Why do people say ‘greed’ caused the recession yet no one can actually explain how greed is responsible?
by Mortgage Rates on Saturday, November 27th, 2010 | 3 Comments
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Its governments fault. Their lending institutions like FRE and FNM had no reason to make good loans bc tax money could make up any losses. However, shit hit the fan and now they are broke which has caused the collapse of all the banks they sold their subprime mortgage bundles to.
Not sure what you are trying to say: banks ‘lend’ money, not ‘loan’. What do you mean by ‘underwrite lending standards’? Before you use economic terminology you should do some ground work to understand the basic words. Otherwise go to the section Politics where you find like-minded people at the same level of ignorance.
Just because you do not understand the theory, does not mean it makes no sense!
The collapse of the financial markets is to a large extent the result of a compensation scheme which promotes, what economists call ‘moral hazard’. Moral hazard is the result of asymmetric information: one party in a transaction has more information than the other party. In the securitization of mortgages the buyers of securitized debt instruments, unlike the sellers, do no longer have transparency and understanding of the underlying risks of the instrument that they hold. A holder of a bond which is the result of securitized credit card receivables, for example, does not need to and cannot have a complete understanding of the credit quality of the individual credit card debt that makes up the bond. All he relies on is an abstract mathematical concept of aggregate default probability, which is partly the result of a rating issued by a rating agency exposed to a potential conflict of interest
The traders in the investment banks trading these positions have an incentive to act less cautious than they should and let the bank pay for the consequences of their actions. This is because their bonus payments are in fact a free call option on the bank’s profit and capital: if the trades that the traders take on the books of the bank are successful, i.e. generate a profit for the bank, they get rewarded with a share in those profits in form of a higher bonus. If the trades are not successful, the bank and the shareholders will have to pay for the loss, but the trader does not participate in the loss (‘tail, I win; heads, you lose’).
In summary, due to asymmetric information and the resulting problem of moral hazard, the greed of the market participants has contributed significantly to the financial crises.