Comments on: Do information asymmetries explain the housing bubble? A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: tariqscherer Fri, 03 Sep 2010 07:32:19 +0000 Surprise, surprise, Information Asymmetry strikes again. But how can we avoid this from adding to systemic risk – indeed, aren’t markets through their diversified channels and means of ongoing price discovery assist in overcoming this disconnections?

Maybe it was the reality that these PLS were stand alone securities that were not traceable and accountable throughout the market both at the end-point in the securitisation process but also in their initial supply.

A solution might be to ensure that some level of market coherence is set in – ie an open marketplace that will identify buyers and and issuers of the securities ensuring that reputation and branding becomes associated with the price discovery process. This should avoid the incentive to purposely ‘game’ the system with an ongoing engagement of the market ensuring a positive incentive to participate openly and efficiently.

I am not saying, for as much, that these securities need be exchange traded automatically – certainly we have many forms of financial arrangements where reputation is engaged without accessing through the strictures of a strict central clearing exchange, eg. credit facilities and credit records – but to skip the whole accountability process entirely is evidently too risky.

Hopefully self regulation will prime in this above externally enforced rules, certainly from a buyer/securitiser’s point of view, the benefits of adequate traceability and fungibility of these securities is paramount for their operations. Another side benefit of self-regulation would be to ensure that compliance costs are properly internalised to the primary beneficiaries rather than redistributed on to other market by-standers who might not be trying to gain exposure, financial or regulatory wise, to the housing market.

TS  /

By: hsvkitty Fri, 03 Sep 2010 03:13:11 +0000 Good stuff Mr. bender. Was that mother Goose?

By: Greycap Thu, 02 Sep 2010 14:48:25 +0000 What AABender1 said.

To which I might add that this question of information asymmetry is hardly unexplored territory. There is a good survey of the literature here: umn09/paligorova.pdf. There is a very accessible blog post on the subject here: http://newyorksocietyofsecurityanalysts. -deadly-frictions-of-subprime-mortgage-c redit-securitization.html.

If you are going to focus on just one issue, I think that agency conflicts are more significant than information. Many agents have incentive to disregard their lack of information. This was recognized quite early on, e.g.:  /Resources/KaneCaprioDemirgucKunt-The20 07Meltdown.pdf.

Finally, first-loss was widely presumed to be the remedy to agency conflict both before and after the crisis. But Hartman-Glaser et al have an interesting argument that the timing of payments to the servicer is more important than the first loss position: ure/upload/2010_3.42582E+08_PA_OSMH.pdf. Others have noted that first-loss is unlikely to be effective when the first-profit position is actually larger (sorry, can’t recall the authors or paper to mind.)

By: Curmudgeon Thu, 02 Sep 2010 13:22:57 +0000 It seems to me that a lot of bubble behavior is psychology-driven, so let me offer this hypothesis. Buying a home is something that the vast majority of people do perhaps three or four times in their lives. They rely on outside source of information as a guide, and realtors and agents are highly biased sources of that information. So they hear that they have to buy sooner or later, before prices increase, while the house or neighborhood are still available, and so one.

Throughout the bursting of the bubble, we are still hearing the real estate people saying that it’s the perfect time to buy. The combination of expertise and bias, coupled by any information to the contrary, is what drives bubbles such as this.

By: AABender1 Thu, 02 Sep 2010 10:43:49 +0000 Right on point.

While interesting, Levitan and Wachter maybe showing some unfortunate “focusing effect.”

The U.S. housing bubble dissipated too much net worth, spread way too far, and involved such an ensemble cast that it can’t be reduced to a game of Clue in which “the butler did it in the Conservatory with the candlestick.” The housing bubble had more similarities to say, “Murder on the Orient Express”–everyone did it. Well, maybe everyone’s cognitive biases did it.

Of course, Levitan and Wachter are right. There are information asymmetries at each level of the mortgage production process and in PLS creation and sales: Homeowners know more about their particular house than brokers do. Brokers know more about the borrower and his house than bankers do. Bankers know more about it than CDO packagers, packagers know more than PLS buyers, etc.

