Subprime Strategies

In my opening essay, “Don’t Panic Yet: A Strategy for Dealing with
the Risk of the Emergence of a Housing Bubble Resulting from the Interdependence of Space and Capital Markets, Fall 2007: Don't Panic Yet, I expressed some concerns about the subprime crisis and suggested the development of a strategy to deal with it. It was part of the decision of the Homer Hoyt Institute’s launching the research roundtable, Research Roundtable of October 2007, on the subject and the ensuing Subprime Crisis Research Program. Preliminary Report on Subprime Crisis Research Program. This blog entry is at least triple my maximum size, but I believe justified as an exception.

Here are some excerpts:

“However, as a relatively new student of the science of networks it seems to me that as with electric power, web communication, and fashion, that some activity goes a long way before it reaches a cascade point, but when it crosses that threshold the system crashes. The behavior of the group, in this case the participants in a local housing market, is an important element in strategy involving the avoidance of a market crisis generated by what is called cascading. The problem is that we don’t have a very good understanding of aggregate market behavior reaching a cascading point, even though we can do pretty well with individual behavior and market behavior continuing on a trend. The great difficulty is in the turning point – and that is what counts…

“…While there does not seem to be much concern that the housing crisis would drive a thriving economy into recession, …we should be mindful that the subprime crisis had an effect on other segments of the capital market; but, we don’t really know what the unfolding impact will be and while it is not prudent to spread an alarm, it is prudent to reduce the risk…
“…The strategy is to mitigate the possibility of a downward spiral in housing prices and the side effect of bringing on a recession. This paper is not focusing on the policies for dealing with the financial crisis as a whole, including preventive measures. That is for parallel work. Rather, the focus is on the avoidance of the financial crisis generating excessive impact on the housing market and the housing market generating an excessive impact on the rest of the economy including the capital market.

“Housing markets are generally local. The strategy is to focus on those housing markets that have the greatest risk of an addition to supply of available housing because of foreclosures or threats of foreclosures. The idea is to keep people in their houses whenever possible.

“The easiest cases are where the homeowner is still employed but living expenses have eroded the discretionary income, and they are faced with an increase in mortgage payments because of a variable rate mortgage, especially teaser rate mortgages. Using such cases as an example, a research program can be designed that would identify the geographical location of defaulted mortgages and mortgages that are high risk.

“Such a study would have an output of market areas that may get substantial increases in supply. Along with such a study would be one that revealed the current oversupply of housing and the trend in local pricing. The result would be the election of a series of markets which are at risk of a bubble. That could be checked against those markets that already experienced high foreclosure rates. The pattern that is likely to emerge is a concentration in a number of states. Some states have already started legislation or other action to help homeowners caught in the problem…

“…A related analysis is to develop model that would indicate when workouts made sense for both the security holder and the homeowner. Lenders may have such models, but buyers are at the risk of asymmetric information. Leveling the playing field may help in getting negotiations that avoid foreclosure.

“Adding foreclosed property to the available supply in an overbuilt market may not help anyone and could do a lot of damage to other homeowners by further depressing prices. The lenders using models may be using micro models that look at the single case without looking at the probability of other lenders taking similar action with the combined result that the oversupply thereby created yields less in proceeds to lenders with numerous mortgages in the area than would be yielded had the market not been further depressed. This is especially true if there is a cascading in the local market.

“The whole idea is to reduce the risk of a cascading price level that would reverberate throughout the local economy and perhaps the national economy in addition to helping homeowners that are in over their heads because they were led astray by aggressive marketing techniques and didn’t realize the risks. The strategy just outlined indicated some ideas for research that are focused on a single housing market. The strategy is to avoid a cancerous decline of prices in the high risk markets, not only because of the impact within the high risk market, but having the price decline metastasize to other local markets.

“While it is true that housing markets are local, there are two ways in which seemingly unconnected housing markets relate to each other. One is that local housing markets are generally tied to their local economies, and not only downturns in local economies affect the local market, but downturns in the local housing market affects the local economies. Further to this line of reasoning, various local economies are linked by their respective economic bases such that depending upon the linkage, what happens in on local economy will generate impacts on its linked other local economies, those from which it buys and those to whom it sells. In a sense, the national economy is a series of linked local economies, some with closer ties than others, but linked. To an increasing extent this is becoming true of selected international economies which may be view as linkages of metropolitan areas.

