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De Omnibus Dubitandum - Lux Veritas

Friday, January 1, 2010

Methodologies! What are they?

By Rich Kozlovich

The dictionary defines methodology as “a set or system of methods, principles, and rules for regulating a given discipline, as in the arts or sciences.” In short, a methodology is whatever someone says it is.   Let's take a look at this. 

This is the first day of 2010 and I watched a show dealing with the mortgage crisis and CDO’s.  CDO’s are similar to “a regular mutual fund that buys bonds. However, unlike a mutual fund, most of the securities sold from a CDO are themselves bonds, rather than shares. In simplest terms, a CDO is an arrangement that raises money primarily by issuing its own bonds and then invests the proceeds in a portfolio of bonds, loans, or similar assets. Payments on the portfolio are the main source of funds for repaying the CDO's own securities. CDOs have become a notable feature of the financial landscape.” (Nomura Fixed Income Research)

INVESTOPEDIA outlines the CDO mortgage market in this manner. Collateralized debt obligations (CDOs) are a type of structured credit product in the world of asset-backed securities.  The purpose of these products is to create tiered cash flows from mortgages and other debt obligations that ultimately make the entire cost of lending cheaper for the aggregate economy. This happens when the original money lenders give out loans based on less stringent loan requirements. The idea is that if they can break up the pool of debt repayments into streams of investments with different cash flows, there will be a larger group of investors who will be willing to buy in. (For more on why mortgages are sold this way, see Behind The Scenes Of Your Mortgage and Why Are Mortgage Rates Increasing?)

These loans would move from a “mortgage originator” to a “mortgage investor”. “Smaller mortgage originators will often sell their mortgages to large scale originators or aggregators, which pool mortgages together and securitize them into mortgage-backed securities (MBS) through Fannie Mae, Freddie Mac or as private-label securities.” The idea was to make sure that you could create a Triple A rating for that bundle of mortgages. Once they got a Triple A rating they would then sell them all over the world; usually to investors with large amounts of capital but very little understanding of what they were buying. However, this lack of understanding wasn’t exclusive to unsophisticated buyers. Alan Greenspan himself stated in the show that he didn’t understand the complexities of the CDO mortgage market either, and that he just didn’t understand the numbers. The greed involved permeated all levels of the financial world. Although many knew that this couldn’t go on and some made an effort to make this clear to some of the biggest players in the field they continued to cling to the idea that the mortgage market would appreciate six to eight percentage points every year to infinity. Clearly that was insane.

Alan Greenspan was asked; why didn’t they just get out. He claimed that they knew the dangers but thought they were smart enough to get out when it was the right time. Baloney! Greenspan, the moderator and all the people interviewed left out the reason they didn’t get out. They couldn’t. Once they bought into the Community Reinvestment Act (see the subprime pest control link at the end) it became a Catch 22 situation; in for a dime in for a dollar, and in forever.

Since they were in so deep and in forever they refused to see anything else except the potential profits for today. The government forced them into this situation and the government was going to back them through Fannie Mae and Freddie Mac, so they went after the short term rewards without any concern for the long term consequences; after all, they were making tons of money and they had no choice. When you dance with the Devil you won’t call the tune, you won’t choose the dance, you won’t lead, you can’t change partners and you may not be allowed to leave the dance.

What does this have to pest control? While interviewing one of the people who created these Triple A ratings for these mortgage bundles she said she had to get out. She claimed that she obeyed to letter of the law, but ignored to sprit of the law in order to make these bundles Triple A. The company she worked for claimed that these ratings were sound and, among other things, were the result of “rigorous methodologies”.

I keep hearing about the “methodologies” of Integrated Pest Management (IPM) and Green Pest Management (GPM) and I wonder…..what methodologies? There is no such thing. We will inspect a property, recommend a treatment program and then perform the service. That’s it! You can flower it up with a ton of written claptrap…but that is it.

When I hear someone touting “methodologies” I immediately have the desire to check to see if this is a subtitle to the movie The Sting; because someone is trying to feed everyone else a load of horsepucky. Triple A rated horsepucky to promote and sell subprime pest control to an unsuspecting public.  What's worse is that many of the "experts" in our industry have bought into it.  Is there any difference between our "experts" and the "experts" who completely failed in their responsibilities from the lending institutions?  Yes...there is.  They have higher IQ's.   I know, I know...... that's a logical fallacy....I'll bet it's true though. 


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