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this podcast is brought to you by
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knowledge at Warton please visit
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knowledge. won. up.edu for more
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information days before the government
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stepped in to rescue Fanny May and
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Freddy Mack knowledge at Wharton chatted
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with Mark xandy the chief Economist and
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co-founder of what is now Moody
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economy.com about his new book Financial
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shock a 360° look at the subprime
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mortgage explosion and how to avoid the
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next financial crisis Mark xandi Chief
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Economist and founder of Moody
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economy.com has a new book about the
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subprime mortgage crisis Financial shock
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knowledge at Wharton talked to zandi
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about his findings today's economic
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conditions and what should be done to
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get out of this crisis and avoid another
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welcome Mr xandy it's good to be here
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the uh subprime crisis is one of those
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things that has unfolded peace meal and
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has taken over a year and a half and
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some elements of it started much earlier
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and now we have have your book uh which
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puts it all into one place and describes
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it all and provides a lot of uh
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additional data and insight that we
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haven't had before and I'm curious that
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in in researching this book what you ran
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across that really surprised you beyond
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what you knew from having followed the
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whole story as it was unfolding right
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well uh many things surprised me but uh
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the most fundamental level was the just
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how egregious the The Lending had become
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at the peak of the housing boom it
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wasn't just simply uh making loans to
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people with low credit scores it was
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making loans to people with low credit
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scores with uh no down payment or down
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payment assistance with no proof of uh
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income uh and uh just enormous amount of
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risk layering that was going on you know
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I had a sense that obviously
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underwriting standards in the mortgage
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industry had fallen I had no concept to
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what degree they had declined and that
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that's a bit Sur Ur rising to me because
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many of my uh clients are in the
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industry uh they're mortgage companies
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uh mortgage insurance companies The
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Fanny May and Freddy Max of the world
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and I thought I had a pretty good
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understanding I thought it was bad but I
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I had no understanding of how bad it
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really was and this refers to things
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like the no do loans or liar loans as
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people came to call them and the 100%
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mortgages and know there sort of eroding
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of underwriting standards that were
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supposed to be the the safety net that
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kept these things from collapsing yeah
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exactly I mean if you go back early in
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the housing boom say 2004 um maybe early
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05 uh the extent of the lending was uh
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aggressive lending was just giving loans
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to people who had problems making
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payments on other kinds of credit bad
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credit scores uh but the lenders would
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require a pretty sizable down payment
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and certainly proof of income uh and a
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stable job by the end of 2005 and into
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2006 all of that had just evaporated and
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lenders weren't checking anything uh
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they weren't uh weren't even doing
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appraisals on the property so uh it was
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uh really the Wild Wild West uh to a
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degree I I did not know and could not
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have imagined just to go back a second
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one of the one of the things that
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happened in the in the buildup to all of
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this was that that you mention in the
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book in some detail that other people
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have talked about is this period when
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risk was seemed non-existent and and
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that risky Securities like uh junk bonds
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and Emerging Market debt and some of
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these mortgage back Securities we're
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we're trading at prices that offered
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yields that provided almost no risk
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premium at all and and apparently that
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was a mispricing that we now know that
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they were much riskier than people
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thought the two questions which is what
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caused people to be so sanguin about
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risk and where do we stand now are we
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are we overestimating risk have we
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gotten too nous Serv or uh is it just
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impossible to tell what risks are well
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in part uh there was a fundamental
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reason for this optimism and that it
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goes to the global economy itself uh the
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ups and downs in the economy seem to be
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moderating was called the Great
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moderation and there's some good reasons
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to believe that our economies are more
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stable than in the past and so if you
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have a more stable economy then uh it
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makes uh risk premiums for financial
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securities uh make there logical to
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expect that they would come in and
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wouldn't be quite as wide you're just
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not going to have big recessions and big
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bankruptcies and lots of credit problem
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so you don't need as much of a risk
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premum so there I think is a good sort
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of fundamental explanation for it but I
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think they got carried to an extreme uh
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and people started in a sense
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forecasting with a ruler and you know uh
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most forecasting is done that way if the
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price of something's going like this
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it'll keep going like that Prices rose
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last year by 10% and they Rose 10% the
