Paul Jorion's Blog

Category: Finance

  • Now that the housing bubble has burst, who’s to blame?

    Blame is flying in all directions: mortgage lenders had stopped bothering whether or not borrowers could repay as they were passing the buck to Wall Street anyway; Wall Street firms were using subprime mortgages of any denomination as innocuous stuffing in Collateralized Debt Obligations (CDOs); regulators failed to curb the worst forms of abuse – that were no longer restricted to unregulated mortgage companies but had become rampant in the whole industry; homeowners, driven by greed, couldn’t be bothered with reading their loan contracts before signing them.

    I’ve got an alternative explanation: each party was following its own well-conceived best … Read the rest

  • The smile in Black and Scholes

    This is a bit of a detective story, a bit of a puzzle. The method is archaeological.
    This morning a colleague of mine sends me an e-mail entitled “importance of correlations.” There are several attachments. One of them is an article by Don Chance entitled “Rethinking Implied Volatility” (*). In it, the author writes the following about the Black-Scholes model for pricing financial options:

    “As we said earlier, the Black-Scholes model produces implied volatilities of traded options that can vary by exercise price for a given underlying asset. How should we respond to such a finding? First, we could suggest

    … Read the rest

  • The Greenspan and Kennedy papers on Equity Extraction from Housing (1990-2006) – A graphic exposition

    The first Greenspan and Kennedy paper (*), published in 2005 provides figures about equity extraction in the US over the 1990 to 2005 period. In the first diagram, the numbers for cash-out extracted at the occasion of refinancing are shown along origination of Home Equity Loans and Lines of Credit. There is no essential difference of course between the two about the way equity is extracted: in both cases the home is used as collateral: cash-out raises the amount of the mortgage, the so-called “first lien” on the house while Home Equity Loans and Lines of Credit establish a “second … Read the rest

  • Please keep quiet Mr. Greenspan!

    Poor Mr. Greenspan: can’t open his mouth without giving investors the heebie-jeebies!
    He promised he would be quiet, just like his predecessor Mr. Volcker was about monetary policy when he himself took over. Even when he only whispers, people pay a lot, a lot of attention, and go into a frenzy of wanting to sell this or buy that. Hear him protest: “What I do talk about are the global forces that are functioning, how the world is running and how the economy is developing, in a manner that I used to do when I was an economic consultant. The … Read the rest

  • Subprime, CDOs and the threat to home ownership

    In a well-documented recent paper (*), Joseph R. Mason of Drexel University and Joshua Rosner of Graham Fisher & Co. ask if a chain of events has not begun unfolding that will end up in a situation where funding for the mortgage industry is massively curtailed. In their paper, Mason and Rosner draw a parallel between the role played presently by subprime loans within Collateralized Debt Obligations (CDOs) and a situation that arose in 2003 leading to the demise of the main collateral types used in those days to enhance CDO credit. These sectors were: manufactured housing, aircraft leases, franchise … Read the rest

  • Where did the housing bubble come from?

    In today’s Wall Street Journal, Andy Laperrière, a managing director of the Washington office of the ISI Group, wrote a piece on the crisis in the mortgage industry, I wrote to the Journal’s editor, the following letter:

    In his “Mortgage Meltdown” (Wall Street Journal, March 21, 2007), Andy Laperrière assigns the residential real estate bubble to the boost to home prices that the subprime market has provided “at the margin.” By that he ignores that housing is segmented and although easier access to the lower part of the market has no doubt contributed at raising prices … Read the rest

  • Malaise in the subprime sector

    In today’s Wall Street Journal, Alex J. Pollock a former President and Chief Executive Officer of the Federal Home Loan Bank of Chicago wrote a piece on the subprime industry, I wrote to the Journal’s editor, the following letter:

    “In his “Credit Crack-Up” (March 12, 2007), Alex J. Pollock offers a perceptive summary of the current malaise in the subprime mortgage industry. Some of his comments however call for qualification.

    1. The risk of “punishing of the innocent along with the guilty”

    Some segment of the subprime industry falls unfortunately under the category of “predatory lending” where the lender … Read the rest

  • The safest financial world of all

    A recurrent theme in Alan Greenspan’s speeches, either when he was head of the board of governors of the Fed or now in his capacity as an invited speaker, has been that the financial world has become in recent years a much more sturdy, much more robust and let’s say it, a safer place, because risk has been redistributed and has essentially found its way to the hands of the investors optimally fit to manage it.

    There are two notions in Greenspan’s statement, neither of which in my mind is true. The first is that risk has been redistributed and … Read the rest