SOPA and PIPA

Wikipedia, and a growing list of other websites have gone black to protest two bills that are currently making the rounds in U.S. Congress.  The Stop Online Piracy Act (SOPA) in the House, and the Protect IP Act (PIPA) in the Senate.  In an effort to stop online distribution of copyrighted materials, the bills would require website owners to police user contributed materials and block sites that are infringing copyrights.  So service providers and search engines would have to inspect all traffic searching for copyrighted material so they can block it [1, 2].

If Congress can back SOPA and PIPA, what's next?  Will phone companies have to listen in on all phone calls ensure that people don't commit illegal transactions over their phone lines?  Will UPS and FedEx have to inspect every package to ensure that they don't deliver stolen goods?  Will cities have to make sure that contraband is not transported over their streets?  How can something so absurd in other contexts have a chance of becoming law in the Internet context?

And why does this keep coming up on the Internet and technology? Are people so obtuse that once the discussion becomes about the technology, they can no longer follow it?  We had movie theaters changing the aspect ratio of their films so they wouldn't fit well on TVs.  Then we had Disney & Universal suing Sony in 1976 when they introduced the VCR to the U.S.  It wasn't settled until 1984, when the Supreme Court concluded that people could tape broadcasts [3].  And in the 1980s, we have the music labels getting a kickback for each blank cassette tape sold (the same holds for blank CDs) [4].  Then it was the RIAA suing people left and right, claiming they were sharing music over the internet.  And don't forget copyright periods that keep getting lengthened.  Everything to protect the industry and nothing for the consumer.

This makes the members of Congress look like corporate shills for Hollywood and the recording industry.  How is it that the book industry is able to change and adapt to the internet era (sort of), but the recording industry and Hollywood can't?  Are the recording industry and Hollywood now too big to fail too?  If not, why is Congress trying to enact SOPA & PIPA?  Of course, the recording industry shouldn't be happy with piracy, but why don't they fight their own battles?  I guess when you're friends with Congress, it's more profitable to try to force someone else to fight for you.

References:

1. https://blacklist.eff.org/

2. http://en.wikipedia.org/wiki/Wikipedia:SOPA_initiative/Learn_more

3. http://www.ce.org/Press/CEA_Pubs/941.asp

4. http://www.pbs.org/wgbh/pages/frontline/shows/music/inside/cron.html

Fannie and Freddie – Is Dismantling the Answer?

In 1938, the collapse of the national housing market led to the federal government’s formation of the Government Sponsored Enterprise (GSE) known as the Federal National Mortgage Association (a.k.a. Fannie Mae) to help rebuild the market. This was done through the agency’s bearing of mortgage default risk through government guarantees. Subsequently, two additional agencies were established – the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Government National Mortgage Association (Ginnie Mae).

Mortgages are sold by issuing banks to agencies or other organizations. These organizations issue pools backed by specific mortgages. Investors purchase shares of the pools. The shares receive monthly principal and interest payments consisting of the principal and interest payments made to the underlying mortgages minus servicing fees. The loans themselves are the collateral backing the MBS pool.

By buying the loans, the agencies remove the loans from the banks’ books. This transfers prepayment and default risk from the banks to the agencies, and gives the banks the money to make more loans, thus fueling home ownership. The agencies then recoup the money by selling shares of the pools, thus effectively transferring the debt and the prepayment risk back to the market itself. Default risk is retained by the agency.


In the event of a default, the agency has to make good on the principal and is compensated by the proceeds of the foreclosure. The agency incurs a loss if the foreclosure sale proceeds are less than the principal, but incurs no gain if the proceeds are greater than the principal (the excess goes to the homeowner).

When originally formed, Fannie Mae was a government agency. The guarantee it gave was backed by the U.S. government. In 1968, Fannie Mae was converted to a private corporation, largely to remove its liabilities from the federal government’s balance sheet. Nonetheless, its guarantees were considered to be in no danger of failing. The only default considerations applied to MBS pools were of homeowner default, which was only considered to cause prepayment, not losses.

