What should we learn from the newly-apparent problems with the mortgage markets, and the stock market's recent dive? That once again, the smart guys (and gals) were wrong.
The smart people were the ones who devised the "securitization" of mortgages. I don't claim to fully understand this process--I think that it was made supremely complex just so the smart guys could tell the rest of us that we don't understand it--but it involves taking a large number of mortgages and putting them into entities like mutual funds. You might think that all of the top-drawer mortgages would be put into one fund, the less-good ones into another and the low-quality mortgages into a third, to be sold at prices that reflect the risks and returns involved. But no, the smart guys mixed mortgages of different qualities together, then got rating companies (Moody's is perhaps the best-known, although not the only one) to rate them.
The rating was key to the deal: a high rating gave a fund the imprimatur it needed to be acceptable to the market. So, how did the rating agencies get to examine particular funds? They bid for the business from the issuers. In other words, they offered their services at a price. Were their opinions trimmed to help in getting the opportunities--and the fees--involved? They deny it, but human nature says that it would be difficult to keep the raters' conclusions from being affected by their self-interest.
It used to be that you got a mortgage from the bank around the corner or downtown, and for the next fifteen or twenty years you dealt with that bank. No more. Now your mortgage comes from a mortgage company or broker. Whether you know the issuer of the mortgage or not doesn't matter, because in most cases your mortgage is going to be sold to someone else shortly after you close.
In the old days, if you had a problem paying the mortgage, you dealt with a bank that at least knew about local conditions. Today, you are likely to have trouble finding out who, exactly, owns the mortgage. Your local bank might have put you out on the street--they were bankers, after all--but you could have tried to negotiate with people who had some idea of what you were dealing with. Now, you could be facing foreclosure before you find someone to talk to who has some authority to deal with your problem.
The thing about the smart guys is that they sold the market on the idea that they had created something new--and what they had created was a solid, secure investment out of individual assets (mortgages) that were not as high in quality as the rating of the overall fund. And other smart guys--mutual fund managers, the people who invest billions of pension dollars and the like--accepted what they were told and bought these mortgage-backed securities.
Did anyone really believe that the housing market would not turn down? Did the smart guys think that the no-money-down mortgages and the adjustable-rate mortgages would all be paid off? Didn't they know that the unqualified borrowers were going to default in large numbers? And didn't they know that when those mortgage-holders defaulted, the value of the funds holding their debts would be hammered?
The more realistic inquiry would be whether they failed to tell the true answers to these questions, or whether they failed to ask them--especially of themselves.
And what about the other smart guys and gals who told us, just a few months ago, that the downturn in the housing market would not have ripple effects on the rest of the economy? What were they thinking?
The exposure of the mortgage-marketeers would not be especially significant if it were not an example of a frequent phenomenon. Look at the dot.com bubble of the 1990's or the real-estate boom of the 1980's. Or look at Iraq, where the "experts" told us that we would be welcomed as liberators.
When should we expect that the smart guys will prove wrong? When they tell us that they have something new--not something technical or physical, but something that deals with human nature (such as the behavior of markets, or Iraqis). Human nature doesn't change and neither does the way that we behave--including our repeated tendency to deny history and to fail to ask questions that will bring answers we don't want.