be a good thing at all.  Example was provided about bond rating process.  Because it is so transparent, it can be gamed by issuers of securities.