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Politics : American Presidential Politics and foreign affairs -- Ignore unavailable to you. Want to Upgrade?

To: TimF who wrote (39732)	12/18/2009 1:36:30 PM
From: DuckTapeSunroof	Read Replies (1) \| Respond to of 71588

Re: "An FDIC document on the risk weights of different bank assets. The higher the weight, the more capital the bank has to hold against that asset. As I read table 1 and table 3, if you originate a loan with a down payment of 20 to 40 percent, the risk weight is 35. But if you buy a AA-rated security, the risk weight is only...." Ah, I thought that was probably what you were talking about. Well, that is simply the mathematical principle that UNDERLIES the entire field of securitization of loans! The principle lies at the heart of Modern Portfolio Theory! The principle that the very PROCESS of securitizing large bundles of heterogeneous loans, (in which process you mix together a large number of loans from geographically disperse locations... which are PRESUMED, because they come from different markets all across the nation or even the world, to have lesser degrees of correlation to each other then they would if they all came from, for example, just one city), itself creates a 'safer' portfolio, which can be assigned a higher credit rating and sold for more money then was possible before these loans from different geographic markets were mixed and melded into a new product. So, I think that you are assuming that it is the 'tail' wagging the 'dog' here, (one lone federal agency 'responsible' for this entire concept, and the capital markets acceptance of it, and all the problems that then came crashing down)... when IN FACT it was Wall Street (and, indeed, capital markets ALL AROUND the WORLD) that moved to apply these basic principles of Modern Portfolio Theory once the Nobel Prize was granted for M.P.T., and innovating Wall Street and London and Tokyo and firms demonstrated how very much more profitable their operations could become through mass securitization operations.... And the big depositor banks learned how much more profits they could generate through ramping-up the leverage on their capital bases (once Congress allowed them to in the 'nineties), and selling the loans quickly off of their books to Wall Street I-Banks for securitization... enabling them - with increased leverage - to make ever more loans, and grow ever much faster. And... the FUNDAMENTAL PRINCIPLE of M.P.T. (lower volitility through diversification of assets, in this case mostly geographic diversification) HELD TRUE and payed it's promised higher returns for year-after-year! Up until the one big "long-tailed" event inevitably came along.... Until the "Black Swan" that the theory had failed to properly account for in it's mathematical risk models made it's big appearance. Until ALL THE MARKETS around the world started acting as one, and all that vaunted 'difference in correlations' VANISHED in a poof of smoke as all the assets started converging in their performances and most all the correlations numbers started converging.... And the house of cards came a 'tumbling down.... The economic Brainaics on Wall Street got it wrong. (And the piss-poor 'regulators' were mostly just around for the ride....)