Financial Shock: A 360 Degree Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis Hardcover – 9 Jul 2008
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As seen on NBC's Meet the Press, CBS Sunday Morning, CNN's Your $$$$$, CNN's Issue #1, CNBC's Squawk Box, CNBC's Kudlow & Company and Fox Business with Dagen McDowell
"The obvious place to start is the financial crisis and the clearest guide to it that I’ve read is Financial Shock by Mark Zandi. ... it is an impressively lucid guide to the big issues."
-- The New York Times
"In Financial Shock, Mr. Zandi provides a concise and lucid account of the economic, political and regulatory forces behind this binge."
–The Wall Street Journal
“Aggressive builders, greedy lenders, optimistic home buyers: Zandi succinctly dissects the mortgage mess from start to (one hopes) finish.”
–U.S. News and World Report
"A more detailed look at the crisis comes from economist Mark Zandi, co-founder of Moody's Economy.com. His "Financial Shock" delves deeply into the history of the mortgage market, the bad loans, the globalization of trashy subprime paper and how homebuilders ran amok. Zandi's analysis is eye-opening. ... he paints an impressive, more nuanced picture."
--Kiplinger's Personal Finance Magazine
From the Back Cover
“The obvious place to start is the financial crisis and the clearest guide to it that I’ve read is Financial Shock by Mark Zandi. ... it is an impressively lucid guide to the big issues.”
―The New York Times
“In Financial Shock, Mr. Zandi provides a concise and lucid account of the economic, political and regulatory forces behind this binge.”
―The Wall Street Journal
“Aggressive builders, greedy lenders, optimistic home buyers: Zandi succinctly dissects the mortgage mess from start to (one hopes) finish.”
―U.S. News and World Report
“A more detailed look at the crisis comes from economist Mark Zandi, co-founder of Moody's Economy.com. His “Financial Shock” delves deeply into the history of the mortgage market, the bad loans, the globalization of trashy subprime paper and how homebuilders ran amok. Zandi's analysis is eye-opening. ... he paints an impressive, more nuanced picture.”
―Kiplinger's Personal Finance Magazine
“If you wonder how it could be possible for a subprime mortgage loan to bring the global financial system and the U.S. economy to its knees, you should read this book. No one is better qualified to provide this insight and advice than Mark Zandi.”
―Larry Kudlow, Host, CNBC’s Kudlow & Company
“Every once in a while a book comes along that’s so important, it commands recognition. This is one of them. Zandi provides a rilliant blow-by-blow account of how greed, stupidity, and recklessness brought the first major economic crises of the 21st entury and the most serious since the Great Depression.”
―Bernard Baumohl,Managing Director, The Economic Outlook Group and best-selling author, The Secrets of Economic Indicators
“Throughout the financial crisis Mark Zandi has played two important roles. He has insightfully analyzed its causes and thoughtfully recommended steps to alleviate it. This book continues those tasks and adds a third―providing a comprehensive and comprehensible explanation of the issues that is accessible to the general public and extremely useful to those who specialize in the area.”
―Barney Frank, Chairman, House Financial Services Committee
The subprime crisis created a gigantic financial catastrophe. What happened? How did it happen? How can we prevent similar crises from happening again? Mark Zandi answers all these critical questions―systematically, carefully, and in plain English.
Zandi begins with a fast-paced overview and then illuminates the deepest causes, from the psychology of homeownership to Alan Greenspan’s missteps. You’ll see the home “flippers” at work and the real estate agents who cheered them on. You’ll learn how Internet technology and access to global capital transformed the mortgage industry, helping irresponsible lenders drive out good ones.
Zandi demystifies the complex financial engineering that enabled lenders to hide deepening risks, shows how global investors eagerly bought in, and explains how flummoxed regulators failed to prevent disaster, despite crucial warning signs.
Most important, Zandi offers indispensable advice for investors who must recognize emerging bubbles, policymakers who must improve oversight, and citizens who must survive whatever comes next.
- Liar’s loans, flippers, predatory lenders, delusional homebuilders
How the housing market came unhinged, and the whirlwind came together
- Alan Greenspan’s trillion-dollar bet
Betting on the boom, ignoring the bubble
- The subprime market goes global
Worldwide investors get a piece of the action―and reap the results
- Wall Street’s alchemists: conjuring up Frankenstein
New financial instruments and their hidden contents
- Back to the future: risk management for the 21st century
Respecting the “animal spirits” that drive even the most sophisticated markets
Top Customer Reviews
Subprime mortgage is a loan made on the basis of a weak or troubled credit history. Historically it was a peripheral financial phenomenon; a marginal market with few borrowers and lenders, but that changed in 1990s. Mortgage lending companies were not setup as traditional depositories or brokers, but as real estate investment trusts (REITs). It is a corporate form for developers to avoid corporate income taxes. REIT pays out the earnings to shareholders who pay personal income taxes on them. Since they are publicly traded, it avoids regulators. But it comes under SEC which focuses mainly on insider trading, and corporate transparency, and not on mortgage lending. This helped REITs financial mismanagement streak through regulatory cracks. By the time subprime financial shock hit, 35% of the after-tax income was spent on debt obligation (Fig 13.5). The financial benefits of outsized asset price gains have gone almost entirely to higher income households (Table 13.1).
