The Computer is your Friend. Trust the Computer. . .
The large majority were refinances made on existing homes, not new construction
I donât have statistics to hand, but my sense is that people in CA, AZ, FL and lots of other places would disagree with you. Even here in staid MA we still have ghost developments, constructed or partly constructed in anticipation of quick sale and then abandoned when the bubble burst. But onwardâŚ
What distinguishes the sale of financial assets from most (but not all) other kinds of assets or services is extreme asymmetry of information.
I realize this is a popular notion, but I think itâs wrong. I think that in every kind of professional relationship one can think of, this sort of information asymmetry exists. A doctor tells you that you need a certain treatment - what can you do? You can try to research online, get a second opinion, etc. but in the end youâre facing a huge information asymmetry. A car mechanic tells you that your entire exhaust system will fall apart in under 1000 miles and needs to be replaced now - what can you do? Your lead architect tells you that the database for this project cannot meet the transaction load that will be required - what can you do? Et cetera. Professionals of all sorts have a depth and specialization of knowledge that the consumer cannot match. We have to trust that they are honest brokers, though we know sometimes they are not. Yes, financial markets have information asymmetries, but so do all markets.
I return to my original point: the sale of financial assets is hard to distinguish from the sale of other assets. Information asymmetry is not a distinguishing factor.
The large majority of subprime loans were in fact refinances or home equity loans. I canât go look up the exact percentages now, which varied from year to year, but I remember being very surprised when I read the statistics in Joe Nocera and Bethany McLeanâs impressive history of the crisis, All the Devils Are Here. Empty subdivisions may be more visible, but most of the dollars flowed to refinances.
As to asymmetry of information, itâs certainly not unique to finance. Medicine is another great example, legal, advice, flying airplanes, and auto mechanics are certainly others. As you point out, we rely on professional standards and ethics, the best information we can get, and, I would add, often on regulation and legally enforceable standards we set through government. I would agree that at the level of the retail investor the information asymmetry is probably not very different than for medicine, or airlines.
But I think what is the concern in finance is not at that retail level, but at the level of the vastly larger âshadow bankingâ system. It got that name for a reason. Much of finance at that level was specifically designed to hide what was going on, particularly from other bankers or ratings agencies. Even many of those supposedly minding the store clearly did not have a reality based conception of the risks they were running. Their models turned out to be wrong. The SEC struggled to understand these markets in derivative securities. The argument that weâre all grown ups participating freely in a market and the buyer must exercise due diligence only holds to a point. Where it fails is that that millions of people who never participated knowingly in this system, who think AAA stands for the folks who jump start your car, who donât know CDSâs from RBIâs and who donât care, were harmed a great deal by this opacity. Their local government funds, supposedly managed by sophisticated investors, lost the money they needed to build schools and water systems. Lots of people lost their jobs, opportunities for education, or their homes.
So yes, I believe there is an exceptional asymmetry of information in finance at that level, an asymmetry that is actively created and maintained by people who generate great riches from it. And I believe this is a big problem because of the potential to harm the global economy and many millions of innocent people. In that sense finance is very different from the other examples you cite- itâs the only one that could (and almost did) send us into a global depression.
Finance information has undergone one of the biggest changes from the internet. 25 years ago even the most basic info (e.g. A quote on AT&T) required a subscription or a trip to a broker. Then suddenly I could get unlimited free quotes and even filter gigabytes of quote history for good ideas.
That is not to say that knowledge about finance became any more widespread. Lots of people are willing to buy into incredibly bad deals from fast talking âprofessionalsâ. Lots of people were refinancing annually to spend their profits from appreciation on their homes. And lots of trust managers were buying mysterious CDO etc. securities on the basis of promises over drinks and news articles about quants with math they didnât understand.
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