Editor's note: This is Part 1 of a special series. Here are Part 2 and Part 3
NEW YORK (
) -- Today I want to get into the weeds a bit on the securitization market. All through the crisis we kept hearing how we needed to "get the securitization engine humming again" in order to get credit flowing, but I am not sure if people fully understood the role of securitization in the crisis.
I think we need to understand how this market evolved over the years -- because if we don't understand how we got here, we will run the risk of jumping to conclusions based on faulty assumptions. In a way, a market based on assumptions that proved to be vastly incorrect eerily foreshadows the dangers of our policy response.
I will warn up front that while I will try to simplify, this may be a little dense. This is not something that can be easily encapsulated into a sound bite or "Tweet," but only through understanding can we properly evaluate the situation. You will not need a PhD in calculus to get through this; simple multiplication is fine, but I will make a few options market allusions.
Part of the reason people have trouble explaining the root of the financial crisis is that this took the last couple of decades to develop. We kept building on what we took for gospel. And as I mentioned in one of my previous articles which encompassed the Hayek quote, sometimes we need to look at the very bedrock of our assumptions -- those views which we took for granted, that couldn't possibly be wrong. When you are in the weeds, often you forget to look at how you got there. So sometimes it is difficult for a market-maker to describe his or her role because the market-maker is on the battlefield. This is why I think some of the traders at the Senate hearing couldn't say, "No my role isn't as fiduciary, I serve my clients by making markets for my clients so that they can best execute
role as fiduciary."
The last systemic financial crisis we had was with the saving and loans in the late '80s. Of course this is subject to debate, because we have had the peso crisis, the Asian flu, the Russia crisis and the tech bubble since then. But the S&L crisis was the last real systemic crisis we had. If you think about the parallels, it seems like our recent crisis was a replay of the S&L crisis: Lax regulatory oversight led to excessive risk taking, we had real estate slumps both residential and commercial, certain key industries were in secular decline (then it was defense, now it is real estate tangential), large U.S. financial institutions failed and the financial plumbing underwent restructuring. Of course there are some differences (rapidity of response, interest rates, global coordination), but I am sticking to the similarities because they are so striking.