Did Speculation Make the Economic Crisis Deeper or Shallower? Posner

Speculators have never been popular, and they have never been as unpopular as they are in the United States today. Increasingly they are blamed for the economic crisis. Probably they should be rewarded for making the crisis less grave than it would otherwise have been.

 

There is a wide range of speculative activities, but my focus will be on financial speculation, which I’ll define as a bet on the future price of some commodity or asset, which could be a house or a bond—to pick the two speculative assets centrally involved in the crisis. (Mortgage-backed securities and collateralized debt obligations, the specific financial instruments at the center of the crisis, are essentially bonds or bond clusters—debt obligations or packages of debt obligations that pay a contractually fixed interest rate or rates.) In the 2000s, until the crash, there was a great deal of speculation in housing prices, including by people who bought a house with a mortgage that they could afford only if the value of the house increased. They would buy the house with no down payment and very low (sometimes zero) interest rates usually for two years, after which the interest rate would be “reset” at a higher level—a level they could not afford unless their house appreciated significantly in value, in which event they would have equity in the house and could use it to refinance the house with a normal mortgage at a normal interest rate. So they wouldn’t have to pay the reset rate.

 

At the other end of the market from the speculating home buyer was the speculating investor. Buying MBSs (mortgage-backed securities) and CDOs (collateralized debt obligations, often an assemblage of the riskier slices of mortgage-backed securities) entailed speculating on future housing prices, because the direction of those prices—up or down—would affect the default rate on the mortgages in which the buyers of the securities were investing indirectly. If the default rate rose because housing prices cratered, the securities might not pay the agreed-on interest rate, and so their value would fall.

 

Some very smart, very unconventional people, though they were only a tiny minority of the financial community, began thinking, some as early as 2005, that housing prices might well crash, that the housing boom was a bubble—house prices were rising because house prices were rising, convincing people that they would keep on rising. The “contrarians”—the subject of Michael Lewis’s new book, The Big Short—wanted to put their money where their mouth was. But while it is easy to bet on a rise in the future price of some asset, simply by buying the asset, it is not so easy to bet on a fall in that price. If it is a stock (or other security, including a bond), you can borrow it and agree to sell the stock to someone at some specified date in the future at a specified price. If as you expect the price falls, you can buy the stock that you’ve agreed to sell at a price lower than the sale price, deliver the stock you borrowed to the buyer and be paid the agreed-on price, pocket the difference, and deliver the cheap stock you just bought to the person you borrowed the stock from for the speculation, thus completing the transaction. The process I have just described is selling short.

 

Selling short is risky, because the price of the stock may rise over the price specified in the short sale when you expected it to fall (which means you’ll have to buy at a price higher than the price specified in the sale contract the stock that you need in order to return stock equivalent to what you borrowed), and costly, because you have to pay interest to the person you borrowed the stock from.

 

As an alternative to short selling, you can buy a credit default swap, which is a form of insurance on debt—not necessarily your own debt. If there is a bond that you expect to go into default (it might be a bond backed by a collection of mortgages), you can buy insurance against the resulting loss in the bond’s value. So if there is a default, the issuer of the credit default swap pays you, and so you gain just as the short seller gains when the price of the stock or bond that he’s shorted falls.

 

Like other speculators, short sellers and buyers of credit default swaps that insure strangers’ debt are unpopular because they are trading on and therefore hoping for a future calamity. When the price of an asset falls as a result of speculative activity, the speculators are blamed. That’s like blaming a thermometer for a fall in temperature. Provided the speculators do not spread false rumors about the assets they’re hoping to see fall in price, or engage in other fraud, their activity is socially beneficial. It adds to the information in the market and by doing so tends to bring about a more rapid and complete alignment between prices and underlying values.

 

It’s hard to sell houses short, but one can speculate that housing prices will fall by selling mortgage-based bonds short, since as I said a housing crash will increase the mortgage default rate and thus reduce the value of bonds that are based on mortgages. Had there been rampant short selling of such bonds in the early 2000s, the price of those bonds would have fallen because a high level of short selling would have been a signal of widespread doubt that housing prices would continue to rise. When bond prices fall, yield rises, because the interest rate of a bond is a fixed percentage of the bond’s face value. (So if the value of a bond that pays 2 percent interest falls in half, the interest rate to buyers of the bond rises to 4 percent.) With interest rates on mortgage bonds higher and housing prices therefore lower (because mortgage interest is a major cost of buying a house), we might have been spared the housing bubble whose bursting triggered the economic crisis that the nation and the world are still struggling to climb out of.

Comments

[jordan cool grey]

Thanks for sharing. This website is to I too have to help. Very good.

[jordan cool grey]

Thanks for sharing. This website is to I too have to help. Very good.

[楽天市場]

[url=http://www.ugg-rakuten.com/]楽天市场[/url] 、これらの価格およびカリフォルニアの検認の迷惑を回避、あなたの資源と金融贈り物事項を秘密にしようとすると、合法的相続人に迅速正当な資産の交換のいくつかの並べ替えを完了する理由です。 Charges.Floridaにある信託は一般的に複雑さを減衰するためにスマートで、法的な準備の手順を使用してとしている避け遺言に、是非"雪鳥"set.Tip＃1カリフォルニア州の不動産を使用するときにフロリダライフスタイル信託の経験は、次のあなたと悲しみをコスト、人気によって雪だるま式にloss.Remarkably、数万人の人々は病気にもされていたり、事件がこれらの、できない経験の浅いまたはずっと悪いの葉、法的move.Ageためのもの不動産のほとんどを準備することはできません！結果は？ものは、税金、債権者の義務と裁判所の検認への多くの"延期".*遺言検認の料金は家族そのすべてについてのすべての解明とともに、全体のESTを所有！家族と、インスタンスのために適切に開発された資産の移動の書類を欠く不動産は取消FLの生活は、あなたの信頼を置く行政裁判所だけでなく、弁護士のサービス料に不動産の魅力に属する20％以上がドロップする可能性が、そして3人もの年と、最大で法廷の時間は、悲しみと、さらにフラストレーションに関する重要なチャンクで、追加し、その結果、氷の時間のそれらの検認期間中に市場から除去債務資産のすべての時間値の電荷を有する実際のケーキを。

[Seo agency]

Hello,

i am Link Builder Form India .I will Provided Quality niche links PR 1,2,3,4 All links are permanent and low out bond links ...

i am waiting For Your Reply

Thanks

[cigarette lectrique]

That's very interpretive article!!

[Steroids Sale]

professional control steroids require america build frequently modern enhance combined building loss contest training hypertrophy product effects high male body.

[Evi]

By :RE: Different decision. The one I'm rernirfeg to wasn't even decided in 2010, when that article was written. Also, it's not like you keep score with the decisions. That doesn't affect the fact that the government was a party to a lawsuit which threw out the entire act. Until that is stayed, that decision is binding on the government.the healthcare law is in effect. that is a fact. prove otherwise. show me how lost their coverage after they had it government mandated.you're wrong. Rate this comment: 0 0