Join        Login             Stock Quote

Hubbard On Relative Risk

 January 08, 2013 03:17 PM

Glenn Hubbard was a major academic bank researcher when I was in graduate school, and later he became a Republican stalwart and dean of Columbia's business school. In connection with the lawsuit of monoline insurer MBIA against Bank of America and Countrywide, he recently gave this interesting deposition.

The plaintiffs are trying to prove Countrywide was negligent or even fraudulent in dealing with customers and investors. Hubbard is trying to support the proposition Countrywide did nothing wrong.  I'm kind of torn because on one hand, Countrywide was pushing the envelope of no-income/no down payment loans that made the bubble much greater than it would have been with mere monetary easing; on the other hand, Countrywide bragged about this for years, and their CEO Angelo Mozillo received many honors for expanding the home ownership to minority communities (eg, he won the American Banker's Lifetime Achievement Award in 2006).  What they did was stupid, but it wasn't a secret, and when it was happening it was encouraged by regulators, legislators, academics, community activists, borrowers, and yes, investors.

[Related -Bank Stocks: The Misbegottenness of the Volcker Rule Truly Knows No Bounds]

[Related -JPMorgan Chase & Co. (JPM): Capital Concerns Should Ease In 2014]

The key problem was not something really complicated in the copulas or a misplaced confidence on correlations, it was the assumption that housing prices, nationally, would not fall in nominal value, significantly. This outcome basically was assigned a zero probability, why the correlation assumption was allowed to stand. So, it wasn't really that subtle, but it was pervasive, and as we all now know, terribly wrong.

Anyway, Hubbard's post-mortem defense is that as Countrwide's portfolio did about as well as other lenders, they didn't do anything wrong.  He gets very testy, just as he did in the Movie Inside Job:

Q. You understand your obligation is to answer my questions to the best of your ability, including as the questions change, as they will throughout the course of the day?

 A. I promise to be as nonlinear as you would like me to be.

Around page 48 of the deposition, the plaintiff lawyers try to get Hubbard to admit that all he did was compare Countrywide to other mortgage originators, so if fraud or misrepresentation was pervasive it wouldn't show up in his benchmark comparison of Countrywide performance relative to its peers.  Hubbard tries to have it both ways, saying at various times he didn't analyze underwriting, that he had no knowledge of what other lenders were doing, but also that Countrywide wasn't doing anything wrong because Countrywide's mortgages did as poorly as everyone else's. 

The analysis Hubbard does is pretty straightforward. That he gets paid hundreds of thousands of dollars by many large corporations highlights that they are all paying for his brand name, because his knowledge of mortgage risk is pretty meager. The problem, however, is that everyone who really understands this market is clearly biased, but then, Hubbard is obviously biased too, so in a sense this is all a sham (get a big name to do pedestrian work that is purportedly objective).

Alas, this brings to mind the famous John Maynard Keynes quote, 'worldly wisdom teaches that it is better for the reputation to fail conventionally than to succeed unconventionally.'  If everyone's doing it, it's hard to call this fraud or negligence, criminally defined.  Singling out bankers would be unjust, as these guys were not doing this outside the Matrix (Fannie Mae's DeskTop Underwriter front-end greatly expedited ninja loan underwriting, and they are a product of the Federal Government). So, while I think shaming should go all around, I don't see the point in criminalizing it because then you either fine/jail everyone, or arbitrarily scapegoat some minority group (here, bankers).

The bottom line is that Hubbard's correct in that there is less risk doing what everyone else does, regardless of how good or bad it is. That's why it's essential to have a Bill of Rights, so majorities can't steamroll unpopular minorities.

In any case, risk, in practice, is relative, the theme of my book, The Missing Risk Premium, which curiously implies a zero risk premium in general and a persistent negative premium to assets desired for reasons outside of standard models.

Relative risk means pervasive benchmarking and the importance of tracking error. It can lead to sunspot equilibria when everyone is going crazy like the in the internet bubble. Now, it's easy to say, you should not benchmark, you should target a Sharpe ratio, not an Information Ratio, but most people don't. I think it highlights that there's an easy way to beat the benchmark, avoiding the crowd any sticking with boring investments, but the key is you need sufficient reputation or capital to be able to do this without losing your job, so it's not so easy to do even if you want to.



Post Comment -- Login is required to post message
Alert for new comments:
Your email:
Your Website:

rss feed

Latest Stories

article imageOversold Airline Ready For A Quick Rebound

Trading countertrend moves can be profitable but risky, so it pays to line up as many factors as possible read on...

article imageWhat Is Your Sell Criteria?

Every stock market cycle has its darlings—the stocks investors believe can do no wrong.  I remember 1999 read on...

article imageUS Employment Growth Continued To Slow In April

Company payrolls increased by a lower-than-expected 171,000 last month, the US Labor Department reports–the read on...

article imageMake America Great Again

Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global read on...

Popular Articles

Daily Sector Scan
Partner Center

Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.