In 1998, the first wave of big subprime profits (Yankee fans should remember Phil Rizzuto commercials for The Money Store) came to a sudden end when subprime lenders lost their financing as investors fled to quality in the wake of Russia's unforeseen default on it's debt and the bailout of Long Term Capital Management.
As it turned out, there were massive default rates by subprime borrowers during the first subprime boom.
Nearly all major subprime lenders went bankrupt before the end of the 1990s. The story of the second subprime boom - during the recent unprecedented housing bubble - had the same ending (with a whole lot of other consequences thrown in)...
Current capital requirements for banks allow for very little bank equity when the credit ratings determine there is very little or no default risk at all, and so the regulators obviously based these requirements on the credit ratings providing correct risk information.
Why? If I was a regulator I would not lose one minute of sleep concerned with the credit ratings being correct, I would only toss and turn about the possibility of these being wrong... and these worries is what I would primarily try to cover for with capital requirements.
As is the current crisis left our banks with no capital simply because they were not required to have any capital against what was ex-ante rated as “not-risky” and “ex-post” turned out to be very risky.
This is an awful crisis, and many are suffering, and so I do think the bank regulators owe us a lot of explanations… and, if they can’t provide us with satisfactory answers, they should be fired and shamed.
PS. Loony bank regulations explained in red and blue! http://bit.ly/mQIHoi
Per Kurowski
A former Executive Director at the World Bank (2002-2004)
Posted by: Per Kurowski | 10 July 2011 at 12:37 PM
You're almost right....in 1998 Phil Rizzuto was our spokesman for National Finance Corp, a subprime mortgage lender. Scooter's time with Money Store was already over by then, but that's what we all remember him for. Within 12 months NFC crumbled.
Posted by: Randy | 31 March 2010 at 11:11 PM