The ripple effect is observed all over economy: The government sold U.S. Treasury bonds to raise cash for the economic stimulus package but the consumers spent the entire check on raising gasoline costs. Saudi Arabia which bought most of these bonds essentially financed the purchase of their own oil!Read more ›
Zandi's prose is crisp, and his style is no nonsense. In the first couple of chapters he does a solid job of summarizing the dizzy pace of change in the mortgage business, from the days of "5-9-2" (though he does not use that expression, the days when Savings & Loans gave 5% interest to depositors on their passbook savings account, loaned it out in mortgages at 9%, and since this was so simple, they were on the golf course at 2 in the afternoon) to the days of complex ARM's (adjustable rate mortgages) and negative amortization (yes, mortgages in which the debt continues to increase). In the next couple of chapters he describes the underlying political background and assumptions which created this latest "bubble.Read more ›
Leaving the omission of assigning the responsibility due too the credit rating agencies, the author works for one, Dr. Zandi tries to write this in an objective tone tracing the beginning of this particular crisis to 1995 with the Clinton's Administration mandate that regulators require lenders to loan to people who could not afford the loans, This is what started this problem! Greed took over from there. And the author shares his opinions on the mistakes in judgment made by Greenspan's Federal Reserve.
Dr. Zandi leaves off on any narrative of the credit rating agencies because he works for one and implies he can not be objective in this area. Which means this book after the initial political decisions which forced lenders to start to make unqualified loans was made will not tell you how it was these very credit agencies that perpetuated and allowed the problem to grow as global large as it did. It is these very credit agencies who have contact with all the financial players and give the ratings to investment vehicles that is a major factor in investors decisions on whether or not to invest. Basically giving the sub-prime product bundles their higher than warranted ratings.Read more ›
Most Helpful Customer Reviews on Amazon.com (beta)
I may have purchased this book anyway. Back in the middle of 2007 when the sub-prime problem first surfaced......I remember a talking head on TV saying the sub-prime issue would not become a problem. His rationale was that sub-prime only represented a single digit percentage of the total mortgage market......and therefore it would have no major impact on financial markets......even if all sub-prime debt went bad. Boy was he wrong!! I have been curious how the sub-prime fiasco almost brought down the entire world financial markets.
Another disclaimer is that I have not personally been involved much with mortgage loans. My first mortgage was back in 1978. It was a 30 year fixed mortgage, and since I only put 10% down, it was mandatory to have mortgage insurance......until my equity reached 20%. I got additional 30 year fixed mortgages in 1980, 1994, and 1995 due to job location changes. In 1999, I got a variable rate loan on a new home.......put 50% down......and then converted to a 15 year fixed rate in early 2007. I also live in Illinois, not one of the national hotbed markets for sub-prime lending.
Zandi says there has been a financial markets panic about every 10 years. He predicts the next one will involve U.S. government debt with all our under-funded liabilities. Other authors have said there is a stock market crisis about every 25 years........because it takes this long for the "burned" generation to retire and be replaced with youngsters who have no memory of the last bubble.
Zandi explains the sequence of the sub-prime fiasco like this:
1. Fed lowered interest rates after 9/11 to stimulate the economy
2. Fed was not worried about creating inflation because the shift in manufacturing to China actually threatened deflation, not inflation
3. With returns on savings accounts being so low, plus the stock market going nowhere after the Tech stock bubble burst.......people chose to invest in their homes
4. Foreign countries could not get decent returns on fixed income investments due to low interest rates......so they chose to buy slightly higher yielding mortgage backed investments
5. Local banks changed from being prudent lenders holding mortgages to simply financial intermediaries driven by loan processing fees. Since they no longer held any mortgages, they didn't have to worry about making sure they were issuing loans that homeowners could really afford.
6. New companies jumped into the mortgage lending market ...with the same motives as the banks. The majority of borrowers did not even realize how risky their new loans were....especially if home prices declined.
7. Wall Street created exotic mortgage backed financial instruments and marketed their higher returns.
8. The Federal Reserve Chairman and all the regulators were asleep at the wheel.
9. Financial rating firms completely missed the boat on how risky these new financial instruments really were.
10. Eventually the music stopped.....there were no people left to keep bidding up the prices of homes. The house of cards came tumbling down.
Zandi points out that sub-prime mortgages peaked at ½ of all mortgage originations.
A way was found to avoid the mortgage insurance if you put down less than 20%. You simply borrowed 80% on the first loan, then immediately took out a 2nd loan for the remaining 20%......apparently mortgage insurance is not required on either the 1st or 2nd loan.
Verification of income also went out the window.
Zandi points out that Americans lead the world in terms of how much housing cost we incur. Americans spend 33% of spending on their homes, while New Zealand spends 25%, France 20% and Japan 14%.
Zandi points out that at the peak of the boom in 2006, foreign investors owned 1/3 of all U.S. mortgages.
