Moral Hazard? - Assuming Morals Still Exist.

Let me first note that I told you so. The time for me to say this has not arrived yet, but it will so I wanted to get it out of the way. We are in a new period of irrational exuberance. I think irrational based upon the stuff I have been posting. At this point, any exuberance I believe is irrational.

Nothing Moral About It!

Here is an interesting bit I noticed today and I am sick. This shows that institutions issuing subprime loans did $370 million in lobbying over the past decade. That is an insane amount. But when you are doing about a trillion in idiotic loans and do not want your business regulated, you go to extremes. Most of the originators of these loans are now bankrupt but were owned or financed by several of the big players that just came out of the stress tests and that have gotten taxpayer dollars. You know, like Citigroup, JP Morgan, Goldman, Wells Fargo and Bank of America. So much for moral hazard.

http://www.ft.com/cms/s/0/ab5cf9aa-39b7-11de-b82d-00144feabdc0.html

And talking about moral hazard, it is receiving far too little attention in this crisis. Let's say I am a regional bank, say Good Bank, and I did not do subprime and maintained good underwriting policies. Despite my good business practices, I am suffering as the economy is going through a crisis that even good underwriting would have a hard time predicting. So I am suffering. Yet I am reading daily about uber-banks that created all these derivatives, that did all this subprime lending, that committed all these sins, and they are going to do fine with the government refusing to allow them to fail to the tune of trillions. And this false government support is unfairly benefiting those who got us here. So I am pissed off as Mr. Good Bank because I have played by the rules and this - even after the discovery of the problems - has put me at a competitive disadvantage. "Screw this, I am not playing by the rules going forward."

I have just portrayed one aspect of moral hazard - good banks going bad. Now assuming they have good management, this will not happen, but it is a risk. The more obvious risk is for those that got away with it. Sure their shareholders had a hunk of pain, but the execs that orchestrated this mess did quite well and the companies are allowed to rise from the dead and repeat - in time - their indiscretions. Sure they will play nice for a while, but then the next wave of financial innovation begins. And I for one have not seen a lot of new regulatory proposals coming out just yet to prevent this happening again. Perhaps those hundreds of millions in lobbying dollars are still achieving their desired effect.

It is difficult to talk in terms of moral hazard when no one has any morality. I hope people - and companies - learn from this mess, but the government is doing its best to teach the companies the wrong lesson.

The Stress Tests

I do not think the tests actually were assuming enough stress, but they are - unofficially - in. If you believe they are accurate and the banks need no more capital than what is being said, good luck with that. The dollars in the linked chart are based upon "leaked" data. Leaks? I am shocked!! If I had the Casa Blanca clip I would link it here.

http://www.calculatedriskblog.com/2009/05/stress-test-table-morgan-stanley-needs.html


Foreclosures at a Bottom - Me Thinks Not!

I noted yesterday that the somewhat distant - as in 2010 and 2011 - future has some nasty surprises in terms of option ARM resets. And here is a bit of a Catch 22 for you; right now interest rates are "as low as they go." Should the economy rebound, which is what everyone seems to be banking upon, then the expectations are that we will get to significant inflation, if not hyperinflation. Now I am refinancing for a new fixed rate mortgage, so I will be fine (not my bank) but all those ARMs that have reset this year and next at lower rates are going to start shooting through the roof on rates and defaults/foreclosures will again shoot through the roof. Seemingly, there is no way around all those subprimes. Any hoot, here is a link that notes our current problems are still there.

http://www.calculatedriskblog.com/2009/05/foreclosures-2nd-wave.html

Disclosures: I bought more put options today. Those I bought last month are all down significantly. I never put much money into these but I will be buying more this week if the market continues to climb. It's that "money where mouth is" thingy. This is not, by the way, investment advice. It is rather the opposite. I am making a very risky bet.