But the fascinating (and horrifying) aspect of the U.S. housing bubble is that it destroyed a significant amount of the U.S. private sector’s main nest egg–home equity–while preying on a bevy of known cognitive biases, e.g. interloper effects (rating agencies), status quo bias (regulatory agencies, CDO buyers), availability cascade (home buyers), and Dunning-Kruger effects (regulators, rating agencies, and almost everybody now with negative equity), just to name a few.

What is more interesting is how we avoid a similar debacle the next time. Levitan and Wachter’s prescription would be to fix the information asymmetries of PLS, which may be a necessary but is not a sufficient condition for a fix.

Regions in the U.S. that fared better had legal, regulatory, or transaction restraints on home mortgages (like state consumer laws or NYC co-op boards). Regions that had stricter rules on second homes and investment homes tended to fare better. States whose economies had a proportionately smaller reliance on real estate and construction fared better. All of this reduced irrational decision-making in those places.

And the differential effect is clearly evident in the FDIC’s most recent quarterly report (June 2010). Home loan delinquencies (as a % of total home loans) in the FDIC Atlanta region reached 12.19% versus 4.71% in the New York region.

On the other hand, the regulatory authorities, in particular the Fed, let everyone’s cognitive bias run wild. Or better said, they refused to believe that such irrationality could exist. Hence, low interest rates created lower carrying costs which certainly goosed the demand for homes. At the same time, the Fed decided not to enforce HOEPA (1994) which accelerated the mortgage origination “corruption multiplier” (i.e. “anyone breathing could get a mortgage”) in non-bank mortgage originators. Non-bank mortgage practices later spread to banks and to the GSEs in their attempt to compete with new non-bank, corrupt product.

We can only hope that the Fed’s new, broader mantle of oversight is assumed with all of these causal factors in mind.

By: GingerYellow Thu, 02 Sep 2010 09:20:47 +0000 “I suspect that doing so would be hard, in which case it’s not that silly to assume that the causes of the US housing bubble overlapped with the causes of the housing bubbles in countries like the UK, Ireland, Spain, Australia, and even South Africa.”

The three largest mortgage securitisation markets in the world? The US, the UK and Australia. Also the only three countries with subprime mortgage securitisation markets of any significant size. Spain was also in the top 5 private label mortgage securitisation markets globally, and while Ireland’s market was small, so is its economy. South Africa’s RMBS market started when the boom started. Now I’d be the first to say securitisation wasn’t the only factor in the bubbles (there’s a reason why so many of the most affected countries are former British colonies and hence common law jurisdictions), but it was certainly a strong contributor.

Subprime is something of a red herring, except that it exposed the fundamental weaknesses of the securitisation model in such a stark way and ensured that when the bubble burst it would be particularly bad. The fundamental issue was massive, often hidden leverage with risks recirculated within the system rather than dispersed, abetted by securitisation in many forms.

By: OnTheTimes Thu, 02 Sep 2010 07:02:25 +0000 There was no housing bubble, at least not nationally. A handful of areas (FL, AZ, Las Vegas, and parts of CA) had bubbles where way too much housing was built because speculators had easy access to cheap debt, and thought prices would only go up. In the rest of the nation, purchase prices went up only because interest rates went down and rules were eliminated. And while purchase prices went up, the cost of owning didn’t, because interest rates were lower. If rates were lowered today, and the rules reset to 2003 (where anybody who was breathing could get a mortgage), prices would rise again, because the monthly payments would decrease.

If you want to talk about bubbles, talk about the debt bubble. That was real, and everywhere.

By: clausvistesen Thu, 02 Sep 2010 06:34:30 +0000 Right Felix, I agree that monocausal explanations here are not the way to go, but after having read the first half of M. Lewis’ The Big Short, it does smell as if there was a huge information asymmetry on Wall Street itself in terms of what the respective players were really getting into.