Zandi also points out that the price-to-rent ratio is a good bubble indicator.......analogous to the PE ratio in stocks. This ratio has been about 17 the last 25 years......but it peaked at 25 at the height of the boom. For this ratio to return to its 25 year average of 17, national U.S. house prices must drop 25%........and the hottest markets must drop 35%.
The author says the sub-prime bubble is 4 times as bad as the S&L fiasco ($1 Trillion versus $250B).
The author has some recommendations to avoid another sub-prime crisis including:
1. Lenders must verify income and assets
2. Lenders must verify borrowers are able to pay back the loan
3. Mandatory escrow for taxes and insurance
4. Start teaching personal finance in high school
I found the book easy to read and entertaining. However, I got very frustrated with the color coding of his charts. I could not distinguish what the variables were in most of his charts. Maybe he made them in color, and then the black-white conversion process made them illegible.
Given my background, I am shocked at how loose the lending process has become compared to 20 or 30 years ago. As the author points out, everyone in the lending food chain assumed "the other guy" had checked out the quality of the loan made...and in reality nobody checked it out.
After reading about the Tulip bulb and South Seas bubble......plus living through the 1989 S&L crisis, the 2000 Tech wreck, and the 2007 sub-prime fiasco.........this book has help give me a better idea of how to recognize the next financial bubble.
Some of the key indicators of bubbles include:
1. "It's different this time"
2. TV shows and advertisements on speculating including store owners who sell stock instead of their normal goods (Tulip craze), ads showing taxi drivers who quit hauling passengers and day-trade (Tech Stocks), and TV shows dedicated to flipping houses
3. Historic valuation ratios are far exceeded (Tulip bulbs, PE ratios of 100 for Tech Stocks, Price-to-rent ratio for housing)
All in all, I thought the author did a good job of exposing the role of each member in the housing loan food chain had in creating the sub-prime mess.
In this age of full disclosure, it can be noted that I am the author and publisher of the book INDEX MUTUAL FUNDS: HOW TO SIMPLIFY YOUR LIFE AND BEAT THE PROS. This book is an introduction to the concept of index funds is and is sold on Amazon. I am also a contributing author to the book THE BOGLEHEADS GUIDE TO RETIREMENT PLANNING available from Amazon with an estimated release date of October 2009. I have also written 21 short stories on investing which are also available on Amazon.
If you are done speculating in the housing market, these books on conventional stock and bond investing may help you slowly grow more wealthy:
The Richest Man in Babylon
Bogle on Mutual Funds: New Perspectives for the Intelligent Investor
The Millionaire Next Door
The Four Pillars of Investing: Lessons for Building a Winning Portfolio
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, Ninth Edition
The Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get On With Your Life
The Bogleheads' Guide to Investing
The author does a fantastic job of explaining the complexity that evolved in the mortgage market over the last 10+ years. As a result, this book is a plethora of information on how the housing crisis has snowballed into what we are experiencing now.
The author explains everything in detail in an engaging and easy-to-understand narrative that even the most financially illerate person can understand. I would have rated this book TEN STARS if that option were available. "Financial Shock" is an outstanding text!
Now, I did find this to be a very interesting book, one that really opened my eyes on what has been going on, and what is still going on. Admittedly, towards the middle, the book got a little too technical for me, but one cannot look at a problem as broad and deep as this without getting technical somewhere along the line.
If you want to understand how we got to where we are, and what steps we need to take, then you really must read this book. I do recommend it to everyone.
(Review of Financial Shock: A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis)
Most economists agree that the incestuous relationship between credit
ratings companies and bond issuers are a significant factor to the current economic meltdown. Being employed by Moodys, the author could not comment. The cup is about 1/4 full, and I recommend that you wait for a more unbiased opinion.
However, as many of the reviews have noted, there are numerous shortcomings that seriously limit the value of this work. His ten recommendations are in most cases absurdly simplistic (with the exception of revising mar to market rules),e.g. suggesting that people get better education on financial issues. His announcement that the worst is over has also proven to be hopelessly optimistic.
Here are some of the really important questions that Zandi ignores (in the first case intentionally):
1. How could both financial rating agencies (like S&P and Moody's) and CPA auditors completely miss the nature of the correlated risks that were emerging, especially given the repeated use of off balance sheet special purpose vehicles that were much publicized in the Enron collapse?
2. What are the implications of these failures to the Sarbanes Oxley law - has this legislation done anything positive? Or should it be repealed? What are the lessons learned here?
3. In a similar vein, what about the role of GLB ("financial modernization") law and the repeal of Glass Steagle - should this law be re-invoked?
4. What is the new normalcy that we can expect over the next decade? Zandi properly mentions that this crisis is an "inflection point" with long term implications, but he does not give us much of a picture on what the new world will look like.
Bottom line: There is a better choice that is far more prescient. Charles Morris' Trillion Dollar Meltdown - published in early 2008 - answers all the above questions. It is also short and easy for normal people to read with zero economic training. If you just buy one book on this subject, the Morris book is the best one I have yet read, by far.
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