The Calomiris-Wallison Citation

On page 144, we write, “The financial crisis was not primarily due to Fannie and Freddie.” That sentence is followed by a footnote (77) that refers to an article by Charles Calomiris and Peter Wallison that, in fact, argues that the crisis was due to Fannie and Freddie. (The article title, which we give in the footnote, is “Blame Fannie Mae and Congress for the Credit Mess.”) This is obviously a mistake on our part.

This is what happened. In the final proofs that we were able to review, that sentence used to read: “We do not subscribe to the theory that the financial crisis is primarily due to Fannie and Freddie,” with the same footnote at the end. In that context, it’s clear that we are citing the Calomiris and Wallison article as an example of that theory.

In the final edits, we decided that this “we do not subscribe to the theory” language was unnecessary scaffolding and an unnecessary use of the first person, so we deleted it. The problem is that without the word “theory,” now it superficially looks like we are citing Calomiris and Wallison to support our position. Since the word “theory” vanished from the text, we should have put it in the footnote, as in, “For an example of this theory, see . . .”

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Moody’s, Rating Models, and CDOs

On page 140, we write this:

“In 2004 and 2005, both Moody’s and Standard & Poor’s modified their rating models in ways that made it easier to give higher ratings to CDOs, helping extend the structured finance boom.”

The source for that sentence is a Bloomberg article entitled “‘Race to Bottom’ at Moody’s, S & P Secured Subprime’s Boom, Bust.” The article begins this way:

“In August 2004, Moody’s Corp. unveiled a new credit-rating model that Wall Street banks used to sow the seeds of their own demise. The formula allowed securities firms to sell more top-rated, subprime mortgage-backed bonds than ever before.”

Further down, the article focuses on a rating model introduced in August 2004 by Gary Witt, which shifted from the older “binomial expansion technique” (BET) for modeling diversity in a portfolio of assets to a “correlated binomial” technique, and quotes other sources saying that the effect of the new model was to boost the ratings of CDOs.

Gary Witt is now a professor of statistics and finance at Temple University, and he sent me the following information by email:

  • The new model would have increased the projected losses for AAA CDOs relative to the BET approach, which might have implied lower ratings, but not higher ones.
  • The model introduced in August 2004 was not actually adopted by Moody’s for rating CDOs based on RMBS (residential mortgage-backed securities) or ABS (asset-backed securities, a category that often included subprime mortgage-backed securities).
  • Instead, in 2005 Moody’s adopted the normal copula approach (favored by the investment banks).

So, if Witt is correct (and I have no reason to think he isn’t), the underlying article we used was wrong. There is still the question of what impact the 2005 change to the normal copula approach had. (Felix Salmon has previously criticized this type of model.)

Witt’s opinion is that the new model on balance did not make it easier to give higher ratings for CDOs. The BET had assumptions about independence that were clearly inaccurate by 2005, and the new model was an improvement. Still, Witt acknowledges that it’s not an open-and-shut case, in part because the models take different approaches to measuring correlation. For one thing, introducing a new model induces investment banks to behave strategically and game the new model, so it doesn’t make sense to simply take a given CDO and rate it using the two models; in practice, the banks will create different CDOs that are influenced by the properties of the two models.

So on balance, the sentence at the beginning of this post isn’t supported by the source we cited (at least when it comes to Moody’s).

The Council on Foreign Relations

I was on Wisconsin Public Radio this morning and got a call from a listener suggesting that the problem was that all the key members of the administration are also members of the Council on Foreign Relations. I said that I didn’t think that Summers and Geithner were official members of the CFR (although the general issue that the members of the administration are part of the same Washington establishment in general is a problem). Afterward I looked it up and both of them have had official CFR affiliations in the past.

I still don’t think the CFR is calling the shots, but I was wrong on the facts. Sorry.

Banks and the 10% Deposit Cap

On page 180, we say this:

“Bank of America, JPMorgan Chase, and Wells Fargo all had to be exempted from a federal rule prohibiting any single bank from holding more than 10 percent of all deposits in the country.”

This is not quite right.

We were relying on this passage from a Washington Post article: “Officials waived long-standing regulations to make the deals work. J.P. Morgan Chase, Bank of America and Wells Fargo were each allowed to hold more than 10 percent of the nation’s deposits despite a rule barring such a practice.”

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