Felix Salmon has taken up the task of trying to show where Holman Jenkins goes wrong in his essay on the crisis in financial markets. Since we’re poured out at least a little love for Holman’s essay, we’ll revisit the debate here.
The main point of contention is whether or not Wall Street was engaged in bad faith when it created many of the mortgage backed securities that wound up laying low so many once-mighty financial firms. Jenkins thinks MBS were created by true believers, while Salmon thinks it was more or less a scam.
- If they didn’t believe in it, why did they have so much? Holman makes a powerful argument that the fact that so many Wall Street firms wound up holding huge portfolios of mortgage backed securities is evidence that they didn’t create these things just to dump them irresponsibly on the market.
- The Hot Potato Theory. Felix says that Holman is misreading the evidence. The Wall Street firms intended to get the stuff off their books and into the hands of unsuspecting investors, but the market crashed while they were still holding much of it. In short, they were playing a high stakes game of hot-potato and lost.
Felix doesn’t put forth much evidence for his position except that he thinks every bank on the Street would have claimed to be “in the moving business, not the storage business.” And certainly, some of the mortgage assets Wall Street banks got stuck writing-down were intended to be sold off. And we don’t doubt that this business of moving rather than storing is is what they might have said. But it certainly wasn’t how they behaved at the height of the mortgage market boom.
The strategy of Wall Street banks changed dramatically during the boom. Where once they might have been mainly involved in packaging and marketing mortgage securities, at least by 2004 they ere buying and holding them. Compared to many other investments, particularly after the collapse of the tech bubble and the rise of the real estate market, the return on MBS was just too good. Wall Street firms began taking bigger and bigger positions in MBS. They bought these with leverage, taking massive and aggressive positions.
Now much of this was held in off-balance sheet entities or hedge funds run by the banks themselves. But this was a way of sharing risk with investors, and often the banks or their employees owned large piece of the entities or hedge funds. When prices for some of these MBS began to decline, many these folks saw it as a buying and holding opportunity.
The hot potato story just doesn’t add up. Wall Street went into the business of storage because it thought storage of MBS had become very lucrative. Jenkins is right when he says “Wall Street can hardly be accused of failing to eat its own dog food. It did not peddle to others an investment product that it was unwilling to consume in vast quantities itself.”