[Grovenet] A new look at an old Constitutional Amendment

[Allen Warren]

The formula developed by Li was both good and bad.  Good in that it was better than most of its predecessors, but bad as already pointed out.  But there were so many other factors, too, contributing to the mess we're in today.  One of the bigger factors is that in the last few years, the percentage of loans historically placed in the lowest tranch grouping increased.  This led to less loans available to group together in a triple A tranch, the lowest ROI but also lowest risk to investors.  So what did lending institutions do?  They took the ever-growing-larger single A tranch groups, separated out the loans and regrouped into triple A, double A, single A and so forth tranches, then sold these off to investors.  See the problem?  Investors wanting to keep low risk investments thought they were getting triple A tranches when in effect they were getting re-packaged, risky single A tranches.  A lot of the banks didn't care because . . . well . . . once they
 started down this road of deceipt, and the housing market slowed some but didn't collapse, the banks figured, "Hey, this isn't so bad.  Sure, we're not being 100% honest here but hey, we're making money and the economy is no more worse for the wear.  What's NOT to like about this?"  What only a very few people realized and what the rest of the financial community didn't see, or didn't WANT to see, was that the financial "body" had basically started to cannibalise itself starting from the inside and it was too late to heal the body once the cannibal was finally noticed.

 
Allen Warren



________________________________
From: Katie Allnutt <allnutt at verizon.net>
To: Forest Grove local interests list <grovenet at rdrop.com>
Sent: Wednesday, February 25, 2009 7:23:24 AM
Subject: Re: [Grovenet] A new look at an old Constitutional Amendment

Good points. I thought the article also did a good job of explaining  
that too many managers believed that the formula by itself made up  
for any variations in those same underlying assumptions.  They had no  
true understanding what the formula actually did or did not take into  
account.
My hat is off to the writer of the article because he explained a lot  
in just a few pages. I wonder if the managers who used this formula  
had read such an article early on whether we would be in the mess we  
are in today.


Thanks for reading it.

Katie


On Feb 24, 2009, at 9:56 PM, David Morelli wrote:

> The underlying assumption of the formula is that the "the market
> knows the value of the product and the market price will reflect the
> risk".  This is close to the standard conservative mantra for a wide
> variety of issues.
>
> The market doesn't know.  It guesses.  And some guesses about risk
> are very expensive mistakes.
>
> Caution can be a useful practice.
>
> David
>
> On Feb 24, 2009, at 10:25 AM, Katie Allnutt wrote:
>
>> While I was dinking around with Bob's article I ran across this one
>> too.
>> Not related to the constitution but more aimed at understanding the
>> economic mess that has been building over the last several months.
>> It helps with vocabulary like tranching, collateralized debt
>> obligations, credit default swaps, etc.  We should all understand
>> both the constitution and the economy better.
>>
>> One good article deserves another....
>>
>> http://www.wired.com/print/techbiz/it/magazine/17-03/wp_quant
>>
>> or
>>
>> http://tinyurl.com/au8f4p
>>
>> Katie
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