“A second way in which seemingly unconnected markets relate to each other is through the psychological impact of events. A series of downturns in various local markets will cause some alarm in other markets and may curtail home buying decisions because of the appearance of rising risk. Behavioral science studies show that many people even when told that some event resulting from behavior isn’t necessary typical of most other cases because the behavior is not representative, nevertheless proceed to act on the unrepresentative behavior.

“The series of research projects that may emerge in order to flesh out a strategy for avoiding rampant housing bubbles may be classified in a number of ways. One way is to starts with a national perspective that explores the relationships between a financial crisis and the spread to economic downturn in general as well as to a housing downturn in particular. Such a study would apply the relatively new science of network science and be particularly concerned with emergence.

“The second group of research projects would concern itself with what policies would reduce the likelihood of further downturns in a specific local market. Part of this is relief of hardship for those households directly affected.

“Additionally, part of this may consider reducing the negative impact of the capital market on the local housing market, or put differently looking for measures that would get favorable influences from the capital market. But the focus is on seeing what policies would contribute to averting excessive declines in the local market. Obviously this is through a reduction in would be foreclosures. But, that raises the questions for the next set of research issues. The third set of research issues is highly dependent upon underlying values, or what may be thought of as philosophical views, and matters of law. On the matters of law it is not only existing law, but public policy and changes in law.

“These questions require research in such issues as to how much of the problem is a result of predatory lending and how much is simply poor decision making on the part of borrowers. That, and the criteria used for relief to borrowers will influence the nature of programs to be developed as a matter of strategy. What will the courts enforce when misrepresentations were present in loans with teaser rates? Is the combination of onerous prepayment penalties enforceable if misrepresentations were made? Will it take class action suits to deal with predatory lending results or will state legislators provide relief in staving off foreclosure under certain circumstances?

“This essay is not advocating any particular set of public policies. Rather it is advocating research that would assist public policy decision makers and other participants in the process, borrowers and those on the lending side including mortgage servicers as well as the holders of the mortgages and the derivatives where they exist.

“As this is being drafted, the next series of steps is uncertain, except that the research roundtable that is scheduled within the week of this draft brings together potential researchers and potential funders of research in addition to the Homer Hoyt Institute representatives. The discussion that ensues will likely have on the table a variety of ideas, and the interested parties may explore what questions are critical to get answered in tuning up a strategy…

“Presumably, at some point a white paper, or series of papers, would emerge, authored by and representing a variety of interested parties. Such a paper or compilation would be suitable for wide distribution as an educational service to help people make better decisions.

“Conclusion [-] Some strategies are expected to emerge from the research that is spawned by the forthcoming roundtable. While some strategies will be addressed to institutional change that would avoid recurrence of similar debacles in the capital markets, this essay is focused on avoiding a cascading of foreclosures in some local housing markets. The concern is not only for those directly affected in such markets, but for those to which migration of default would similarly affect other markets, and for the fallout to the economy in general…”


Consilience: A Biological Example -John Khosh


The human body is a good example for demonstrating consilience which implies that what is true for part of nature is true for all of nature. A single set of laws of nature is applicable to all things in the universe, animate and inanimate. The laws of thermodynamic, electromagnetic, gravity etc. are subsets of the single set of laws.

A dynamic and holistic approach is applicable to all biosystems including cells, students and colleges. The phenomena in biosystems are not isolated events, nor stationary. For example, consider health. Our biological system attempts to be self corrective. It is dynamic. As a whole, our health is a matter of degree; and, the degree keeps changing as the biological systems get results from a dynamic process. The tendency is to move toward balance.

Each bodily system is made of organs, which are made up of tissues, which are made up of cells, which are made up of molecules etc. The complexity process in our hierarchical organizations creates some differences in properties in higher layers of organization that may not exist in the lower layer of the system, but the underlying principles are the same for a heart that pumps blood and a water pump in an automobile.

The linked essay Consilience: A Biological Example provides examples from the human body as system, with its various subsystems. The concern is with the wide range of the body’s scale of subsystems that are treated as systems. The synchronization of their dynamic activity is responsible for survival of a biosystem. This biosystem includes the fourteen human's biological systems Synchronization is only possible because of information present in the DNA.

Posted by Maury Seldin on behalf of John Khosh.