Thursday, April 29, 2010
Where May The Next Bubble Come From?
It now appears that the debate can go forward on the financial reform legislation. While there are several items that need to be addressed before a substantive bill can be passed, the issue for me, and for a few others that know how things work, is the issue of the way the credit rating agencies are being paid. This basic conflict of interest, in my opinion, is at the center of the creation of the housing bubble. Yes, there are many other components to this legislation that will help prevent another housing bubble, but bubbles come in many forms, not just housing. For this reason, there needs to be a change in the way investment bankers pay the credit rating agencies for their credit rating on a new issue of bonds. As each bundle of mortgages is different than those previous bundles that have been securitized into mortgaged-backed bonds, the credit rating for each new issue of mortgage-backed bonds is really all the bond portfolio manager has to work with. When the credit rating agencies place a Triple-A rating on a mortgage-backed bond new issue, especially when there is no historical information about the issuer (like in the case of a corporation or a municipality or state), the credit rating is of utmost importance in determining whether the bond will be purchased.
Yesterday, it was the mortgaged-backed bonds, tomorrow it may be something else, such as auto loans, manufactured housing or even credit card debt. Almost any kind of debt can be securitized and then sold off as securitized debt obligations - structured finance debt bonds. Controlling the next housing bubble is good, but the next bubble may come from another direction, and then what? Will we have to go through this whole bond market meltdown and financial crisis again?