The credit crisis has reversed the status of the agencies. Both Fannie and Freddie held huge volumes of Alt-A and subprime debt. When homeowner default skyrocketed and these positions deteriorated in value, the agencies lost enough to become insolvent. In fact, their 2008 losses were higher than their total profits from 1990 through 2007.  On Sept. 7, 2008, the government stepped in and took ownership of both agencies.

The federal government formed the agencies in the wake of the housing market collapse of 1938. Now, in the wake of the most recent housing market collapse, the federal government is proposing to dismantle the agencies.

Would it not be more prudent to consider returning them to a prior incarnation, where the agencies gave support to the housing market through securitization of conforming loans instead of warehousing subprime debt (which, while profitable at the time, was also urged by the federal government)?

After all, it wasn't the agencies per se that caused the subprime crisis. The fuel was the leverage with which the banks maintained both positions in these loans as well as outright bets on them (synthetic positions).

With the focus on winding down the agencies instead of on overall market and bank risk management, aren’t we taking our eyes off the ball?

More information about the agencies and mortgage debt valuation can be found in my article Analysis of Mortgage-Backed Securities: Before and After the Credit Crisis, which can be found in the new book Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity.

Economic Recovery: The Role of Low Rates and the Housing Agencies

The full article Economic Recovery: The Role of Low Rates and the Housing Agencies is on http://www.tabbforum.com.  It started out as two articles, one on low rates, and one on the role of the housing agencies Fannie Mae and Freddie Mac now that they've gone bankrupt and have been taken over by the federal government.  One must register on the web site to read the article, so I'll reproduce the rest of it here when I have a chance.

Low Rates and Mortgage Debt

The mortgage debt market is the largest debt market in the U.S. Before the credit crisis, the housing market was expanding at a high rate. From mid-2003, when interest rates fell to 5.1 percent, through the beginning of the credit crisis (mid-2008), the debt outstanding grew 63 percent (see the above chart). Since then, it has fallen 4.8 percent. While low rates caused an explosion of mortgage debt, they had little overall impact on corporate and federal debt. Corporate debt has grown slowly and independently from interest rates. Federal debt grew steadily since mid-2001, only to take off due to the government’s attempts to remedy the crisis, growing 41 percent from mid-2008 to September 2010.

The growth in different sectors’ debts gives some insight into the mechanism whereby low rates fueled the economy. While we cannot say that corporations did not benefit from low interest rates, one would have expected their debt to have grown faster with low rates if their borrowing played a major part in fueling the economy through its previous woes (the Internet bubble, the effects of the 9/11 terrorist attack, the 2002 stock market crash, etc…). And, while we do not know exactly what was done with the money borrowed by home buyers and homeowners, the huge growth in mortgage debt does lead one to suspect that homeowners made substantial use of low rates and high home prices to remove a large amounts of equity from their homes.

The large growth in mortgage debt compared to the relatively flat level of corporate and federal debt leads one to believe that the previous economic troubles were largely mitigated through homeowner spending fueled by their use of low rates to leverage the housing bubble.

With the housing market deflated, and banks unwilling to make nonconforming loans, this is unlikely to happen again, as is evidenced by the drop in outstanding mortgage debt since mid-2008.  If this is the case, how exactly will low rates help revitalize the economy today?

More information about interest rates and mortgage debt can be found in my article Analysis of Mortgage-Backed Securities: Before and After the Credit Crisis, which can be found in the new book Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity.

New book - Credit Risk Frontiers

Credit Risk Frontiers is now available on Amazon.  The full title is Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity, edited by Tomasz Bielecki, Damiano Brigo, and Frederic Patras.  I wrote two chapters for the book:

   Counterparty Valuation Adjustments
 
and

   Analysis of Mortgage-Backed Securities: Before and After the Credit Crisis

If you are interested, please pick up a copy and write a nice review!  Thanks.

