Mortgages of 100% 'were foolish'

[Patrick]

So sayeth the "Banking Minister" Lord Myners.

I seem to recall the same thing being said 17 years ago.

Oh - Get this..........

"The Tories said Mr Brown's regulatory system had allowed 125% deals. "

Pot, Kettle, Black! How dare they criticise anyone's handling of the economy when they have never had a clue themselves! Not to mention the fact that 125% mortgages suited them well enough when they wanted to bribe the electorate.

[Ben Becula]

100% mortgages are not a problem when house prices are increasing at a normal and acceptable rate, and if one can meet the repayments. They become a problem in a falling market, and when the holders have overstretched themselves in the first place. This may be a little trite, but I recall taking out my first mortgage many years ago. The B.S.were prepared to advance me a multiple of 3.5 times my salary, and this included my wifes income. To get that amount I had to produce wages slips from my employer for the past six months, and even then the adviser dealing with us stressed the importance of careful consideration, and of being cognizant of the fact that interest rates could well go up in the future.

Now THAT is really the only way to advance a large loan. The idea of an applicant being allowed to "self certificate" his income is too ludicrous for words, and the large amounts being sloshed around simply drove the market up to the recent ridiculous levels which are one of the main causes of the present credit crisis.

[Patrick]

Exactly the way we did it just five years ago. We also used our own bank - so in a way they were forearmed with the knowledge they needed - nevertheless their financial advisor came out and looked at our "evidence" himself. In a way it's also the Target Driven nature of modern business that's screwing things up too. Across the board of services. A bank or building society can make a profit without having to push limits all the time surely!?

[swl]

Just skimming the new issue of 'Wired' and this caught my eye:


'A year ago, it was hardly unthinkable that a math wizard like David X. Li might someday earn a Nobel Prize. After all, financial economists—even Wall Street quants—have received the Nobel in economics before, and Li's work on measuring risk has had more impact, more quickly, than previous Nobel Prize-winning contributions to the field. Today, though, as dazed bankers, politicians, regulators, and investors survey the wreckage of the biggest financial meltdown since the Great Depression, Li is probably thankful he still has a job in finance at all. Not that his achievement should be dismissed. He took a notoriously tough nut—determining correlation, or how seemingly disparate events are related—and cracked it wide open with a simple and elegant mathematical formula, one that would become ubiquitous in finance worldwide.

For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart. . .'

www.wired.com/techbiz/it/magazine/17-03/wp_quant

[Patrick]

Feb 25, 2009 8:38:23 GMT swl said:

For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

As soon as I read that (above) I just knew it would be flawed!

Feb 25, 2009 8:38:23 GMT swl said:

Then the model fell apart. . .'

Exactly!

"The reason that ratings agencies and investors felt so safe with the triple-A tranches was that they believed there was no way hundreds of homeowners would all default on their loans at the same time. One person might lose his job, another might fall ill. But those are individual calamities that don't affect the mortgage pool much as a whole: Everybody else is still making their payments on time."

It's The Emperor's New Clothes all over isn't it!

This is Great!

To understand the mathematics of correlation better, consider something simple, like a kid in an elementary school: Let's call her Alice. The probability that her parents will get divorced this year is about 5 percent, the risk of her getting head lice is about 5 percent, the chance of her seeing a teacher slip on a banana peel is about 5 percent, and the likelihood of her winning the class spelling bee is about 5 percent. If investors were trading securities based on the chances of those things happening only to Alice, they would all trade at more or less the same price.

But something important happens when we start looking at two kids rather than one—not just Alice but also the girl she sits next to, Britney. If Britney's parents get divorced, what are the chances that Alice's parents will get divorced, too? Still about 5 percent: The correlation there is close to zero. But if Britney gets head lice, the chance that Alice will get head lice is much higher, about 50 percent—which means the correlation is probably up in the 0.5 range. If Britney sees a teacher slip on a banana peel, what is the chance that Alice will see it, too? Very high indeed, since they sit next to each other: It could be as much as 95 percent, which means the correlation is close to 1. And if Britney wins the class spelling bee, the chance of Alice winning it is zero, which means the correlation is negative:

If investors were trading securities based on the chances of these things happening to both Alice and Britney, the prices would be all over the place, because the correlations vary so much.

The terrible thing is - for all the clever Nobel Prize Winning calculations - it seems no one was in a position to be able to evaluate what was happening in the domestic market place. When you're sitting reading the local paper each week and noticing that that not far off derelict house at the end of the street is £80,000 in November and then back on the market in January at £95,000 and yet no one has done anything to it, you know there is something wrong. No amount of statistical data is going to tell the chaps in their offices that silly things are happening in the housing market 300 miles away. I don't suppose that even the single garage in North London with a tap and a light bulb going for £100,000 has the slightest indication to some of them that something is clearly wrong.

Sometimes people need to sit back and take stock. Not by reading the finance pages but by, well, by the nature of the Butterfly wings theory - asking the newsagent how many people have cancelled their deliveries that week.