- A fascinating conversation with Gerald Posner, author of God’s Bankers: a History of Money and Power at the Vaticas, with crazy and horrible details of the Vatican’s bank’s dealings with the Nazis (hat tip Aryt Alasti). Also a review of the book in the New York Times.
- Nerding out on an interesting blog post by Laura McClay, who describes her involvement researching flood insurance (hat tip Jordan Ellenberg). One of my favorite point about insurance comes up in this piece, namely if you price insurance too accurately, it fails in its most basic function, and gets too expensive for those at highest risk.
- There’s a new social network created specifically to get people more involved in politics. It’s called Brigade, and it gets users to answer a bunch of questions about their beliefs. The business model hasn’t been unveiled yet, but this is information that political campaigns would find very valuable. Also see Alex Howard’s take. Could be scary, could be useful.
This is a guest post by Todd Schneider. You can read the full post with additional analysis on Todd’s personal site.
[M]ortgages were acknowledged to be the most mathematically complex securities in the marketplace. The complexity arose entirely out of the option the homeowner has to prepay his loan; it was poetic that the single financial complexity contributed to the marketplace by the common man was the Gordian knot giving the best brains on Wall Street a run for their money. Ranieri’s instincts that had led him to build an enormous research department had been right: Mortgages were about math.
The money was made, therefore, with ever more refined tools of analysis.
—Michael Lewis, Liar’s Poker (1989)
Fannie Mae and Freddie Mac began reporting loan-level credit performance data in 2013 at the direction of their regulator, the Federal Housing Finance Agency. The stated purpose of releasing the data was to “increase transparency, which helps investors build more accurate credit performance models in support of potential risk-sharing initiatives.”
The GSEs went through a nearly $200 billion government bailout during the financial crisis, motivated in large part by losses on loans that they guaranteed, so I figured there must be something interesting in the loan-level data. I decided to dig in with some geographic analysis, an attempt to identify the loan-level characteristics most predictive of default rates, and more. The code for processing and analyzing the data is all available on GitHub.
The “medium data” revolution
In the not-so-distant past, an analysis of loan-level mortgage data would have cost a lot of money. Between licensing data and paying for expensive computers to analyze it, you could have easily incurred costs north of a million dollars per year. Today, in addition to Fannie and Freddie making their data freely available, we’re in the midst of what I might call the “medium data” revolution: personal computers are so powerful that my MacBook Air is capable of analyzing the entire 215 GB of data, representing some 38 million loans, 1.6 billion observations, and over $7.1 trillion of origination volume. Furthermore, I did everything with free, open-source software.
What can we learn from the loan-level data?
Loans originated from 2005-2008 performed dramatically worse than loans that came before them! That should be an extraordinarily unsurprising statement to anyone who was even slightly aware of the U.S. mortgage crisis that began in 2007:
About 4% of loans originated from 1999 to 2003 became seriously delinquent at some point in their lives. The 2004 vintage showed some performance deterioration, and then the vintages from 2005 through 2008 show significantly worse performance: more than 15% of all loans originated in those years became distressed.
From 2009 through present, the performance has been much better, with fewer than 2% of loans defaulting. Of course part of that is that it takes time for a loan to default, so the most recent vintages will tend to have lower cumulative default rates while their loans are still young. But there has also been a dramatic shift in lending standards so that the loans made since 2009 have been much higher credit quality: the average FICO score used to be 720, but since 2009 it has been more like 765. Furthermore, if we look 2 standard deviations from the mean, we see that the low end of the FICO spectrum used to reach down to about 600, but since 2009 there have been very few loans with FICO less than 680:
Tighter agency standards, coupled with a complete shutdown in the non-agency mortgage market, including both subprime and Alt-A lending, mean that there is very little credit available to borrowers with low credit scores (a far more difficult question is whether this is a good or bad thing!).
Default rates increased everywhere during the bubble years, but some states fared far worse than others. I took every loan originated between 2005 and 2007, broadly considered to be the height of reckless mortgage lending, bucketed loans by state, and calculated the cumulative default rate of loans in each state:
4 states in particular jump out as the worst performers: California, Florida, Arizona, and Nevada. Just about every state experienced significantly higher than normal default rates during the mortgage crisis, but these 4 states, often labeled the “sand states”, experienced the worst of it.
