- Miller Samuel Real Estate Appraisers & Consultants - https://www.millersamuel.com -

[Bloggingheads] Solutions To Crunch: Derivatives Are Derivative

I like to check in with bloggingheads.tv [1] periodically – the topics can get pretty abstract for my limited intellectual capacity, but every so often it strikes a chord and today was one of those days – I saw two clips that appealed to me (They caught my attention initially because I know and admire 3 of the 4 the participants). The two sessions were covering the “subprime” situation but seemed at odds about interpreting the risk of existing financial instruments. Great comments on these posts as well.

A commenter from Yves and Dan’s excellent but far too short “Slums of Greenwich, CT” writes:

An intereresting thing here was that the interlocutors implied that the shadow banking system, and here one suspects that they mean the derivatives market, poses greater risk to the financial system than do the poorly underwritten residential mortgages. This is the reverse of what the majority of people think. It makes sense to think that the greater risk is posed by the securities which underly derivatives, that the risk posed by derivatives is entirely derivative.

In the next segment, The Subprime Solution, Professor Shiller, who has been making the rounds with his recent book suggests we don’t “blame” anyone for the crisis and discusses his ideas for a solution – the devil seems to be in the details. In the background hovers his life’s work, the advocacy of a housing derivatives market to enable investors to manage risk.

Here’s a representative comment on the post:

I understand his work-out proposal, and insofar as it would remove some uncertainty and provide a mechanism to adjust nominal terms or contract-time expectations to unexpected situations I can see the appeal, but wouldn’t all of this be incorporated into the expectations of the lender, secondary purchasers, and buyer at the time of the contract? It seems like the plan would have to make mortgages more expensive (relative to today’s–or really yesterday’s market price) to the borrower and less attractive to the secondary market. If the new contract terms were fully incorporated into the mortgage price up front, how will this solve the problem; it seems like it would shrink the market for mortgage lending without affecting the asset bubble dynamics overall. Homeownership is extremely politically popular–how would Prof. Shiller counteract this fact, in his (correct) push to remove the many subsidies for home purchases?

A fun way to deliver commentary, bloggingheads is available as a download, but it’d be a lot easier if it was a videocast via itunes.