The TED spread drops below 3, and other signs of the receding apocalypse

"One reason, as Stephen Gandel was among the first (maybe the first) to point out last week--right here on TIME.com--is that the new temporary federal guarantee of unsecured bank debt has reduced the relative attractiveness of Frannie's MBSes, which for a couple of months were unique in their federal guarantee (granted by Congress over the summer) but now have to share it with others."

Doesn't this show the power of government guarantees, if only in one area.

Well, at least one government decision in the past few weeks appears to be having the effect of steering investment out of housing and into other sectors.

Do you consider the "bundled" mortgage and its derivatives part of the "housing" sector?

The crisis wasn't about too much money being invested in housing -- it was caused by the availability of what can only be described as sub-subprime mortgages. And those mortgages were made available because of the mortgage derivatives market -- and that is three steps removed from "the housing sector"

1) money spent on home purchase and home improvement - housing sector
2) mortgages to finance #1) -- step one
3) secondary (bundled) mortgages -- step two
4) derivatives of #3 -- step three

Absent those derivatives (and the arbirtrage of same) the current problem would not exist -- and "investing somewhere other than the housing sector" is just another way of saying "give more money to the sleazebags who created this crisis, and will continue to issue more derivatives to inflate asset prices."

lp1

While "The crisis wasn't about too much money being invested in housing", it was about conditions which favored overinvestment in housing in general- that is at all levels supply began to outstrip demand. Certainly, you needed step 4 to enable the prior steps, but it alone was never sufficient although a necessary component of the seizing up of part of the engine of the economy.

While "The crisis wasn't about too much money being invested in housing", it was about conditions which favored overinvestment in housing in general- that is at all levels supply began to outstrip demand. Certainly, you needed step 4 to enable the prior steps, but it alone was never sufficient although a necessary component of the seizing up of part of the engine of the economy.

I disagree, mostly because the crisis was not precipitated by increasing defaults on mortgage loans, but by a collapse in the derivatives created with those mortgages. The "housing bubble" was already deflating well before this crisis -- indeed, in certain markets (like San Diego) the bubble was deflating before there was a bubble in other markets. It wasn't the secondary "bundled" mortgage securities that were the problem -- they could be "marked to market" relatively easily based on the status of the mortgages themselves. In was the collapse of the derivatives market based on dividing up those securities into "traches"...

And it was the creation of that derivatives market that lead to the expansion of the market for securities backed by "bundled" mortgages. Prior to that derivative explosion, the market for those securities was limited to those who were happy with the rate of return you could get from a mortgage -- by dividing up the "risk" inherent in those securities, the market was expanded to include those who demanded a higher rate of return -- you could get a fairly high rate of return as long as you were willing to assume more risk from any default you could get a higher rate of return if you bought a trache that was backed by the "last 20%" of the value of the mortgage -- if an owner defaulted, and the house was sold at auction for only 80% of the mortgage, you lost your entire investment.)

The collapse of the derivatives market led to the collapse of the secondary mortgage market -- as the market for derivatives collapsed, the "geniuses" who borrowed money short term to buy the secondary mortgage securities with the intent of recovering their investments through the creation/sale of derivatives found themselves having to dump those securities on the market to raise cash to pay off their loans at below market prices.

As a result, the value of the secondary securities were no longer based on the underlying assets, but on their value in a market full of such securities being dumped at fire sale prices. "Mark to market" practices meant that institutional investors who considered the secondary mortgage securities safe had to take write-down on their financial statements -- resulting in some institutions becoming "insolvent" on paper, and others very close to it.

Bottom line is that the reason that so much sub-subprime mortgage money was made available was because of the market for derivatives of secondary mortgage securities. Profits for mortgage bundlers became dependent far more upon the "churn" -- how fast they could bundle and pass on the mortgages -- rather than from the "bundling" itself, and the only way to keep the flow going was to make cash available to mortgage originators who engaged in the creation of extremely high risk mortgages.

While I dispute none of the process you lay out, I beg to differ on the effects and causes. I think many rational economists would conclude when presented with the data that we were already in a bubble which would need defusing even well before the explosion of derivatives. Certainly, however one cannot discount the effect that derivatives had on exacerbating the problem. Fundamentally, that is where I differ with your statement. Derivatives exacerbates an already fundamentally unsound business model and cycle, but it did not create it. Many folks are coming, I think correctly, to the conclusion that it was Greenspan's put that created yet another [asset] bubble.

Bryan, I think the difference here is that I'm talking about "the crisis", and you're talking about "the bubble". I certainly agree that Greenspan's (and Bernacke's) monetary policies played a major role in inflating real estate values -- both directly and indirectly.

IMHO, a "housing bubble" does not inevitably lead to a potential complete meltdown of the worlds financial infrastructures -- and that's because there isn't a unified US housing market. Absent the derivatives market, the bundled mortgage securities would not have crashed -- they would have decline in an "orderly" and absorbable (word?) fashion because their value under "mark to market" would have been based on the asset value of the performing mortgages plus the liquidation value of the non-performing mortgages, rather than being "marked" based on a market that suddenly had far more of those securities than there was a demand for.

lp1, I see what you are talking about. There is a distinction to be drawn between the bubble and the crisis. But I guess, my ultimate point is that without the bubble, there would likely be no crisis.

How? Glad you asked.

It seems to me that the bubble laid the groundwork for the derivatives market. The derivatives always resulted (at least initially) from the mortgages (granted, other things could have been packaged and were). Without the original mortgages (the largest personal wealth asset class), I don't see how the effect could have been as large. That is to say, had the asset class been much smaller (autos, airlines, etc.) the failure of the derivatives market while still painful would not have had a global effect. By sheer magnitude, the effects reverberated throughout the U.S. and ultimately, the world. Just like how an earthquake sub-sealevel in Hawaii can create a tsunami in Japan...smaller quakes may have large systemic global effect. But it was not the US housing bubble alone, I believe it was a confluence of factors...ECB put, BOE put, and unsustainable house appreciation in many other world markets at the same time that resulted in a small earthquake in the middle of the Atlantic that ultimately led to a tsunami.