If you’re interested in more technical discussion, including an attempt to identify which loan-level variables are most correlated to default rates (the number one being the home price adjusted loan to value ratio), read the full post on toddwschneider.com, and be sure to check out the project on GitHub if you’d like to do your own data analysis.
If you’re anything like me, this week’s announcement that 5 banks – JP Morgan, Citigroup, Barclays, RBS, and UBS – have pleaded guilty to manipulating foreign exchange markets is both confusing and more than vaguely familiar.
It was a classic price fixing cartel, and it went along these lines: these big banks had all the business, being so big, and the traders got on a chat room and agreed to manipulate prices to make more money. The myth of the free market was suspended, and eventually they got caught, in large part because of leaving stupid messages like “If you aint cheating, you aint trying”.
But hold on, I could have sworn that these same banks, or a similar list of them, got in trouble for this already. Or was that LIBOR interest rate manipulation? Or was that for mortgage fraud? Or was that for robosigning?
Shit. I mean, here I am, someone who is actively taking an interest in financial reform, and I actually can’t remember all the fines, settlements, and fake guilty pleas to criminal charges.
I say “fake” because – yet again – nobody has gone to jail, and the banks found guilty have immediately been given waivers by the SEC to continue business as usual. According to this New York Times article, the Justice Department even delayed announcing the charges by a week so those waivers could be granted in time so that business wouldn’t even be disrupted. For fuck’s sake.
But again, same thing as all the other “big bank events” that we’ve grown tired of in the last few years. What it comes down to is fines, but then again, the continued quantitative easing has essentially been a gift of cash to those same banks, so I wouldn’t even count the fines as meaningful.
In fact I’d call this whole thing theater. And really repetitive, boring theater at that, where we all nod off because every scene is the same and they’ve turned up the heat too high.
The saddest part is that, given how very little we’ve improved about the integrity of the markets – I’d argue that we’ve actually gone backwards on incentives not to commit fraud, since now everything has been formalized as pathetic – we are bound to continue to see big banks committing fraud and then not getting any actual punishment. And we will all be so bored we won’t even keep track, because nobody can.
As it turns out, it takes a while to write a book, and then another few months to publish it.
I’m very excited today to tentatively announce that my book, which is tentatively entitled Weapons of Math Destruction: How Big Data Increases Inequality and Threatens Democracy, will be published in May 2016, in time to appear on summer reading lists and well before the election.
Fuck yeah! I’m so excited.
p.s. Fight for 15 is happening now.
I was taught that justice is a right that every American should have. Also justice should be the goal of every American. I think that’s what makes this country. To me, justice means the innocent should be found innocent. It means that those who do wrong should get their due punishment. Ultimately, it means fair treatment. So a call for justice shouldn’t offend or disrespect anybody. A call for justice shouldn’t warrant an apology.
Those who support me, I appreciate your support. But at the same time, support the causes and the people and the injustices that you feel strongly about. Stand up for them. Speak up for them. No matter what it is because that’s what America’s about and that’s what this country was founded on.
I think I will take him up on that suggestion, this morning at Citigroup Headquarters, 399 Park Avenue (near 54th Street) at 10:30am, in part inspired by Liz Warren’s speech from last week. See you there!
I don’t have enough time for a full post today, but if you haven’t already, please watch Liz Warren’s speech from last Friday. She lays out the facts about Citigroup in an uncomplicated way. Surprising and refreshing coming from a politician.
There’s some tricky business going on right now in politics, with a bunch of ridiculous last-minute negotiations to roll back elements of Dodd-Frank and aid Wall Street banks in the current budget deal. Hell, it’s the end of the year, and people are distracted, so the public won’t mind if the banks get formal government backing for their risky trades, right?
Occupy the SEC has a petition you can sign, located here, which is opposed to these changes. You might remember Occupy the SEC for their incredible work in public comments on the Dodd-Frank bill in the first place. I urge you to go take a look at their petition and, if you agree with them, sign it.
After you sign the petition, feel free to treat yourself to some holiday satire and cheer, namely The 2014 Haters Guide To The Williams-Sonoma Catalog.