This is a fantastic article, but I have a question. When talking about how this financialization of mortgages prevents banking crisis associated with traditional lending: How does this hold up...
This is a fantastic article, but I have a question. When talking about how this financialization of mortgages prevents banking crisis associated with traditional lending:
We have learned, through long and painful experience, that this is an extremely repeatable recipe for banking crises. Interest rates go up, which increases banks funding costs and decreases the value of all the mortgages they own.
How does this hold up against 2008's "too big to fail?" Last I heard, it was caused by this very financialization.
Case study: The house next door to me. Worth about $210k as far back as 2010, has changed hands a few times. Until late 2020, now is on market for $400k. No major renovations.
Housing is in another bubble. Mortgages are being manufactured at all-ime low rates at all-time high amounts. People are doing cash-out refi because the values are high and interest is low.
What happens when that bubble bursts, housing values plummet, and everyone is underwater? Is that not a banking crisis?
I'm kinda confused as to what you're saying it holds up against. Having mortgages owned by pension funds rather than banks does not have any implications on rising housing prices. The severity of...
I'm kinda confused as to what you're saying it holds up against. Having mortgages owned by pension funds rather than banks does not have any implications on rising housing prices.
The severity of 2008's financial crisis was mainly around a conflagration of financial derivatives and financial derivatives on financial derivatives plus either collusion or incompetence by rating agencies on those derivatives. Those derivatives exponentially magnified the impact of foreclosures, whereas there is an entire industry of insurance and risk management with boring old heavily regulated mortgages.
Not to mention it's not a binary thing; 2008 was quite bad, and it'd be even worse if we had cyclical mini financial crisis every ~5 years because of unexpected interest rate fluctuations.
I'll admit that I'm no fan of financialization broadly speaking... I think abstracting money from being merely a tool to facilitate transactions of goods to being a good itself, as the article...
I'll admit that I'm no fan of financialization broadly speaking... I think abstracting money from being merely a tool to facilitate transactions of goods to being a good itself, as the article shows, is quite harmful. I think the only way to really stop these kinds of boom/bust cycles is to do things like de-privatize banking.
I also don't think those mini cycles are inherintly bad. When interest rates rise, this is also beneficial for saving. So higher interest rates, more saving and financial stability. When I was growing up, I was told to invest in CDs, because my parents had some pretty secure savings on account of those, given they paid out well over 5% APY. Nowadays I'm probably better off just leveraging the 'take a penny' tray.
Having mortgages owned by pension funds rather than banks does not have any implications on rising housing prices.
Howso? By abstracting away most/all of the risk to others, more mortgages are able to be created, which drives up housing prices. It certainly did for college costs, where risk for lending went to absolute 0. If nobody can get a mortgage for more than $150k, it puts a fairly solid soft cap on home prices.
Seperately, IMO pension funds shouldn't absorb the risk. They should be rock-solid, reliable retirements. Not yet-another-tool for further financialization.
It would actually be the reverse, at least in the current situation. It's not like long term investment funds like pension funds are black boxes that banks can just shove mortgages in. Since...
Howso? By abstracting away most/all of the risk to others, more mortgages are able to be created, which drives up housing prices.
It would actually be the reverse, at least in the current situation. It's not like long term investment funds like pension funds are black boxes that banks can just shove mortgages in. Since pension funds are hypothetically resistant to short term interest fluctuations, they act as a countervailing force to cyclical market pressures (as they would right now to the current boom).
If you charted out the hypothetical demand graphs of a pension fund vs a bank for mortgages, the bank would be like a sine curve on a slight incline. The pension fund would be a linear line with the same slope but some delta upwards due to hypothetical increased efficiency. Over the long term, there would be the same amount of mortgage demand, plus a small delta.
So, in the current housing boom and low interest rates, the banks would be incentivized to issue more mortgages, giving homeowners more access to capital and increasing housing prices even more, whereas an entity like a pension fund would not have an increased demand for mortgages. And on the other side, when the bust occurs, pension funds would then continue to keep roughly their average amount of demand whereas the banks would have a fire sale.
Although this is a hypothetical that wouldn't be born out in the real world; if banks did not smooth out their risk profile by externalizing it to long term investment funds, they would just find another solution, not just live with the boom and bust cycles. Whether that be by externalizing it to someone else, or by creating new financial derivatives to hedge against the cycles, there wouldn't be much change on a macro sense. This is just the solution that ended up occurring.