For reference, here's the table of contents:

Foreword (Greg M.Gupton).
Introduction (Tomasz R. Bielecki, DamianoBrigo, and Frederic Patras).
PART I: EXPERT VIEWS.
CHAPTER 1: Origins of the Crisis and Suggestions for Further Research (Jean-Pierre Lardy).
CHAPTER 2: Quantitative Finance: Friend or Foe? (Benjamin Herzog and Julien Turc).
PART II: CREDIT DERIVATIVES: METHODS.
CHAPTER 3: An Introduction to Multiname Modeling in Credit Risk (Aurelien Alfonsi).
CHAPTER 4: A Simple Dynamic Model for Pricing and Hedging Heterogeneous CDOs (Andrei V. Lopatin).
CHAPTER 5: Modeling Heterogeneity of Credit Portfolios: A Top-Down Approach (Igor Halperin).
CHAPTER 6: Dynamic Hedging of Synthetic CDO Tranches: Bridging the Gap between Theory and Practice (Areski Cousin and Jean-Paul Laurent).
CHAPTER 7: Filtering and Incomplete Information in Credit Risk (Rudiger Frey and Thorsten Schmidt).
CHAPTER 8: Options on Credit Default Swaps and Credit Default Indexes (Marek Rutkowski).
PART III: CREDIT DERIVATIVES: PRODUCTS.
CHAPTER 9: Valuation of Structured Finance Products with Implied FactorModels (Jovan Nedeljkovic, Dan Rosen, and David Saunders).
CHAPTER 10: Toward Market-Implied Valuations of Cash-Flow CLO Structures (Philippos Papadopoulos).
CHAPTER 11: Analysis of Mortgage-Backed Securities: Before and After the Credit Crisis (Harvey J. Stein, Alexander L. Belikoff, Kirill Levin, and Xusheng Tian).
PART IV: COUNTERPARTY RISK PRICING AND CREDIT VALUATION ADJUSTMENT.
CHAPTER 12: CVA Computation for Counterparty Risk Assessment in Credit Portfolios (Samson Assefa, Tomasz R. Bielecki, Stephane Crepey, and Monique Jeanblanc).
CHAPTER 13: Structural Counterparty Risk Valuation for Credit Default Swaps (Christophette Blanchet-Scalliet and Frederic Patras).
CHAPTER 14: Credit Calibration with Structural Models and Equity Return Swap Valuation under Counterparty Risk (Damiano Brigo, Massimo Morini, and Marco Tarenghi).
CHAPTER 15: Counterparty Valuation Adjustments (Harvey J. Stein and Kin Pong Lee).
CHAPTER 16: Counterparty Risk Management and Valuation (Michael Pykhtin).
PART V: EQUITY TO CREDIT.
CHAPTER 17: Pricing and Hedging with Equity-Credit Models (Benjamin Herzog and Julien Turc).
CHAPTER 18: Unified Credit-Equity Modeling (Vadim Linetsky and Rafael Mendoza-Arriaga).
PART VI: MISCELLANEA: LIQUIDITY, RATINGS, RISK CONTRIBUTIONS, AND SIMULATION.
CHAPTER 19: Liquidity Modeling for Credit Default Swaps: An Overview (Damiano Brigo, Mirela Predescu, and Agostino Capponi).
CHAPTER 20: Stressing Rating Criteria Allowing for Default Clustering: The CPDO Case (RobertoTorresetti and Andrea Pallavicini).
CHAPTER 21: Interacting Path Systems for Credit Risk (Pierre Del Moral and Frederic Patras).
CHAPTER 22: Credit Risk Contributions (Dan Rosen and David Saunders).
Conclusion (Tomasz R. Bielecki, Damiano Brigo, and Frederic Patras).
Further Reading.
About the Contributors.
Index.