Saturday, April 16, 2011

Felix Salmon: Quote of the Week

I was beginning to despair this week. It seemed like the theme was Free Market Idiots Run Amok and someone had forgotten to tell me to put on my Atlas Shrugged underwear.

First, there was Larry Summers saying don't blame financial innovation, but rather, the housing bubble, for the Financial Crisis on Steroids that we went through. Which leaves me wondering: This guy was the president of What-vard? You gotta be kidding.

Larry has nary a disparaging word to utter about any CDO, CLO, CDS, SIV, RMBS, CMBS, REMIC, re-REMIC, structured note. None of those products are bad, fee-gouging, or in any way contributed the teensiest to systemic instability?

Thus, I sentence the estimable Mr. Summers to hereafter receive all his compensation as an income stream from the bottom tier of a synthetic CDO squared.

The second forehead-slapper was Peter Wallison, who at this point isn't even interesting any longer. He's too busy riding his ideological hobbyhorse: Fannie and Freddie are the chief perps in the financial crisis, get the government out of the housing market, private enterprise can do no wrong, blah blah blah. His latest wildly inaccurate piece, on the Bloomberg Web site, was easily shredded by Daily Kos.

Which brings me to Salmon's quote of the week ... the antidote to all the uninformed opinion.

Responding to Gary Gorton's assertion that we need "informationally insensitive financial assets" (debt whose price doesn't change when new information about it emerges), Salmon is quick to respond, "No, we don't."
Informationally-insensitive debt is the best repository the world has ever constructed for housing tail risk in an invisible and impossible-to-measure manner.
That's a great line. Because "informationally insensitive debt" (except when applied to common currency, which is arguably a trivial usage) is a dangerous, oxymoronic twist of phrase. The varieties of "informationally insensitive debt" spawned in the shadow banking system, and used in the repo market before the financial crisis, didn't collapse because of a panic. Rather, the values plunged because investors realized this debt was complex, misrated and overvalued.

Gorton likes to think there was an irrational panic in the shadow banking system. He's right there was a panic, but it was more the sort of panic you experience when you realize the gold bars you're holding are bricks of horse manure spray-painted gold. It wasn't all that irrational. And to prevent that kind of panic, you need assets to be more informationally sensitive, and constantly adjusting for risk -- not less sensitive.