It's a good deal for pension funds. They get better prices over the long term via the hypothetical market efficiency of their short term interest rate neutrality, and for a given asset like this, can craft whatever risk portfolio they would like to have with a mixture of being choosier on what mortgages to buy and buying hedging financial derivatives.
I don't think anyone is saying that interest rates shouldn't rise, interest rates are a tool of the central bank and depending on the forecasted future should be high or low as desired. Whether or not they do is unrelated to how entities manage interest rate cycles.
This is a fantastic article, but I have a question. When talking about how this financialization of mortgages prevents banking crisis associated with traditional lending:
How does this hold up against 2008's "too big to fail?" Last I heard, it was caused by this very financialization.
Case study: The house next door to me. Worth about $210k as far back as 2010, has changed hands a few times. Until late 2020, now is on market for $400k. No major renovations.
Housing is in another bubble. Mortgages are being manufactured at all-ime low rates at all-time high amounts. People are doing cash-out refi because the values are high and interest is low.
What happens when that bubble bursts, housing values plummet, and everyone is underwater? Is that not a banking crisis?
I'm kinda confused as to what you're saying it holds up against. Having mortgages owned by pension funds rather than banks does not have any implications on rising housing prices.
The severity of 2008's financial crisis was mainly around a conflagration of financial derivatives and financial derivatives on financial derivatives plus either collusion or incompetence by rating agencies on those derivatives. Those derivatives exponentially magnified the impact of foreclosures, whereas there is an entire industry of insurance and risk management with boring old heavily regulated mortgages.
Not to mention it's not a binary thing; 2008 was quite bad, and it'd be even worse if we had cyclical mini financial crisis every ~5 years because of unexpected interest rate fluctuations.
I'll admit that I'm no fan of financialization broadly speaking... I think abstracting money from being merely a tool to facilitate transactions of goods to being a good itself, as the article shows, is quite harmful. I think the only way to really stop these kinds of boom/bust cycles is to do things like de-privatize banking.
I also don't think those mini cycles are inherintly bad. When interest rates rise, this is also beneficial for saving. So higher interest rates, more saving and financial stability. When I was growing up, I was told to invest in CDs, because my parents had some pretty secure savings on account of those, given they paid out well over 5% APY. Nowadays I'm probably better off just leveraging the 'take a penny' tray.
Howso? By abstracting away most/all of the risk to others, more mortgages are able to be created, which drives up housing prices. It certainly did for college costs, where risk for lending went to absolute 0. If nobody can get a mortgage for more than $150k, it puts a fairly solid soft cap on home prices.
Seperately, IMO pension funds shouldn't absorb the risk. They should be rock-solid, reliable retirements. Not yet-another-tool for further financialization.
It would actually be the reverse, at least in the current situation. It's not like long term investment funds like pension funds are black boxes that banks can just shove mortgages in. Since pension funds are hypothetically resistant to short term interest fluctuations, they act as a countervailing force to cyclical market pressures (as they would right now to the current boom).
If you charted out the hypothetical demand graphs of a pension fund vs a bank for mortgages, the bank would be like a sine curve on a slight incline. The pension fund would be a linear line with the same slope but some delta upwards due to hypothetical increased efficiency. Over the long term, there would be the same amount of mortgage demand, plus a small delta.
So, in the current housing boom and low interest rates, the banks would be incentivized to issue more mortgages, giving homeowners more access to capital and increasing housing prices even more, whereas an entity like a pension fund would not have an increased demand for mortgages. And on the other side, when the bust occurs, pension funds would then continue to keep roughly their average amount of demand whereas the banks would have a fire sale.
Although this is a hypothetical that wouldn't be born out in the real world; if banks did not smooth out their risk profile by externalizing it to long term investment funds, they would just find another solution, not just live with the boom and bust cycles. Whether that be by externalizing it to someone else, or by creating new financial derivatives to hedge against the cycles, there wouldn't be much change on a macro sense. This is just the solution that ended up occurring.
It's a good deal for pension funds. They get better prices over the long term via the hypothetical market efficiency of their short term interest rate neutrality, and for a given asset like this, can craft whatever risk portfolio they would like to have with a mixture of being choosier on what mortgages to buy and buying hedging financial derivatives.
I don't think anyone is saying that interest rates shouldn't rise, interest rates are a tool of the central bank and depending on the forecasted future should be high or low as desired. Whether or not they do is unrelated to how entities manage interest rate cycles.