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year before that what do you think the
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price increase is going to be next year
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10% right and so you start building that
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into your forecasting and and uh you
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tend to take more risk uh in response
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the third thing is there was just a lot
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of of U of liquidity a lot of cash you
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can remember uh liquidity raining
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everywhere and there's a lot of
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discussion as to you know what drove
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that uh part of it was very aggressive
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monetary easing back earlier in the
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decade uh it was also related to the
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fact that we have this very large
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current account trade deficit so we're
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pumping out dollars buying goods
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produced overseas and that's putting
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dollars out there to be invested uh and
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that provided a lot of liquidity and so
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money managers investors uh had lots of
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cash lots of liquidity and they have to
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put that to work uh they just simply
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can't uh put it on the sidelines and
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wait for something bad to happen
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they could do that maybe for a year but
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if in that year Prices rose 10% they
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can't do that in year two because no one
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will invest with them they're saying
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what the heck are you doing I gave you
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my money to make to put it to invest it
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in whatever it is you do and now you're
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not doing that so inv the the
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professional money managers the the
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folks that were taking these these
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Global investor dollars and and
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funneling it through these these these
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these Investments really felt like they
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had no choice they actually felt
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uncomfortable have many money managers
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as client they they just knew that this
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wasn't right but it didn't feel right
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you know you go to conferences and
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everyone's hand ringing that this this
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doesn't make sense but that doesn't
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matter because I've got cash to invest
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and I'm going to I'm G to have to invest
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it and so they were they were they were
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willing to accept uh a a infinitesimal
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risk premium for buying Emerging Market
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one asset class to the next right I mean
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you you you look for first thing you got
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a ripple effect yeah because you know
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you buy one asset the risk premiums come
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in then you go okay well this asset has
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a higher risk premium so let me go
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invest in that that risk premium comes
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in and then you know at the peak you
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know going back to 2006 end of 2006
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early 2007 right before the financial
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shock risk premiums on everything junk
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corporate bonds uh mortgage back
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Securities uh commercial mortgage back
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Securities uh uh uh investments in in
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direct investments in property
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everything all the wrist spreads were as
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narrow as they have ever been it seems
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to me that a lot of people in this
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circumstance would kind of you know draw
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the line at what went wrong here as the
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the the innocent bystanders who was hurt
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all of us who did not take out crazy
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mortgages and see our home prices fall
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or see our stocks fall that sort of
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thing so what you know where sort of
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along that Continuum you know would
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would the should the proper amount of
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Regulation be what should its goal be
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just to protect the innocent or to to
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guide the markets more in in a in a
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deliberate fashion in a certain
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direction well you know my view is that
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it's important to set down some basic
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rules that uh that uh you need certain
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levels of capital and these are the ways
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you measure capital and these Capital
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levels need to be uh uh equivalent
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across all financial institutions that
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the entire credit risk in the financial
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system is at least being monitored so
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that everyone can see it and we have
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something palpable that we can measure
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and have an understanding of well is the
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risk level of risk Rising is the level
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risk falling we need to have rules that
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increase transparency we talked about
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transparency in in the trading of
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Securities but also in terms of the
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balance sheets of the institutions that
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are in our financial system so you know
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I think it's it's it's not saying that
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this is a bad mortgage loan or this is a
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good credit card loan or there's some
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basic things we might want to lay out
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with regard to that like don't make a
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mortgage loan to someone you don't think
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who can repay you that makes sense sense
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to me but it's pretty basic but it's not
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it's not as much that as it is you know
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sort of the basic rules of the game and
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have a regulator that can sort of watch
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over the entire system as opposed to
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just a part of the system and a better
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sense of knowing what's going on and
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just having the information I mean I'll
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to end it this way we still don't know
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really don't know how many people are
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being forclosed on no one knows and
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that's not the fod of good policymaking
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well let's come back next here and talk
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about it again I would appreciate it
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thanks for the opportunity thank you
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very much and good luck with the book
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Thank
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you for more information please visit
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knowledge. won. up.edu
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