America’s housing system still has not been properly reformed

I remember listening to an EconTalk podcast (highly recommended!) after the quantitative easing started. Very interesting.

Typically lowering interest rates pushes inflation higher. When your economy is sluggish, that's a good thing, but once it picks up steam, it can cause runaway inflation.

The challenge raised is that there is a delay in the response of the economy. Usually interest rates aren't increased dramatically until inflation is already underway. Otherwise, if you raise rates when the economy is only doing "a little" better, you risk squashing the growth.

So what happens is that inflation starts to go up and by the time the Fed has the balls to really raise rates (because it's plainly obvious the economy is doing well), it's too late and you really overshoot your inflation target which causes rates to rise dramatically.

Overall, I would agree that it seems unlikely interest rates will go up in the near future. However, that can change really quickly.

Back in 1979, the interest rate when up 400 basis points from 10% to 14% in less than a year.

Whatever the implications of letting the debt just "fall on floor" would have been, it's worth noting that the decision to not allow that outcome was reached years before the events themselves. Ben Bernanke's helicopter money speech was at least one demonstration of this.

Thanks didn't know about that, and podcast link is super great!

> The big question is the likelihood of the gamble paying off. For a lotto ticket that's easy to figure.

I agree. The gamble is tricky.

> Now some of the winners of the collapse seemed to have had a firm grasp of the situation. But how would _you_, as an investor, know that? How do you measure that?

Read all the data. Defaults of 4% are expected in the ideal market. Their bet only needed defaults to reach 5% to pay out. Those who started in the game carefully selected from the sub prime mortgages the ones most likely to default after 2 years: the interest only no documentation loans. The real question is why were they able to short the ones more likely to default for the same cost as the ones less likely to default. Those risks were all upfront.

Note that the methods these people used is obvious even with foresight: read the data on the investments, it was all there. The only hard part was the data was 100 pages of fine print. This data was was there and honest, if I gave any investor this data and forced them to read it they would arrive at the same results. Again though, reading the data is a hard job and so most of those who should read it didn't, they just assumed everything was as it was before not noticing the the numbers of no documentation loans was going from few to a majority.

If there was any luck involved it was only that the investors who made money had the idea to one day not read a stock 10-k report and instead read a bond report. There were signs that these guys saw that others didn't, but once they had the idea to look at the data it really is a no brainier.

The only thing I didn't have is enough money to invest (minimum investment is $30 million and that was raised to $100 million quickly), the patience to wait 2 years for it to pay off, the luck to think of the bond market (if I was looking for a great stock in China at the time I might have found something good, but not this great investment in bonds), and the willingness to wade though all these finance documents looking for any that are worth investing on. The last is by far the most important: I find the data boring and so I don't want to analyze it.

Note that the subprime bubble is over. You cannot pull that off today in subprime. Or at least I don't think you can: I haven't looked at the data. Every 10-20 years some opportunity comes up. 3/4ths the battle is the idea to look in the right place, the other 1/4th is to actually understand all the data. There might be something now, there might not. I don't have a crystal ball.

Even if I did, I don't have enough money to ride out the market. As more than one person has said, "the market can remain irrational longer than you can remain solvent". Several of those who made a ton of money nearly went bankrupt holding onto their bets for just the 2 years they knew it would take for them to pay off - and they were right about the 2 year prediction!

> Shorting is a risk. Shorting with big money is a big risk.

Calling it "shorting" suggests the downside was unlimited (as it is when shorting equities). That wasn't the case for this trade.