Sunday, August 23, 2009

The decline of Gillian Tett continues

Sadly, as Gillian Tett's prominence has risen, the quality of her columns has plummeted. Take this paragraph from her latest column, which is pure gibberish:

[S]ecuritisation has produced a particularly curious – or absurd – paradox. A few years ago, it was widely assumed that the process of slicing and dicing credit would create a more “complete”, free-market financial system. But by 2005, credit products had become so complex and bespoke, that most never traded at all. Thus they had to be valued according to models, since they could not even be priced in a market – in a supposed free-market system.
This makes no sense at all. Apparently Tett thinks that a financial instrument can't be efficient unless it's frequently traded. Huh? Lots of corporate bonds are very thinly traded, but that has nothing to do with whether corporate bonds are efficient financial instruments. This isn't even a coherent argument. Tett also thinks that bespoke credit products are inherently inconsistent with a "free-market financial system." Why? Because they can't be easily marked-to-market. Umm, of course bespoke credit products can't be easily marked-to-market—they're bespoke. (Believe it or not, there aren't a lot of investment firms that are interested in buying a credit product that was custom-made for a different firm.) The simple fact is that free-market financial systems have bespoke credit products—after all, every financial product that's sufficiently standardized to be heavily traded started out as a bespoke product. And how bespoke credit products are valued for accounting purposes has absolutely nothing to do with whether they make financial markets more complete. It's strange that Tett has a reputation for being an expert on structured credit markets when she so frequently makes these kinds of basic errors in discussing structured credit. (Errors like claiming that JP Morgan created credit derivatives in 1997, even though every single bank on the Street had a credit derivatives department by at least 1994.)

7 comments:

JCH said...

I really don't know what George Bailey did with the mortgages he originated, but let's say he kept them in a drawer in his desk. He was a bit of softy, so invariably he probably originated a few that were shaky.

How is that drawer a single bit different than a MBS? In good times, to raise more money for more originations, he could easily sell his drawer to Potter for a value that would probably have been determined by a financial model that used a lead pencil that computed the drawer's present value. In a market panic, Potter wouldn't go near that drawer for a penny more than 23 cents on a dollar. George's balance sheet degrades. Potter calls...

To me, this is the same old same old.

spyros said...

contrary to the bond market, the derivatives market in general does not have an "underlying" limit. in other words, the total value of the bond market will always represent the corresponding value of the debt. this is not the case for cds and other derivative instruments where the limit is the sky and the underwriters appetite. that's why liquidity does matter in derivatives market as its bust can hurt more than it should.

Economics of Contempt said...

JCH: You're right, at least in theory. In a housing bust, a portfolio of residential mortgages should be almost exactly as illiquid as a comparable MBS. The fact that certain MBSs turned out to be highly toxic doesn't necessarily prove that securitization is inferior to traditional commercial banking, because who's to say that the non-securitized mortgages aren't just as toxic? Of course, in practice, there are significant differences between MBSs and whole loans. But I agree that at root, the US housing bubble was just that: a bubble. Same as it ever was, same as it will be again some day. Anymore, the whole "securitization vs. whole loans" argument is just about dividing up the losses from the housing bubble.

Kena said...

If I recall, Tett has a degree in cultural anthropology.

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